Costs in payments – part 3: chargebacks and fraud.
By Marco Conte
Welcome back to our series on costs in payments! Check out our previous posts to learn about pricing models and the different payment fee types applied to online payments. Now that we’ve established the true factors and relationships in payment costs, we can look into the specifics of the category. In part 3 we’ll discuss chargebacks and fraud and their potential costs.
Chargebacks
A chargeback or payment dispute occurs when a customer disputes a charge to their credit or debit card. When this happens, the merchant will have to refund the purchase before going through a lengthy process to prove and validate that charge. Ultimately, if the merchant is able to adequately identify all the necessary data about the transaction, then will they recoup the money originally refunded.
Chargebacks can be stressful as it is the merchant’s responsibility to prove the authenticity of the customer’s purchase. In order to do so, merchants need to provide evidence of authentication, authorization, and approval of the purchase on the customer’s card. Tied with the rise of friendly fraud cases, where users try to take advantage of the process despite their transactions being genuinely authorized, chargebacks are becoming more difficult and time consuming for merchants to dispute.
Chargebacks can due to a variety of reasons, the most common ones can be:
- Unauthorized purchases (frauds)
- Services not provided or goods not received
- Incorrect charges from merchants
- Recurring billing cycles when customer requests cancellations
On a larger scale, chargebacks are a $40 billion issue, often tied with fraud, that impacts every business’s bottom line. From decades of industry experience working with merchants and acquirers on chargebacks, we’ve estimated that for every $100 in chargebacks, the true costs are around $240 in wasted time, fees, penalties, and additional losses of goods and services.
The true cost of an $100 chargeback:
The costs of chargebacks
Now let’s dive deeper into the different aspects that can harm businesses by identifying the true costs of chargebacks:
1. Chargeback fees
While merchants have the ability to refute chargebacks through their acquirer or PSP, they are always accompanied by a chargeback fee. This fee can range anywhere from $15 to $50.
Amongst shop systems popular with Shopify users, chargeback fees vary from $20 for payment methods like cards or Paypal to a range of $10 – $30 for PSPs like Stripe or Adyen. Typically, depending on the PSP used, these fees are non-refundable even if the merchant wins the case.
Things like marketing acquisition costs, shipping costs, operational expenses and reputation damage all add up to a much higher impact than just lost cost of goods sold and tacked on chargeback fees.
When disputing a chargeback there are additional costs and fees applied by card schemes and can result in much higher costs compared to the original transaction.
2. Lost revenue
At the core of every chargeback is an immediate loss of revenue from the original sale. When the chargeback is issued, the original transaction is reversed, meaning the customer is refunded the purchase amount. Unless the charge is validated, businesses are left with a financial void. Additionally, the projected revenue and financial payment consideration and management are disrupted, utilizing wasted time and efforts on the chargeback. From the different allocation of resources, the budget for other strategic activities and focuses have to be consequently reduced. The impact is straightforward yet severe: each chargeback directly reduces revenue, undermining sales efforts and financial projections, ultimately hindering growth and productivity for businesses.
3. Lost merchandise
In many cases of fraud prompted chargebacks, customers decide to keep the merchandise originally shipped. As a result, businesses will not only lose the value of the merchandise but also don’t receive it. This scenario is especially common in cases of fraud or buyer’s remorse, where the customer decides to keep the item but disputes the charge to recover their money. In some cases, even if the merchandise is returned, it’s often not in a condition suitable for resale. Additionally, businesses might have to incur additional costs for shipping and handling penalties to retrieve goods from the customers. Eventually, chargebacks will lead to inventory management complications as disputed items need to be tracked and managed. This makes it challenging to maintain accurate inventory and future stock needs. The uncertainty surrounding returned items can also lead to overstocking or stock shortages, affecting sales and operational efficiency.
4. Lost overdue
While interchange fees are a known cost of doing business, what many merchants may not realize is that in the event of a chargeback, these fees are not refunded. When a customer disputes a transaction and a chargeback is initiated, the merchant not only loses the sale revenue but also does not recover the interchange fees paid to the bank. This double hit exacerbates the financial strain caused by chargebacks, making it crucial for merchants to manage and minimize these disputes effectively. In addition to interchange fees, merchants must also consider the impact of chargebacks on shipping and handling costs. When an order is shipped, the costs associated with logistics, packaging, and shipping are incurred upfront. In the event of a chargeback, these expenses are typically non-recoverable. Whether the product is returned or not, the original shipping costs represent another financial loss that merchants must absorb..
5. Operational costs
Businesses lose operational costs in a variety of ways. When a chargeback occurs, merchants must allocate resources to investigate the dispute. This process involves multiple departments like customer service, finance, and legal teams, leading to increased labor costs and needing to divert resources from other essential business functions. Alongside costs from investigating, businesses also have an administrative burden of managing chargebacks. This can be substantial, requiring dedicated teams and labor.
Chargebacks often stem from customer dissatisfaction and misunderstandings. In order to address these issues merchants also have to allocate and invest more in customer service and training. Additionally, businesses have to contribute more costs towards technology and infrastructure in response to chargebacks. Things like fraud detection systems, chargeback management software, and data security procedures all become essential in minimizing future chargebacks and fraud.
6. High transaction fees
When businesses exhibit a higher number of chargebacks, their risk profile elevates in the eyes of PSPs and acquiring banks. Consequently, businesses will face higher processing fees. To mitigate potential losses, PSPs will charge overall higher fees for businesses with high chargeback rates. Additionally, businesses will also face higher rolling reserve requirements or PSPs will decide to delay payouts and settle less with merchants to reduce their exposure and maintain funds longer. When they have high chargeback rates, businesses may be required to maintain a reserve fund; this is a percentage of monthly sales held back to cover potential chargebacks. Ultimately these costs tie up cash that could be used for other operational needs.
7. Penalty fees
Excessive chargebacks can result in additional penalty fees like non-compliance fees. These are charged for failing to comply with merchant agreement terms, such as maintaining a low chargeback ratio. Another type of penalty fee is an account termination fee: If the chargeback rate becomes too high, the payment processor may terminate the merchant account, often accompanied by a hefty termination fee. Merchants can also enter card schemes’ dedicated monitoring programs where chargebacks are more expensive, risking them from accepting card payments. For a more detailed structure of these programs take a look at Mastercard’s chargeback monitoring program here.
8. Damaged relationships with issuing banks
Issuing Banks are changing scoring logics on merchants (MIDs) when they see an increase in frauds or chargebacks. This leads to lower acceptance rates and genuine customers being declined. This can damage business performance as it requires the direct intervention of payment specialists to discuss strategies and approaches with PSPs while also reaching out to issuers. This task is crucial and challenging, usually requiring plenty of time and effort.
9. Acquirer relationships and terminations
If a merchant receives too many chargebacks in proportion to total transactions, they might be denied their right to process credit card payments by acquirers or PSPs. In these cases, they are placed into a terminated merchant file (TMF) and blacklisted from utilizing similar services. For example they will be flagged into a MATCH list from Mastercard.
Manage chargebacks effectively
Chargebacks pose significant challenges to businesses, impacting both revenue and operational costs. To mitigate these effects, it’s crucial to monitor chargeback activity closely. By defining the true cost of chargebacks—which includes direct financial losses, increased transaction fees, administrative burdens, and potential damage to customer relationships—businesses can better understand the full scope of the issue.
Resources spent on managing disputes could otherwise be directed towards growth initiatives, innovation, and improving customer experiences. These opportunity costs can have long-term impacts on a business’s competitive edge and market position.
To address these challenges effectively, businesses must define a robust chargeback management strategy. This strategy should encompass advanced fraud detection systems, clear communication with customers, efficient dispute resolution processes, and regular reviews of transaction data. Implementing these practices not only help reduce chargebacks but also maintain financial health and operational efficiency.
Learn more on how you can effectively manage chargeback costs by scheduling a call with us today!