Everything Your Small Business Should Know About Chargebacks

Key takeaways

• Recognize that a chargeback reverses a card payment through the customer’s bank, not through your business.
• Prevent chargebacks by setting clear return policies, billing after shipping, and keeping product details accurate.
• Watch for friendly fraud, which drives a large share of chargebacks and often goes unnoticed.
• Protect your revenue by disputing invalid chargebacks and cutting the fees and operational costs they carry.

Chargebacks 101

A chargeback is a forced reversal of a card payment. Also known as reversals, chargebacks occur when a cardholder disputes a charge. If the chargeback is approved, the issuing bank reverses the charge, reimbursing the cardholder and debiting the business’s account. Unlike a refund, a chargeback lets the customer bypass the retailer and get their money directly from the card issuer. Chargebacks are a powerful tool for cardholders. At the same time, they are a massive headache for businesses of all sizes.

There is a whole host of reasons people file chargebacks, but the most common ones include:

• Customer dissatisfaction: The customer didn’t receive the items purchased, the products were damaged, or the products were not as described
• Fraud: The cardholder didn’t authorize the transaction or charges were made on a stolen card
• Returns: Cardholder returned merchandise but the business didn’t successfully process the credit
• Processing errors: Transaction was incorrectly billed

How the chargeback process works

A chargeback moves through a few clear steps, from the first dispute to a final decision.

1. The cardholder contacts their bank to dispute a charge.
2. The bank reviews the claim and, if it agrees, reverses the payment and pulls the funds from your account.
3. Your payment processor notifies you of the chargeback and the reason behind it.
4. You can accept the chargeback or respond with evidence that the charge was valid.
5. The bank makes a final decision and either upholds the chargeback or returns the funds to you.

Friendly fraud

Friendly fraud is when a customer disputes a charge they actually made. It turns a consumer-protection tool into a source of loss for businesses. Commonly referred to as chargeback abuse, friendly fraud accounts for nearly half of all chargebacks.

People commit friendly fraud for a lot of different reasons, sometimes unintentionally. For instance, people commonly fail to recognize a transaction they made in the past, a family member may have used their card without their knowledge, and so on. However, people sometimes intentionally commit friendly fraud. They may lie that they never got their product when in reality they did. Whatever the reason, friendly fraud costs businesses big bucks every year.

How chargebacks affect businesses

Chargebacks cost businesses more than the disputed amount. Beyond the chargeback fee, several hidden costs add up:

• Transaction fees: Every time you process a payment, you pay a transaction fee. This fee ranges from 1.5% to 3.5% per transaction.
• Operational costs: A significant amount of time and labor goes into processing each order. It begins with ordering the inventory and ends with shipping it. These costs eat into the revenue from each order, all of which is lost with a chargeback.
• Marketing costs: Considerable marketing budget is typically put towards winning each customer’s business. Every time a sale is reversed due to a chargeback, this money put towards acquiring new customers and keeping old ones is wasted.

Add these up and a single chargeback can cost far more than the original sale, so preventing even a few protects real revenue.

Constant chargebacks can also damage your reputation. You can dispute a chargeback, but the process is long and rarely guaranteed to succeed. A high volume of disputes can even push banks to shut down your account or push card acquirers to cancel contracts. The good news is that there are many ways to prevent this from happening in the first place.

Chargebacks vs. refunds

Chargebacks and refunds both return money to a customer, but they work in very different ways.

A refund is something you handle directly. The customer asks you for their money back, and you return it on your own terms.

A chargeback skips you entirely. The customer goes to their bank, the bank reverses the payment, and you often pay an extra fee on top of the lost sale. A refund keeps you in control, while a chargeback takes that control away.

How to prevent chargebacks

Preventing chargebacks comes down to setting clear expectations and communicating well. These eight steps help you do both:

Chargeback protections have your back

We know that’s a lot of information to digest. But rest assured you can take matters into your own hands to prevent chargebacks and ensure things continue running smoothly.

If you also want your bill pay process to run smoothly, Melio is a great place to start. An accounts payable and receivable tool built specifically for the needs of small businesses, with Melio you can pay how you want while your vendor still gets paid their way, rack up credit card points on payments, increase cash flow, and maintain tight control over your finances. Sign up for Melio today.

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