By Rich Stuppy

A chargeback happens when a consumer disputes a charge to their debit or credit card with their bank. In many cases, disputes are the result of fraudulent activity. As a result, banks reimburse consumers for the charged amounts: the “chargeback.”

But those disputes are bad news for merchants that are on the hook for the costs, especially as the coronavirus pandemic has accelerated the adoption of eCommerce and mobile payments. Canadians banks have reimbursed customers for more than CAD860 million in fraud-related losses according to the Canadian Bankers Association. And businesses are paying in lost revenue, fees and penalties, operations and more.

So, what can businesses do about chargebacks? First, it helps to understand where chargebacks come from. Essentially, chargebacks are the result of three types of transactions: criminal fraud, legitimate disputes and friendly fraud.

Criminal fraud happens when bad actors use stolen payment information to fraudulently obtain goods and services. Criminal fraud covers a lot of circumstances. Sometimes, it’s straightforward. A bad actor uses a stolen credit card to buy a big-ticket item. Sometimes, it’s more subtle. A bad actor uses stolen payment information to buy gift cards in small, easy-to-overlook denominations to conduct card testing. Either way, the cardholder sees the fraudulent charge and initiates a chargeback.

But chargebacks aren’t always the result of criminal intent or activity. A customer may have a legitimate dispute. For example, maybe an item they purchased was damaged upon arrival. Instead of going to the business, they call their bank or credit card company. Maybe the return or refund policy wasn’t immediately clear, or they couldn’t get a hold of customer service. In a legitimate dispute, the customer may not know their bank will issue a fee to the merchant. They’re just looking for the simplest solution.

Finally, chargebacks may result from friendly fraud, which can take many forms. In some cases, a consumer makes a legitimate purchase but disputes the charge for any number of illegitimate reasons. Maybe a consumer intends to claim that their product never arrived to pocket a refund. Maybe the consumer doesn’t recognize the transaction name on their bank statement. Maybe the chargeback was a result of shared card use, and one cardholder doesn’t recognize a transaction. Friendly fraud can be malicious, but more often than not, there’s been some kind of misunderstanding.

How chargebacks affect businesses
Regardless of the type of transaction that led to the chargeback, businesses and merchants carry the weight of a chargeback’s direct and hidden costs. Direct costs include the cost of the products sold as well as their shipping costs. But chargebacks can also come with fees and penalties. The bigger the order, the higher the fees. And if a business sees a high number of chargebacks, their payment processor may increase fees to offset risks.

Frequent chargebacks also raise a business’s chargeback rate. That rate is the percentage of all purchases that result in a chargeback. When the chargeback rate gets too high — above 0.9 percent for Visa purchases, for example — the credit card company may place the business in a fraud monitoring program. In the program, businesses face much higher fees until they bring their rate below the program threshold.

But those direct costs can trickle down to business operations and introduce costs that are harder to see and quantify. Chargebacks waste labour resources on manual reviews. Fraud analysts have to spend more time reviewing transactions to evaluate their level of trust or risk. And similar to higher processing fees, banks may lower their authorization rates or decline more orders. As a result, merchants can lose revenue from legitimate purchases.

At the end of the day, chargebacks make businesses spend resources on fraud management that they could devote to customers. That leads to higher opportunity and customer acquisition costs. Overall, the greater customer friction and damage to the brand are costs no business wants to manage.

Steps to take
There are practical things all businesses can do to prevent fraud and the chargebacks that come with it. Follow these steps to mitigate criminal fraud, legitimate disputes and friendly fraud.

1. Implement AI and machine learning. The best way to prevent criminal fraud, reduce chargebacks and cut back on manual reviews is a fraud prevention solution. The right solution has a robust data network that uses artificial intelligence (AI), including supervised and unsupervised machine learning, to establish a level of trust or risk for each transaction. If the solution deems a transaction is of high or questionable risk, it can deploy additional measures to confirm the customer’s identity trust level and deter bad actors.

2. Intercept and deflect chargebacks. Some fraud prevention providers partner with credit card processors to help businesses deflect chargebacks. They share transaction data that can help credit card representatives to help customers understand their statements. Plus, a chargeback prevention solution can help businesses avoid penalties, recover revenue, save the sale and retain good customers. Investing in chargeback prevention can cut the time it takes to resolve disputes significantly.

3. Make your business the first stop to resolve customer concerns. Businesses that put time and care into their products should put that same care into the entire customer experience. That may mean evaluating return and exchange policies and using customer communications to advertise how easy it is to return an item or contact support. Businesses will want their customers to go to them to resolve legitimate disputes first, not their banks.

4. Update your documentation. Perhaps one of the easiest ways to prevent friendly fraud is to make sure customers can understand what they see on their bank statements. For example, a parent may authorize a child to make an in-app purchase. But if the parent doesn’t recognize the transaction name on their bank statement, they may go to their bank to claim fraud. Similarly, businesses and merchants can update their product descriptions. If customers don’t think they received what a business advertised, they may go to their bank. Preventing misunderstandings can boost a customers’ overall experience with a business and reduce the business’s chargeback rate.

Rich L. Stuppy is the chief customer experience officer at Kount. For more than a decade, Rich has developed fraud mitigation, compliance and big data strategies. Rich regularly works with executives from all areas of the commerce, payments and fraud prevention ecosystems to discover trends and develop strategies that create value.

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