How Chargebacks and Refunds Are Different and How to Deal With Them

March 31, 2022 by Irongate Payment Solutions

As the global credit card industry continues to expand, credit card chargebacks have become a significant problem. By 2023, chargebacks will constitute a substantial portion of the estimated $130 billion loss for retailers on account of card-not-present fraud. For perspective, the average chargeback cost is expected to reach $191 by then.

To combat this growing drain on the bottom line, merchants should understand how chargebacks and refunds differ. Retailers should also learn how to prevent chargebacks and dispute them when they occur. By becoming proactive on this troubling issue, retailers of all sizes can stay ahead of the curve.

What is a Credit Card Chargeback?

A chargeback results from a cardholder’s dissatisfaction with a previous credit card or debit card transaction. The purchase typically involves a branded Visa, Mastercard, American Express, or Discover card. The customer disputes the sale and asks their issuing bank to reverse the entire process.

After the card-issuing bank receives the chargeback request, a banking associate evaluates it. The issuing bank interacts with the merchant’s bank (or acquiring bank) to gather more information. In most cases, the acquiring bank asks the merchant to furnish documentation regarding the request.

Sometimes, the merchant can prove that the cardholder approved the transaction. Alternatively, the merchant can show that their products reached the cardholder in good condition and in a timely fashion. If either condition is met, the merchant can dispute the chargeback.

Unfortunately, the chargeback dispute cycle is often a time-consuming process. In addition, the card issuer frequently decides in favor of the customer. If so, the merchant loses the sale proceeds along with the merchandise. To add insult to injury, the merchant must also pay a chargeback fee.

Even if the issuing bank determines that the merchant is correct, the chargeback process is not yet finished. The merchant must wait for 60-90 days to receive their funds. Finally, merchants should know that PayPal purchases are also subject to chargebacks.

Common Chargeback Causes

Chargeback requests were originally designed as a consumer protection mechanism. Some customers believed they were the victim of fraudulent card transactions. In that case, they could dispute the charges with their credit card company (or issuing bank). Today, customers issue a chargeback request for several reasons besides a fraudulent transaction.

1. Different name descriptors

Some companies have a legal business name that differs from their storefront or eCommerce website name. To illustrate, the Mary Smith Corporation may actually do business as the “Top Toy Store.”

As a result, the customer may not recognize the business’ official name on their credit card statement. Because of the different name descriptors, the customer may file a chargeback request to have a sale reversed.

2. Friendly fraud

The term “friendly fraud” applies to non-fraudulent chargeback requests. Friendly fraud encompasses 86% of all chargeback cases. These incidents are especially common in eCommerce “card-not-present” transactions.

This type of chargeback request may arise if the customer considers your products or services to be substandard. Or if they may have been incorrectly billed for the purchase. Alternatively, a fulfillment associate may have sent the wrong products. Some chargeback requests stem from a delivery-related issue.

Certain customers may simply want to avoid the return process. They may not understand what’s involved or regard it as an inconvenience. A store’s return policy may impose strict time limits on customer returns. The customer knows the store will refuse the item because the return period has expired.

3. Fraudulent card transactions

Some customers have unfortunately been the victim of actual credit card fraud. Maybe a thief stole the cardholder’s purse or wallet. The criminal charged multiple items before the cardholder was able to contact their issuing bank.

Large-scale card fraud is also possible. Clever cybercriminals may have hacked into a large retailer’s customer database and obtained customers’ card numbers. Whether they rang up numerous online transactions or used the data for identity theft, the customer was harmed in some way.

How Does the Chargeback Process Work?

A typical chargeback cycle involves a multi-step sequence. The chargeback process can easily take weeks and sometimes months.

1. A customer buys a product from a merchant’s brick-and-mortar store or eCommerce website.

2. The merchant’s payment processor completes the transaction. Afterward, the merchant receives the net proceeds in their merchant account.

3. The customer views the transaction on their credit card statement. They contact the credit card company to file a chargeback request.

4. The customer’s bank (the card-issuing bank) begins the chargeback process. The bank contacts the merchant’s bank (or the acquiring bank). The issuing bank requests documentation that allows the merchant to dispute the chargeback.

5. The issuing bank awaits the acquiring bank’s response. If the bank does not respond, the issuing bank will likely rule in favor of the customer. The bank deducts the transaction proceeds from the merchant’s bank account. The issuing bank returns the funds to the customer.

6. If the merchant’s bank sends the documentation, the issuing bank reviews the evidence. Next, the bank decides whether the chargeback request has merit.

7. If the bank rules in the customer’s favor, it deducts the funds from the merchant’s bank account. The funds are then returned to the cardholder.

8. If the bank rules in favor of the merchant, the customer must submit funds to cover the charge. Alternatively, the customer may choose to start arbitration. Here, the credit card company reviews the chargeback dispute and makes a final decision.

How Chargebacks Impact Merchants

Chargebacks can negatively impact merchants in two ways. First, the merchant is assessed chargeback fees for each disputed transaction. Each payment processor sets its own chargeback fee, which typically ranges between $5 and $50. The merchant often must pay this fee even if they win their chargeback case. Additional fees are also possible.

As an extra insult, some customers game the system to obtain a double refund. In essence, they obtain two refunds for a single transaction. Although the merchant only issues one refund, they maintain financial responsibility for both refunds.

A chargeback request can potentially damage the merchant’s reputation. To illustrate, an unhappy customer may share their story on social media. The resulting negative publicity can seriously affect the merchant’s standing with current and potential customers.

High-risk merchant accounts

The merchant’s chargeback ratio determines the next step. Some unfortunate retailers show a high percentage of chargebacks vs their processing volume. These merchants will likely be forced into a chargeback management program.

Here, the merchant’s acquiring bank and card networks require them to open a high-risk account. This lower-tier merchant account often requires payment of a stiff induction fee and higher processing fees. To make matters worse, many payment processors do not deal with high-risk merchants.

What is a Retail Refund?

A retail refund accurately describes a refund from a retail store. The merchant issues the refund after the customer returns a product they have previously purchased. Regardless of the reason, the customer must comply with the store’s refund policy.

The merchant often outlines this refund policy on their website’s FAQ Page (or Frequently Asked Questions page). For example, the customer may need to show a receipt and meet certain time limits to receive the refund.

Refunds are a drain on a business’s bottom line. In addition, the merchant likely considers them a hassle to process. However, credit card associations do not monitor a merchant’s refund occurrences.

How do refunds work?

The refund process is simple and straightforward. A customer decides they don’t want a previously purchased product. Maybe the product was of substandard quality or it did not perform as advertised.

Perhaps the customer ordered the product from an eCommerce merchant. The online retailer’s fulfillment service may have sent damaged or incorrect merchandise. Alternatively, maybe the product delivery took an unusually long time.

When the customer brings the product back to the store, the merchant carefully inspects the item. If they agree to the return, they will refund the amount paid or credit the customer’s account.

However, the merchant can refuse to accept the return. If the refund time limits have expired, the merchant is adhering to the store’s refund policy.

Chargebacks vs. Refunds: Key Differences

In the retail environment, dissatisfied customers use refunds or chargebacks to negate previously made purchases. Both methods essentially produce the same end result. However, comparing chargebacks vs. refunds produces several major differences.

1. The main difference between the two processes is the path the customer travels to get the desired result. With a chargeback, the customer contacts their issuing bank to begin the chargeback process. With a refund, the customer contacts the merchant directly to receive their money back.

2. The chargeback and refund resolution periods also differ. The Visa, Mastercard, American Express, and Discover card associations give each cardholder 120 days to initiate a chargeback request. The clock starts on the transaction’s actual effective date. In contrast, the merchant’s refund policy determines the refund request time limit. Resolving a chargeback request typically takes between 60 and 90 days. Refunds are usually resolved within seven business days.

3. Each credit card association tracks merchants’ monthly chargeback numbers along with their chargeback rate. Ideally, merchants should stay below 100 monthly chargebacks. In contrast, credit card associations have nothing to do with individual merchants’ refund policies.

How to Prevent and Fight Chargebacks

Regardless of their cause, chargebacks create financial and reputation problems for small- and medium-sized businesses. View these strategies that can help to prevent or reduce the number of chargebacks that occur.

Chargeback prevention guidelines

• Create well-defined business policies (including return policies)

• Provide clear product pricing information for customers

• Maintain PCI compliance to ensure customer data security

• Adhere to recommended credit card acceptance standards

• Require thorough debit card verification

• Ensure that credit card statements contain the correct business name

• Urge customers to contact the business directly to resolve issues

Chargeback dispute guidelines

• Maintain complete transaction documentation

• Take steps to combat friendly fraud

• Know the merchant services provider’s chargeback process

How to Minimize and Manage Refunds

Merchants can take several steps to minimize legitimate customer refunds.

• Selling high-quality products means customers are less likely to return them.

• By offering superb customer service, store associates can resolve potential customer disputes before they escalate.

• Ecommerce retailers should utilize a top-tier delivery service. By making that commitment, customers’ packages are more likely to arrive safely during the specified period.

• Merchants can ask their payment processor to choose a more accurate store descriptor. This should help to eliminate confusion that could result in a refund or chargeback request.

Reducing Friendly Fraud Incidents

Retailers can also use the following strategies to decrease friendly fraud occurrences.

• The merchant should always ask for the cardholder’s card verification number. Using an address verification system (or AVS) is also helpful.

• Ecommerce merchants should eliminate their online store’s guest checkout function. By requiring user log-ins, merchants can more easily track customers’ purchases.

• Ecommerce retailers should also install fraud management filters that track suspicious card purchases from unconfirmed locations.

• Brick-and-mortar and eCommerce merchants should send all customers a post-purchase discount or gift. If the user claims this item, they probably won’t be able to prove their original purchase was unauthorized and/or fraudulent.

• Finally, refund prevention policies are a step in the right direction.

However, merchants should also publicize their easy, stress-free refund policies. Ideally, customers will utilize this option instead of more costly, time-consuming chargeback requests.

Partner With the Right Merchant Services Provider

A small business-friendly merchant services provider can help you resolve payment issues like chargebacks more seamlessly. Irongate Payment Solutions has received industry recognition for its excellent customer and technical support services.