AN INTRODUCTION TO CHARGEBACKS: THE EVOLUTION OF THE CHARGEBACK PROCESS

Chargebacks can be a challenging and potentially harmful process to businesses, as although originally introduced as a consumer protection tool with good intentions, the ease of the chargeback process completion has led to widespread abuse of the mechanism. We explore how chargebacks came about, how the process has evolved and the impact of chargeback exploitation on merchants.

How did the chargeback process originate?

The 1970s saw the beginning of the widespread use of plastic cards as a payment method. Issuers, mostly Visa and Mastercard, were pushing the use of cards to facilitate payments instead of cash. But people weren’t picking up on the new approach because of consumer fears and concerns. Businesses with less than honest dealings, such as generating false charges, were a cause of concern. Being consumer-friendly was not at the height that it is today. 

Companies and regulators alike started looking for ways to address the issue and provide confidence to consumers, and that’s how the chargeback process came about.

Consumers holding merchants to account with chargebacks

Chargebacks are essentially forced refunds. Prior to chargebacks being introduced, consumers had no recourse to contest receiving an incorrect service or product. If a consumer wasn’t happy with the service or product, they had to rely on the honesty of the business to correct the issue. However, this wasn’t a reliable solution. So, a mechanism was added for consumers to force businesses to return their money, giving consumers a shield to get their money back in cases of disputes or dissatisfaction.

In theory, the idea of the chargeback process was to help consumers feel secure and confident in making purchases using cards. Also, knowing that the consumers had this power, chargebacks kept merchants in check and made them think twice before doing something to upset the consumer. The mechanism was also meant to eliminate fraud. Or at least force merchants to be more aware of fraud and try to combat it.

The evolution of the chargeback process

Did the chargeback mechanism achieve its goal? Yes. Card payments quickly exploded – so much so that 50 years later it’s the number one payment method that is ubiquitous with actually paying money. However, the chargeback mechanism has unfortunately skewed the system that may have been tilted in favour of the merchant previously, all the way in favour of the consumer. This resulted in shortfalls like friendly fraud. Where regular refunds rely on the participation of the merchant, chargebacks force merchants to pay back consumers without active participation.

Key reasons for chargebacks being made by consumers

1. Fraud

In instances where consumers see transactions occur that they didn’t initiate or condone, chargebacks can be processed under the guise of “fraud”. In our experience, what consumers claim to be fraudulent transactions on their cards is more often than not purchases made within their own household without their knowledge or consent, by a child or spouse for example.

2. Consumer dissatisfaction

This occurs in instances where consumers purchase something they don’t receive or that’s different to what they were promised. They have exhausted all attempts to resolve the issue directly with the merchant.

3. Processing errors

Errors in payment processing can include technical issues that result in incorrect payments.

4. Authorisation issues

This is a smaller category because most transactions now occur in real-time. But these can include instances where a merchant completes a payment on a card that’s been reported as stolen, or when a consumer is charged in the incorrect currency.

Reason codes enable consumers to contact their card issuer and express in their own words what has happened with their transaction. But issuers don’t necessarily assign the proper reason code when processing chargebacks. Rather the reason code that requires the least amount of effort from them to successfully process the chargeback request.

The evolution of consumer protection laws all over the world requires issuers to check every instance of chargebacks. Due to limited resources and the volume of chargeback process requests, they can’t conduct a thorough investigation of every chargeback case and still be compliant with consumer laws. So, they choose the easiest way to get their desired result. As such, fraud is the easiest reason code to provide.

The rise of friendly fraud

Friendly fraud is when a consumer requests a chargeback without real justification. They’ve received the goods or services they required without any problems, but abuse the chargeback process for their own gain. Buyer’s remorse is a common reason for friendly fraud, as is when consumers can’t actually afford their purchases. However, the ease of the chargeback mechanism and the human challenge of controlling our impulses is what results in abuse of the system.

Where a legitimate chargeback is requested on a purchase when a consumer had a legitimate grievance that the merchant didn’t address, realising it took less than five minutes to make the request with no one asking for evidence of what happened and still getting their money back is an “aha!” moment for many consumers. Some may think, “maybe I can use this to exploit the system.”

A big spike in friendly fraud is seen during the Christmas period. More often than not, consumers make no attempt to communicate to the merchant, simply because there’s no grievance to resolve. Due to international trade and eCommerce, consumers often don’t see the faces of the merchants they’re purchasing from. It’s a common misperception that every business is this conglomerate that won’t feel the very real repercussions of their chargebacks. It’s assumed that the business has insurance or can recover from the chargebacks quickly.

Chargeback process repercussions for merchants

These activities have repercussions. Here are just some of the ways that merchants can be impacted by the chargeback process:

Merchant penalty fees

When a consumer charges a transaction back there’s a penalty fee for handling the chargeback. This means a merchant is paying twice – first to refund the consumer and then to handle the penalty fee of the chargeback.

Monitoring programmes

If merchants face a large number of chargebacks, they’re eligible to enter monitoring programmes with payment schemes, which can result in significant fines that risk bankrupting their businesses.

Friendly fraud and factors outside the merchant’s control

It’s easily assumed that if a business is receiving a lot of chargebacks, it’s their fault. Maybe they’re an unreliable merchant to purchase from. In our experience, 9/10 times a chargeback is not the merchant’s fault. Either the nature of their business is risky and chargebacks are prone to happen. Or something happens that’s out of their control, resulting in chargebacks (as was seen with the Tourism industry at the onset of COVID-19), or because of friendly fraud.

Account blacklisting 

What consumers don’t realise is that when they abuse the system and commit friendly fraud, someone pays for it. If businesses go bankrupt they’re left with fewer options and places to purchase from as consumers. Additionally, merchants can try to bring the cost of dealing with chargebacks into the price of their offering and ask consumers a lot of questions to try to curb the likelihood of chargebacks. But this just makes the purchasing process more cumbersome.

The future of the chargeback process

We don’t think chargebacks are needed anymore. Do we now need to provide more confidence to consumers that their purchases are protected? The chargeback mechanism needs to be reassessed and amended. We need to create a system where merchants and consumers are at the same level and are working together with acquirers and issuers to create a just system in which merchants can’t abuse consumers and consumers can’t abuse merchants.

This guest post was written by Fibonatix, a leading payment service provider with vast experience in supporting businesses with a subscription-based payment model.