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Calculating the cost of chargeback complacency

What happens to businesses that roll over to friendly fraud? Can the risk just be accepted as a cost of doing business? 

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Chargebacks are something of a ‘necessary evil’ for any retail business, cropping up when a customer disputes a purchase or payment. What follows is a predictable pattern: the cardholder contacts the bank to dispute a purchase, their account is credited, and the merchant sacrifices revenue. 

“While chargebacks were intended to protect consumers and boost consumer confidence, the process has become rather one-sided,” explains Nisha Suwali, international partner business director at Kount, an Equifax Company. “Since cardholders often find it easier to contact their bank than the merchant, chargebacks have grown to become commonplace in the ecommerce market. And unfortunately, merchants are bearing the brunt both financially and reputationally.”

Becoming a ‘high-risk’ business

Much of what constitutes first-party fraud is beyond merchants’ control, making its prevalence and unpredictable, highly exploitable nature an especially hard pill to swallow.

Purchasing regret comes with the territory in ecommerce. But the cost-of-living crisis and social pressure to keep up with ever-shortening trend cycles are also contributing to a noticeable spike in the number of people “trying their luck”. According to a study by Juniper Research, the total cost of ecommerce fraud will surpass $48bn (£40bn) in 2023, up from $41bn in 2021, and the vast majority is the result of friendly fraud.

If a merchant attracts a lot of chargebacks, they may be considered a high-risk business and need to find a payment provider willing to take them on

But whether or not disputes are fraudulent, the financial consequences of chargebacks are legitimate. “Yes, merchants lose the revenue from the lost product or service, but they can also incur fees, penalties, and potential fines from the payment processors and card networks – not to mention the operational cost involved in managing the chargeback process,” says Suwali.

Beyond being a time-consuming and labour-intensive process, attendant fees remain non-refundable even if a merchant is able to prove that the chargeback was false.

In any case, if a company’s monthly chargeback-to-transaction ratio is roughly 1% or more, alarm bells will sound out loud and clear for banks. Suwali continues: “When a merchant attracts a lot of chargebacks, they may be considered a high-risk business and could even lose their payment processing privileges. Of course, this can have a lasting and damaging effect on business growth.” 

For firms in the UK and the EEA, the new PSD2 regulation requires merchants to keep their fraud and chargeback basis points low if they want to access exemptions that allow their customers a frictionless experience while shopping online – piling on the pressure in an already challenging environment. 

It begs the question, what can merchants do to ensure that they reduce their number of chargebacks?

A united front

The answer, it would seem, is to adopt a multi-layered approach, starting with strong and direct communication. Suwali flags that online businesses should have impeccable customer service and a clear refund policy to help reduce confusion and encourage customers to approach them with an issue rather than their bank. 

By the time merchants receive a chargeback, days, weeks, or even months may have passed, and it’s usually too late for the company to resolve the dispute with the customer. Although firms may rely on their own systems to reduce the risk of chargebacks at the outset from criminal activity, these efforts in the early part of the transaction cycle won’t stop chargebacks where customers have intentionally set out to challenge legitimate purchases, says Suwali. 

“Fraud is complex and requires businesses to be constantly vigilant,” she adds. “There are multiple types of fraud – and each requires different management strategies. What works against criminal fraud might not be effective against friendly fraud.” 

She suggests bringing in tools that cover the entire transaction cycle from pre- to post-authorisation, including solutions like Kount’s. Technology can assess risk signals such as email addresses, shipping addresses and device IDs to detect and block fraudulent activity pre-authorisation. It’s even possible for businesses to intercept and deflect friendly fraud disputes post-authorisation, communicating directly with the issuing bank and providing real-time data or automated resolutions.

“Although the types of fraud have changed over the years with the increase in online consumerism, the fundamentals of chargeback management remain the same. If a merchant does not have a clear overview of their data and consumer behaviour and are not able to provide evidence to counter a chargeback claim, they will find themselves impacted over and over, financially and reputationally,” warns Suwali. 

Fortunately for merchants, card brands are joining the fight against friendly fraud. Visa recently launched Compelling Evidence 3.0, designed to help merchants reduce the impact of chargebacks. The update is based on the premise that if a customer has made other purchases with the merchant in question and those transactions were not disputed, the current dispute cannot be fraud.

Mastercard Collaboration is a further initiative aimed at resolving cardholder disputes at the early stages of the chargeback process, opening a new line of communication between issuers, acquirers and merchants so disputes can be handled more quickly and with fewer costs. 

For those to work, Suwali adds, merchants will need technology that enables them to compile the information from transactions and send the data to issuers in real time. “Data and analytics are critical to a good chargeback management strategy. By harnessing the power of data, merchants can pinpoint the cause of chargebacks and solve issues at their source.”

For a long time, it has been a matter of the ‘customer is always right’ and, in some sense, that message stands. However, chargebacks no longer have to be ‘just a cost of doing business’. Businesses can and should take a stand. 

For more information, view Kount’s chargeback management solutions.