Chargeback vs refund: what is the crucial difference for your business

Chargeback vs refund: what is the crucial difference for your business

A chargeback is a rightful way to protect a customer from a potential bad quality experience with a merchant. But in the cases of misunderstanding, how can a merchant be protected from a chargeback? Today we will talk about what is a chargeback, why they occur, and how a refund can save the business.

What is a chargeback?

A chargeback itself is a very old concept that originated from a simple return of the purchased goods to its paid value. Today in the world of digital payments, a chargeback becomes an essential option for a customer, as well as something a merchant should be careful about.

It all started around 50 years ago. In 1974 banking institutions implemented a chargeback as a rightful appeal for any consumer that uses a credit or debit card instead of the usual cash or checks. It was done mostly to convince people that a new payment type is secure, as well as promote card payments in general.

A definition of a chargeback is the following: it is money that a banking institution returns to a customer’s payment card after this customer successfully disputes the transaction made for a product or service. Until today a chargeback remains a post-purchase option for any customer.

So in simple words, a chargeback is a return of funds to a customer from a merchant that is facilitated by an issuing bank. The reason for this return of funds can differ quite a lot, from technical issues on the merchant’s website or with the equipment, to delivery problems, poor quality of products, and fraud.

Chargeback reasons

  • Technical errors. A customer might face trouble on the website at the checkout page or the point of sale.
  • Double purchase. Again, a matter of error when a customer accidentally purchases the same product or service multiple times.
  • Wrong purchase. A mistake when customers purchase something they did not mean to.
  • Subscription cancellation or simply a funds withdrawal from an unwanted recurring payment.
  • Product not received. It happens due to a mistake at the dispatch or delivery problem.
  • The wrong product was received, which mostly refers to the processing or dispatch problems.
  • False product presentation. It occurs when a product on the website appears to be slightly or a lot different by its look, functionality, or any other parameter, from a received item.
  • Quality issues. A product does not meet the quality state claimed by a merchant.
  • Fraud. This last reason refers to a situation when a customer exposes fraudulent behavior and simulates one of the reasons to receive money back for the delivered product.

When it comes to statistics, a Midigator’s The Year in Chargebacks survey presents that the summed amount of revenue lost because of chargebacks dropped by almost 14% in the last two years, giving us a 49.8% reduction since 2016.

The most common reason for Visa cardholders’ issue is fraud. With a significant prevalence, fraud disputes take around 77%, while cardholder disputes take a share of only 22%. For Mastercard owners, the situation percentage-wise remains pretty much the same.

In this article, we focus on how a merchant can minimize chargebacks just by improving some aspects of the business: “What is a chargeback?”.

How does a chargeback work?

When a chargeback is initiated it creates a multi-network link between a customer, an issuing bank of a customer, an acquiring bank of a merchant, and a merchant. At first, a customer is demanding a chargeback. This request goes directly to his or her issuing bank. An issuing bank contacts a merchant’s acquiring bank in order to obtain funds and send them to a customer. An acquiring bank takes funds from a merchant account and redirects the amount to an issuing bank, which forwards it back to a customer.

By the way, if you are curious about the nature of merchant accounts, how they work, and what they cost, here we have an article for you: “Why do you need a merchant account and what you need to know”.

Why a chargeback is a threat to your business

A simple repayment of money does not seem to be so dangerous, isn’t it? Unfortunately for merchants, there is so much more to a chargeback than just a funds return. During a chargeback process, a merchant also pays fees to cover the costs of the processing network and fees for the acquiring bank.

In this situation, a merchant is a passive figure, losing a product, the money for it, time, and paying fees to banking institutions. Thus, every chargeback costs so much more than just a simple repayment.

And it is not just that. An acquiring bank always sets up a special chargeback ratio that should not be exceeded. If chargebacks occur too often, a merchant will face at first some extra charges, then can be labeled as a high-risk merchant, and at last, their merchant account can be terminated.

If you would like to be well informed about a high-risk merchant account, check out the article: “What is a high-risk merchant account?”. And if there is a doubt about high-risk business categories, we have this article: “Which industries do banks consider high-risk?”.

Chargebacks vs refunds

With chargebacks causing significant damage to your business, a refund in its forms and ways is the best option to avoid extra fees and potential termination of a merchant account. Here is how a refund differs from a chargeback.

Merchant’s perspective. Replacing a chargeback with a refund is a chance to have back a product that a customer was not satisfied with. Avoiding a chargeback also protects a merchant first of all from huge fees per each dispute, then it keeps a chargeback ratio low, saving a business from getting into the high-risk category, and protecting a merchant account from closing. 

Customer’s perspective. When a merchant is offering a refund, they can present a solution to a customer and maintain a good customer experience. Often, the personal approach may solve the dispute without even returning the transacted money.

Friendly fraud cases. Normally, fraudulent events would be easily spotted in a case of a refund offering and personal contact.

Chargeback prevention

Luckily there is a way to ‘convert’ chargebacks into refunds without involving acquiring banks and issuing banks. There are chargeback prevention alert services on the market that are available for any merchant. Implementation of them makes a business join the service’s network of various bank institutions. 

So, when a customer demands a chargeback, a chargeback prevention alert service receives a notification from the customer’s issuing bank. That’s what happens next. Firstly, a chargeback is being frozen for the next 24 hours. Thus, the merchant’s acquiring bank is not aware of a dispute. Secondly, a prevention service sends a notification to the merchant with the information of a requested chargeback. 

Within the time of a chargeback being on hold, the business has an option to contact a customer and solve a problem on-site, offering a refund, returns, or proposing another solution. With no extra fees from a bank, and no increase of the chargeback ratio involved. If you are curious about one of the services Maxpay offers and trusts, here you go: “What are Ethoca alert services”.

A chargeback prevention alert service protects a business from paying extra fees to banking networks for each dispute, exceeding an established ratio, getting into a high-risk category, and losing a merchant account. And besides that, it is a chance to build a better business reputation, resolving problems personally, and offering a quality customer experience.