What is chargeback fraud?

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April 18, 2023
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What is chargeback fraud?

Chargeback fraud is a significant challenge for businesses operating in the digital economy. And it's a challenge that's intensifying. Our data finds that 27% of retailers have experienced increased chargeback fraud - otherwise known as friendly fraud or first-party misuse - in the past six months, resulting in millions of dollars in lost revenue and additional expense.

Understanding what chargeback fraud is, how and why it occurs, and what you can do to minimize its occurrence is vital to reduce revenue loss. In this article, we go back to basics to cover:

  • What is chargeback fraud?
  • Why chargeback fraud happens
  • Why is chargeback fraud complex for businesses to identify?
  • How to prevent chargeback fraud

Looking to understand how machine learning and advanced rules can help you prevent chargeback fraud? Find out more about our Fraud detection solution.

What is chargeback fraud?

Chargeback fraud, also known as friendly fraud,  is when a legitimate customer contacts their card issuer to charge back a card purchase, claiming they do not recognize or did not make it. They then keep the goods or benefit from the service purchased without paying for it.

Why chargeback fraud happens

Chargebacks are a vital part of the rules set out by all the major card schemes. They enable customers to ask for the payment they made to you back for a variety of reasons, including, but not limited to, businesses:

  • Failing to deliver the goods or services ordered
  • Providing goods that are defective or not as described
  • Charging the customer the wrong amount or duplicating the payment
  • Making unauthorized transactions

The chargeback rules and processes largely favor the consumer initiating the chargeback. Issuers generally don't require much evidence other than the cardholder's assertion to charge back a transaction. The burden of proof then falls on you as the business, who must prove the cardholder participated in the transaction or received the goods as promised.

Consumers can also use the chargeback mechanism to make fraudulent chargeback claims. These generally fall into two groups, customers that:

  • Deliberately game the system by initiating chargebacks for the goods and services they've received correctly. An example of this would be someone falsely claiming they hadn't received the pair of shoes they ordered.
  • Initiate a chargeback for goods incorrectly ordered or ordered without their knowledge. An example would be someone requesting a chargeback after their child used their card to make in-game purchases.

Learn more: Friendly fraud vs. chargeback fraud

Why is chargeback fraud complex for businesses to identify?

When cardholders dispute charges on their statement, they typically contact their issuer instead of the merchant. However, as you hold the purchase details, issuers often don't have the necessary information to validate cardholder claims. Or prevent payment disputes from becoming chargebacks.

How to minimize chargeback fraud

Here's some helpful advice to help you pick your battles and successfully defend chargeback fraud:

Improve customer communications

Unrecognized transactions are a key driver of chargeback fraud. If the information on customer card statements is unclear, customers are more likely to contact their card issuer. If customers have no way of linking a transaction with your business, it's nearly impossible for them to query it without contacting their issuer.

Ensure the billing descriptor that flows through onto customer statements is clear. Adding the website address could be a memory jogger if you're selling online.

Communicate terms and conditions. This is not only good business practice; it'll also help prevent chargebacks for goods/services not received or not as described at the time of the sale. Include return, refund and cancellation policies. Ensure the frequently asked questions on your website are easy to find and up to date.

Offer a best-in-class service

Provide contact details that are straightforward to find on your site. This will make it easy for customers to resolve queries with you in the first instance.

According to Javelin Research customers bypassed merchants and went directly to their issuer in around three-quarters of cases. However, in more than eight-in-ten cases, contacting the merchant first prevented a chargeback.

There are other ways to offer best-in-class service, which also helps prevent chargeback fraud. Ship goods before charging the customer's card. Let the customer know if goods are out of stock, no longer available, or the delivery will be delayed. Managing the customer's expectations, offering them an alternative or canceling the transaction are all great ways to prevent a complaint from turning into a chargeback.

Following industry best practices if you're part of the subscription economy and offer free trials or introductory promotions.

  • Get express consent from the customer for a regular or recurring payment at sign-up.
  • Offer an easy way to cancel the subscription or payment method each time you bill.
  • Notify customers before each recurring payment and provide a receipt.
  • If it's a trial, add this to the statement descriptor.

Pick your battles

Understand which chargebacks you can contest and the costs of doing so. This may come down to risk appetite. Consider your risk tolerance for disputes. This may differ by sales channel, business line or geography. For example, suppose you operate in a sector with a gap between taking orders and delivering goods. In that case, there's potential for higher chargebacks than in industries with immediate fulfillment.

Providing compelling evidence that the customer participated in the transaction and/or received the goods helps defend chargeback fraud. Configure your internal processes to capture the customer's account order history, clearly showing all transactions. Collect and retain signed delivery receipts from the customer, courier tracking documentation, or the customer's IP address, description, date and time of download, if you sell digital services.

Leverage Strong Customer Authentication rules

The introduction of Strong Customer Authentication (SCA) in Europe is a potential game-changer for preventing chargeback fraud. That's because it shifts liability away from the merchant and onto the issuer. It also encourages merchants to be more diligent with fraud detection and share liability, where the cardholder experience is more important than the liability shift.

It offers a layer of protection for both merchants and issuers against the fraudulent use of accounts. PSPs and banks now guarantee merchants payment for certain successful online transactions authenticated with 3DS2. More importantly, 3DS2 is an opportunity to share more data and help issuers with risk-based authentication provide better experiences at the checkout.

You can find more ways to prevent chargebacks here.

How Checkout.com helps businesses combat chargeback fraud?

Developing a chargeback strategy, pre-empting disputes, and knowing which chargebacks to challenge and the costs of doing so are all ways to protect cash flow, profitability and competitive advantage.

At Checkout we are helping businesses in this area in many ways, including with Fraud Protection Pro.

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April 18, 2023 7:06
April 18, 2023 7:06