Chargebacks are an inevitable part of running a business in the modern eCommerce landscape. For merchants, they can be both a financial and operational burden, especially if they occur frequently or unexpectedly. But by understanding the chargeback lifecycle, eCommerce merchants and finance professionals can mitigate damages, reduce risks, and ensure seamless operations.
This blog unpacks the six key stages of the chargeback process, explains why it matters for merchants, and offers proactive strategies to manage disputes effectively.
Why Understanding the Chargeback Lifecycle Is Important for Merchants
A chargeback is a transaction reversal initiated by a customer’s bank (known as the issuing bank) to refund the cardholder. Chargebacks serve as a consumer protection mechanism, ensuring buyers don’t pay for fraudulent or unauthorized transactions. However, chargebacks aren’t always legitimate and can cost merchants significant time and money to resolve, especially when customers misuse them or misunderstand their purpose.
Chargebacks are more than just financial losses; they can damage your reputation, increase your operational overhead, and affect your relationships with banks or payment processors. Furthermore, if your chargeback ratio exceeds industry thresholds (typically 1%), card networks like Visa or Mastercard may penalize your business or label it as high-risk. By understanding the chargeback lifecycle, merchants can respond effectively, protect revenue, and maintain compliance with payment industry standards.
Stage 1: Transaction Occurs
At the heart of every chargeback is the initial purchase. Here’s a breakdown of what happens behind the scenes:
- Authorization: The cardholder’s issuing bank verifies they have enough funds or credit to complete the transaction. If approved, the transaction is authorized.
- Settlement: The acquiring bank (the merchant’s bank) submits the transaction to the card network, which then transfers the funds from the cardholder to the merchant.
While this might seem straightforward, various challenges can arise post-purchase, including:
- Third-party fraud involving unauthorized transactions resulting from stolen payment details.
- Customer dissatisfaction caused by unmet expectations or unresolved complaints.
- Processing errors such as duplicate transactions or incorrect charges.
- Friendly fraud, which occurs when customers dispute purchases they authorized.
Stage 2: Dispute Initiation
The chargeback process begins when a cardholder disputes a transaction. This happens for various reasons, such as claiming they didn’t make the purchase, the product was defective, or the service was unsatisfactory.
- Issuing Bank’s Role: After the cardholder reports the issue, their issuing bank reviews the claim to determine if it’s valid.
- Dispute Timeframes: Customers generally have 120 days from the transaction date to file a dispute, though this may vary by card network and reason code.
Once the dispute is accepted, it moves into the next stage.
Stage 3: Chargeback Filed
After evaluating the cardholder’s complaint, the issuing bank officially files the chargeback with the acquiring bank or payment processor. Here’s what happens next:
- Funds Reversed: The cardholder temporarily receives a refund while the claim is investigated. These funds are deducted from the merchant’s account.
- Notification to the Merchant: The acquiring bank notifies the merchant about the chargeback. This notification outlines the reason code (explaining the customer’s claim) and any required response deadlines.
Stage 4: Merchant Response Representment
Once the chargeback is filed, the merchant has an opportunity to challenge it through a process called representment. Here’s how it works:
- Building a Defense: Merchants collect and submit evidence to prove the transaction was legitimate. This may include sales receipts, tracking information, signed proof of delivery, or communication with the customer.
- Format and Timelines: Evidence must adhere to specific formats and be submitted within a defined timeframe, typically 20–40 days, depending on the payment network.
Timeliness is critical. Missing a deadline can result in automatically losing the case.
Stage 5: Issuer Review & Resolution
The issuing bank carefully reviews the submitted evidence and determines the outcome. There are two possible decisions:
- Chargeback Reversed: If the merchant’s evidence is compelling and valid, the funds are returned to the merchant, and the dispute is closed.
- Chargeback Upheld: If the evidence fails to disprove the customer’s claim, the refund stands, and the merchant must absorb the financial loss.
Stage 6: Arbitration (Optional)
If the chargeback is upheld but strongly contested by the merchant, arbitration is the final step. During arbitration:
- Card Network Mediation: The card network (Visa, Mastercard, etc.) acts as the mediator, reviewing evidence from both the cardholder and the merchant.
- Final Decision: The card network delivers a binding decision, determining which party is financially liable. Arbitration is typically costly and time-consuming, which is why most parties aim to avoid it unless absolutely necessary.
Best Practices to Manage the Chargeback Lifecycle
Being proactive and informed is key to reducing and managing chargebacks effectively. Here are some best practices:
- Prevent Fraud Before It Happens:
- Use fraud detection tools to flag suspicious transactions.
- Require AVS (Address Verification Service) and CVV matching for all online purchases.
- Maintain Clear Policies:
- Ensure your return and refund policies are easy to find and understand.
- Set clear expectations for product delivery, pricing, and shipping fees to prevent misunderstandings.
- Be Responsive:
- Always respond to chargeback notifications promptly to avoid losing disputes by default.
- Submit accurate, well-organized evidence to strengthen your case.
- Monitor Chargeback Metrics:
- Keep an eye on your chargeback ratio and reason codes to identify recurring issues.
- Resolve the root causes of disputes by addressing operational weaknesses.
The chargeback lifecycle may seem daunting, but understanding its stages empowers merchants to protect their revenue and reputation. By focusing on fraud prevention, maintaining clear communication with customers, and responding diligently to disputes, businesses can minimize chargebacks and thrive in the competitive eCommerce landscape.
When it comes to chargebacks, an informed and proactive approach makes all the difference.