What is a chargeback fee: How can you avoid them?

Chargeback fees are penalties that banks or payment processors impose on merchants when they reverse the charges of successfully disputed transactions. Such fees can be a major concern for merchants, especially those that operate online or handle a high volume of transactions. Online payments tend to be more prone to chargebacks due to the card-not-present nature, which limits physical verification and increases fraud risks. Issues like non-delivery, damaged goods, and unrecognised transactions also often lead to disputes. When a customer successfully disputes a transaction and the card-issuing bank reverses the charge, a chargeback is applied.

Managing chargeback fees can be costly, time-consuming, and take resources away from the core activities that grow your business. In this article, we’ll explain what chargeback fees are, how the chargeback process works, common causes of chargebacks, and the associated costs. Most importantly, we’ll share strategies on how to avoid or reduce instances of chargeback fees.

Key takeaways:

• Chargebacks can occur due to fraud, misaligned expectations, merchant errors, and system errors. There are various ways to avoid chargeback fees, such as implementing security measures to prevent fraud, updating your inventory regularly, having clear policies, and providing excellent customer support.

• Consider a dispute management tool that helps you resolve disputes before they escalate into costly chargebacks, which can help you maintain a healthy chargeback ratio.

• A healthy chargeback ratio could help you ‌negotiate for a favourable chargeback fee structure with your payment service provider.

What is a chargeback fee?

A chargeback fee is a penalty imposed on a merchant when a customer disputes a transaction and the bank or payment processor reverses the charge. This fee is imposed to cover the administrative costs associated with managing the chargeback process. Chargeback fees typically range from $15 to $50 per incident. The exact amount can vary based on the payment processor, the nature of the dispute, and the merchant's agreement with the bank.

The cost of chargebacks doesn't stop at the upfront fee imposed on the merchant. It can also include a loss of the original transaction amount, creating a financial double hit. High chargeback rates can damage a business's reputation and lead to increased scrutiny from payment processors and card networks. Over time, this can result in higher processing fees, stricter contractual terms, or even service termination, making chargebacks a critical issue for businesses involved in payment processing.

What is the chargeback process?

Chargebacks are designed to protect consumers against fraud and processing errors. A chargeback fee is applied when a customer disputes a charge and successfully gets it reversed. This process involves the customer’s card-issuing bank, the merchant’s acquiring bank, and the merchant.

Here’s what a typical chargeback process looks like:  

1. Customer disputes transaction The customer contacts the card-issuing bank to dispute a charge on their statement. Common reasons include unauthorised purchases, missing goods or services, or transaction processing errors.

2. Issuing bank initiates chargeback The issuing bank reviews the customer's claim and initiates a chargeback if they find the dispute valid. They'll temporarily credit the disputed amount back to the customer’s account.  

3. Issuing bank notifies merchant’s acquiring bank The issuing bank notifies the merchant's acquiring bank (the bank that processes payments for the merchant) about the chargeback. The acquiring bank then informs the merchant and imposes the chargeback fee.

4. Merchant responses to chargeback The merchant can either accept the chargeback and issue a refund, or dispute it by submitting evidence to prove the transaction’s legitimacy. This evidence may include order confirmations, shipping details, customer communication, etc.

5. Issuing bank reviews The issuing bank reviews the evidence provided by the merchant. They may also request additional information from the customer.

6. Issuing bank decides outcome Based on the evidence, the issuing bank makes a final decision. They either uphold the chargeback (customer keeps the refund) or reverse it (funds are returned to the merchant). In some cases, the chargeback fee may be refunded to the merchant, but it depends on the terms set by the acquiring bank.

What are the causes of chargebacks?

Understanding the various reasons for chargebacks is crucial for businesses to address the underlying issues and reduce the occurrence of disputes. Here are the common causes of chargebacks:

True fraud

True fraud occurs when a criminal uses stolen credit card information to make unauthorised purchases. When the customer realises this, they file a dispute against the charge, starting the chargeback process. True fraud can lead to significant financial losses, including the cost of the goods or services, the chargeback fee, and potential fines from the payment processor.

Friendly fraud

Friendly fraud happens when a legitimate customer disputes a charge despite having authorised the purchase. This might be due to genuine reasons, such as the customer forgetting about the transaction or not recognising the merchant’s name on their statement. In other cases, customers intentionally file disputes to get a refund even though nothing is wrong. Friendly fraud can be just as damaging as true fraud.

Merchant error

Errors made by businesses can also trigger chargebacks. Common mistakes include charging customers multiple times for the same transaction, shipping the wrong items, or failing to deliver goods or services.

Processing errors

Technical glitches or payment system malfunctions can result in incorrect transaction amounts. Examples include duplicate transactions, processing issues, and human error.

Dissatisfaction with goods or services

When customers are dissatisfied with the product or service they receive, and feel their complaints aren't adequately addressed, they may turn to their bank for a chargeback as a last resort.

How to avoid chargeback fees?

The most effective way to avoid chargeback fees is to prevent chargebacks from occurring in the first place. The common causes highlighted above show the importance of having a robust payment system with effective security and fraud prevention measures, and strong customer service to support dispute resolution. With these, businesses can minimise chargebacks and improve overall customer satisfaction:

🟠 Verify the cardholder’s identity to prevent fraudulent transactions

When processing online payments, you can implement security measures to ensure that the cardholder is who they claim to be. For example, the Address Verification Service (AVS) checks if the billing address provided by a customer matches the one on file with the issuing bank. Requiring the Card Verification Value (CVV), a three- or four-digit code on the back of credit and debit cards, confirms that the person making an online purchase has the physical card. These measures add layers of security so that it’s harder for fraudsters to use stolen card information, preventing chargebacks related to true fraud.

🟠 Keep your inventory updated to prevent out-of-stock situations

Accurate inventory management can reduce the risk of shipping the wrong item or failing to deliver on time, which are common causes of chargebacks. Update your inventory regularly to ensure you show accurate stock levels on your website. This way, you can ensure customers only purchase items that are available and prevent out-of-stock sales that could end up in cancellations or chargebacks.

🟠 Clear communication and customer support can help prevent chargebacks

Clear communication can prevent chargebacks by reducing customer confusion. Ensure your business name is easily recognisable on bank statements and avoid using abbreviations or unrelated names. Provide accurate shipping estimates and, if possible, real-time order tracking to help customers monitor their deliveries. For returns and refunds, outline your terms and conditions clearly, such as the eligibility, process, and expected timeline for refunds. Prompt and accessible customer support is crucial. Offer multiple contact options so customers can easily reach out with questions and resolve issues before they escalate into disputes.

🟠 Respond to disputes quickly and professionally

When a dispute arises, a prompt and professional response can increase the chances of winning the dispute and avoiding the chargeback fee. Online payment service providers often have advanced tools and services that you can leverage to help you manage chargebacks. Some providers, like Alirwallex, offer pre-chargeback programmes that notify merchants of disputes, and help you gather evidence of transactions, so you can try to resolve disputes before they escalate into chargebacks.

Chargeback fees and costs

The financial impact of chargebacks extends beyond the initial chargeback fee, often catching merchants off guard with hidden costs that can significantly affect profits. While chargebacks are meant to protect consumers, they can pose a substantial burden on merchants if not managed effectively. 

Direct costs

The most upfront cost of a chargeback is the fee imposed by the payment processor, which typically ranges from $15 to $50 per incident. This fee is dependent on the payment processor and the risk profile of the merchant. Merchants with a history of frequent chargebacks or high chargeback rates can be labelled as “high-risk,” and tend to face higher chargeback fees. Merchants also lose ‌revenue from the original transaction when the disputed amount is refunded to the customer.

Hidden costs

Besides the direct costs, chargebacks come with a host of hidden costs:

• Operational costs: Businesses must dedicate time and staff to handle disputes, gather evidence, and respond to chargebacks, which diverts resources from other tasks.

• Administrative fees: Some payment processors charge additional fees to manage chargeback disputes.

• Loss of merchandise: If the chargeback is tied to a shipped product or delivered service, merchants often lose both the item and the payment. This is especially damaging for those dealing with high-value goods.

• Increased processing fees: High-risk merchants face higher processing rates from payment processors, as they are perceived to have a higher risk of financial loss.

Beyond the financial costs, chargeback fees can damage a business’ reputation and disrupt operations. High chargeback rates can signal to customers and payment processors that a merchant is unreliable or prone to issues like fraud or poor service, eroding customer trust and sales. If chargeback rates remain high, merchants may face stricter consequences, such as fund withholding or account termination. Most payment processors enforce a chargeback ratio threshold, often around 1%. Exceeding this ratio can result in account termination, severely impacting businesses that rely heavily on card transactions.

Securing lower chargeback fees through payment providers

While it’s difficult to avoid chargebacks entirely, there are ways to reduce per-chargeback costs. One way is to negotiate for lower chargeback fees. Payment service providers and acquiring banks often set standard chargeback fees, but these aren’t always fixed. If your business handles a high transaction volume and maintains a low chargeback ratio, you may be well-positioned to request lower fees. To strengthen your negotiation, gather data on your transaction volume, chargeback history, and any fraud prevention measures you have in place. Present this information to your provider to demonstrate your commitment to reducing chargeback risks.

Another strategy is to choose a payment service provider with a favourable chargeback fee structure. Some providers may offer specific programs with lower fees for merchants in industries with traditionally lower chargeback risks, while others may waive fees for successfully disputed chargebacks.

Reduce chargeback fees and protect your finances with Airwallex

Airwallex makes managing disputes and chargebacks for online payments easier by helping you spot and handle issues before they escalate into a charge. We offer a combination of proactive fraud detection, real-time alerts, and dispute management tools.

With advanced algorithms and machine learning, our platform can detect and prevent fraudulent transactions before they are processed, reducing the likelihood of chargebacks caused by fraud. Whenever a suspicious transaction occurs, we’ll send you a real-time alert so you can act quickly, like reaching out to the customer or cancelling the transaction.

Our dispute management tools help you respond swiftly to chargeback disputes, giving you access to detailed transaction data for all cases. You can track disputes, view past cases, and take the actions required on one platform.

Through our pre-chargeback programme, we can help you resolve disputes before they turn into full chargebacks and fees. Based on your pre-configured thresholds, we'll review disputes and automatically accept or reject them. In doing so, we prevent cases from escalating into costly chargebacks, saving you from unnecessary fees and maintaining healthy chargeback ratios.