Chargebacks—a topic that often causes confusion and frustration among merchants. After all, they can disrupt your business and impact your financials. In this guide, we’ll dissect the chargeback process and discuss its impact on merchants and consumers alike.

Picture this. You’re a business owner, and suddenly you receive a notification from your financial institution about a chargeback due to a merchant error. The product you sold, the service you rendered, and the customer’s payment—all seemingly straightforward transactions—are now under scrutiny. As unsettling as it may sound, this is a common occurrence in the world of eCommerce, and having a reliable merchant account can help mitigate such issues.

Around 625 billion transactions were accounted for credit card payments. On one hand, it’s an easy way for your customers to embrace the convenience of subscription-based services like yours. But this widespread use of credit cards also exposes you to a risk: chargebacks

What are chargebacks, though? Knowing them is crucial because even a single chargeback can quickly compound into multiple lost payments. Plus, more than half of merchants report higher chargeback volumes. 

In this guide, we’ll cover:

  • What are chargebacks, and how do chargebacks on credit cards work?
  • How it impacts subscription-based businesses 
  • Tips for preventing chargebacks
  • action plan for handling any that slip through the cracks

Understanding chargebacks

Online consumer holding a credit or debit card

Chargebacks appear minor at first, but they can become a serious problem. That’s why it’s critical to get a solid understanding of it.

What are chargebacks?

Chargebacks are forced payment reversals when a credit or debit cardholder disputes a transaction with their card issuer. They’re a nightmare for any business, resulting in lost revenue and causing payment processors to terminate their accounts. 

Common reasons for chargebacks are:

  • a subscription service the cardholder forgot about (42% of consumers admitted to forgetting about subscriptions)
  • a charge they didn’t authorize
  • mistaken double-billing or overcharge
  • when goods are not received 
  • or the cardholder receives an item that’s broken, damaged, or not as described. 

If and only if the dispute is found valid, the transaction amount is reversed and withdrawn from cardholder’s account to the merchant’s account. And when it happens, it only means one thing—you’re losing money.

Note: It’s not the same as a “refund,” which is usually a straightforward process. A refund has little to no direct cost besides the refunded amount itself. 

Examples of chargebacks

There are three classifications of frauds in the context of chargebacks. They’re:

  • True fraud which involves stolen card details
  • Friendly fraud which involves the legitimate cardholder mistakenly disputing a real purchase
  • False fraud which involves the legitimate cardholder intentionally disputing a real purchase as unauthorized.

Here are sample scenarios for each classification.

Chargeback due to true fraud

A customer places an order on your online store. The order ships, but a week later, you receive a chargeback notification from the merchant’s acquiring bank claiming the card was stolen and that the purchase wasn’t authorized. This is a strong sign of true fraud.

Chargeback due to friendly fraud

A customer gets charged for a subscription he noticed two payments later. It turns out the customer totally forgot to cancel the subscription after the free trial. This could be friendly fraud. You must communicate with the customer to resolve the issue.

Chargeback due to false fraud

A customer visits your online store and makes a large purchase. A month later, you receive a chargeback notification from acquiring bank claiming the purchase was unauthorized. There’s a chance this is false fraud, especially if the customer signed a receipt or entered a PIN. You’ll need to investigate and provide evidence to the bank to fight the chargeback.

How does a chargeback work?

Let’s break it down.

  1. It all starts when one of your customers disputes a charge on their debit or credit card statement with their bank or credit card provider.
  2. The issuing bank (issuer of the card) evaluates the dispute to determine whether the customer has valid grounds for filing a customer chargeback. The disputed funds are typically deducted from your business account until the dispute is resolved.
  3. If accepted, the bank initiates the retrieval request for evidence that the charge was legitimate—like a subscription agreement, proof of delivery confirmation, or any other supporting documents.
  4. In the absence of solid proof (within the timeframe typically 20 days) to counter the dispute, the customer automatically wins. And the full amount charged is withdrawn from you. But if the bank rules in your favor, the disputed funds are returned to you.
  5. If either party is dissatisfied with the decision, an arbitration process starts. The chargeback dispute goes to the relevant credit card network (like Visa and Mastercard) for a final decision.

But here’s the brutal part: if you lose, your payment processor charges you a chargeback fee, usually between $20-$100. So you’re out of the original charge PLUS an extra fee. There’s also:

  • Cost of goods/services rendered that you’ll never get paid for
  • Shipping/delivery costs if physical products were involved 
  • Subscription fees for the billing period covered
  • Labor costs for dealing with the whole representing process

How do chargebacks impact subscription businesses?

Graph or chart showing the effect of chargeback fees on other data or trends

Chargebacks for unauthorized transactions can result in substantial financial losses for businesses, including the disputed transaction amount and additional fees. It’s essential for businesses to effectively manage and prevent chargebacks to minimize their impact.

So are you asking, “Does disputing a charge hurt the credit card company?” Yes! Here’s a detailed breakdown of how they can wreak havoc:

It disrupts revenue projections

When a customer disputes a charge, the money gets pulled back from your account while the case is investigated. For subscription businesses like yours that rely on recurring revenue, this can complicate your financial forecasting and cash flow. Unpredictable revenue makes it difficult to accurately plan operating expenses, inventory, staffing, and growth initiatives.  

It lowers profitability 

As mentioned, the costs go way beyond just the lost subscription charges and processing fees. Payment processors also closely monitor your chargeback rates. You could face even higher processing fees or account closures if they deem you a “high-risk” merchant due to excessive chargebacks.

It stunts growth

The cumulative effects of chargebacks take a big toll on your subscription business’s growth potential. Resources that could be reinvested into new product development, marketing, and other growth drivers instead are spent fighting chargebacks.

It strains customer relationships

Finally, there’s the customer experience aspect. Chargebacks create super awkward situations with your subscribers. Even if you “win” a chargeback dispute by providing compelling evidence, the truth is you already lost that customer.

The bottom line? Chargebacks aren’t just back-office annoyances. They’re threats that require a holistic prevention and management strategy. The financial impacts are just too severe to ignore.

5 tips to prevent chargebacks

Team discussing how to prevent bank chargebacks

So how can you protect your business against chargebacks? Here are some tips so you can stop the leaky bucket that chargebacks can create:

Tip #1: Be transparent with your subscription terms.

If your customers can’t easily see and manage their subscriptions, expect more “What’s this charge?” remarks. So, clearly spell everything out—subscription pricing, billing dates, auto-renewal policies—multiple times like during signup, in your documentation, and in lifecycle emails. 

Tip #2: Make it easy to cancel 

Look, subscription cancellations are inevitable. When your customers want to move on, make canceling stress-free. Offer seamless cancellation flows and honor them to avoid revenge chargebacks. A smart move is to provide an option for them to leave feedback on why they’re departing.

Tip #3: Double down on fraud protection

Fraudulent credit card transactions are a major cause of chargebacks for subscription businesses. The key is layering multiple fraud protections throughout your checkout funnel so you have various lines of defense against fraudsters. In 2021, over 389,000 cases of credit card fraud were reported to the Federal Trade Commission (FTC).

Tip #4: Represent early and often

If you don’t get your evidence in promptly, they tend to side with the customer by default. So when a first chargeback request does come through, provide compelling evidence ASAP. The sooner you can address it, the better your odds.

Tip #5: Provide excellent customer service

At the end of the day, addressing customer issues early is one of the best ways to prevent chargebacks. So, set clear permissions and workflows for the customer service team to refund, cancel accounts, and update billing information to legitimate customer issues.

Also, consider this: When customers reach out about updating a declined card, your support team needs to be able to quickly retrieve that request, access the payment details, and manually push through the update seamlessly. A top-notch support team is vital in executing a sound dunning strategy.

Tip: If you want to improve customer retention and recover lost revenue with a done-for-you failed payment recovery service, Recover Payments specialists can help. 

How to handle chargebacks

Customer support agent handling payment disputes on merchant's behalf

Handling chargebacks properly is crucial for subscription businesses to minimize losses and prevent recurring issues. Here’s how to handle a chargeback situation:

Time becomes your most precious commodity when a chargeback notification hits your inbox. Most banks have strict timeframes for merchants to respond to chargebacks. So, trigger your representment process and compile all the relevant evidence that proves the charge was legit. 

  • For friendly fraud cases, get in touch with the customer and find a solution that satisfies them. Offer a refund, exchange, or store credit to resolve the issue and potentially prevent the chargeback from finalizing.
  • For clear-cut accidental chargebacks from loyal customers, consider automating instant refunds or credits without formal disputes.
  • For true fraud or false fraud disputes, you’ll need to submit a rebuttal to the bank. This document should clearly explain the transaction’s legitimacy and provide evidence to support your claim.

Throughout the back-and-forth dispute process, stay hyper-responsive to any requests for additional documentation or info. Regardless of who ultimately prevails, approach each incident as a learning experience. Analyze chargeback reasons, identify any problematic payment flows or confusing policies, and iterate your processes continuously to seal those leaks moving forward.

Win the chargeback war

Customer support agent pleased with a successful transaction

While credit cards help subscription businesses thrive, the potential for credit card chargebacks can be a real headache. They can be damaging, so understand customer chargebacks and prevent them. With the tips outlined in this guide, you can tackle them head-on and successfully minimize them to maximize your subscription’s profitability.

Did you know frequent payment failures increase the risk of chargebacks? 

This is because they indicate potential issues with customer accounts or your payment processing system. So, invest in failed payment specialists like the Recover Payments team. Book a free consultation, and let us help you grow your subscription business’s revenue.