Chargebacks explained: What they cost you and how to reduce them

What are chargebacks? 

A chargeback is when a consumer disputes a transaction and has the funds returned to their account. They typically occur when the customer believes a transaction was fraudulent, unauthorised, or unsatisfactory. The consumer contacts their bank, which then investigates the claim. If the claim is valid, they will issue the charge back to the merchant, effectively reversing the original transaction. 

Imagine you made a purchase but later discovered that the product you bought was not what you expected, didn’t work or it was a purchase you didn’t make at all. You can then dispute the charge with your bank. Your bank will initiate a chargeback process and investigate the transaction. If the investigation finds that the charge was unauthorised or that there was an issue with the transaction, the funds will be returned to you and your bank will claim the cost of the original transaction from the merchant. 

Why are chargebacks bad for you, as a merchant?

Chargebacks can be a significant burden for merchants as they result in financial losses, are time-consuming, increase costs, and increase the risk of fraud:

• Financial loss. A chargeback results in a direct financial loss for you, as you have to repay the disputed amount and a chargeback fee. Fees vary by acquiring bank, from around $20-$100. This can add up to a significant financial burden, especially for small businesses with a high volume of chargebacks. 
• Time-consuming. The chargeback process can be time-consuming for you as you have to respond to each dispute and provide evidence to support your case. This takes away valuable time and resources away from growing your business and serving your customers. 
• Increased fraud. Chargebacks also increase the risk of fraud, as some consumers may abuse the process to receive free products. Ultimately, if your fraud rates are too high as a merchant it can lead to blacklisting by PSPs.

What causes chargebacks?

By understanding the causes of chargebacks, you can take steps to prevent them from occurring and develop effective strategies for managing them when they do. Here are five common causes:

1. Fraudulent transactions: A customer may dispute a charge if they suspect that their card was used without their authorization, or if they believe that the transaction was fraudulent.
2. Dissatisfaction with product or service: A customer may initiate a chargeback if they are unsatisfied with the product or service they received, or if the product was not as described.
3. Technical issues: Technical issues such as website errors or glitches during the checkout process may result in duplicate charges or incorrect amounts being charged, leading to chargebacks.
4. Processing errors: Processing errors such as incorrect billing information or incorrect transaction amounts can also result in chargebacks.
5. Subscription or recurring billing issues: Customers may forget about recurring subscription charges, or they may dispute them if they believe they were not adequately informed of the terms of the subscription.

Why are subscription businesses more at risk?

For SaaS companies that offer a subscription product with automatic recurring billing and payments, there is a heightened risk of chargebacks that can come about from either:

1. Buyers who do not recognise recurring payments after an introductory offer or free trial for various reasons
2. Buyers who, whilst recognising the business, did not expect to be charged a recurring payment
3. Buyers who recognise the payment and know about the subscription terms but nevertheless claim to their bank that they did not authorise the payment (this is commonly known as ‘friendly fraud’)

It is important to note that all of these give rise to disputes and chargebacks from card issuers, but also, a large proportion of these are categorised by card issuers as ‘fraud’, which impacts a merchant’s fraud dispute rate in the standing of card brands.

How to reduce chargebacks

While it’s almost impossible to reduce chargebacks to zero, you can take steps to reduce how often they happen. 

Here are six best practices from Paddle’s risk team to help you keep your chargeback rate low:

1. Be clear in your statement descriptor. This brief descriptor appears on your customer’s bank/credit card statement. Make sure it is recognizable to your business; they should be able to identify the purchase immediately so they don’t mistakenly initiate a chargeback. If you’re a Paddle customer, you can find more information on changing your descriptor here.
2. Be transparent in your billing terms. Make sure your product pages and pricing pages have clear and obvious information. i.e. If your subscription is set to auto-renew or if your product is related to a number of licences or a set number of devices -  make sure this is clear to the buyer. 
3. Be proactive in refunding suspicious transactions. If you are confident that a payment is fraudulent, it is important to issue an immediate refund. By doing so, you can avoid being charged a dispute fee, prevent your dispute rate from increasing, and avoid the possibility of losing the product or service associated with the payment. If you’re unsure about a transaction, refer to our tips on identifying fraud here and take the necessary action. 
4. Make use of our various transaction notifications. Paddle gives you the option to send a variety of notifications to assist with your buyer communication. Increased buyer communication surrounding billing will help to reduce chargebacks. Pre-Billing Notifications are a card scheme requirement for all subscriptions with a 6-month or longer billing cycle. But are also particularly effective on monthly cycles too. 
5. Make your refund and cancellation policies clear. It is essential to clearly communicate your refund and cancellation policies to customers at the point of sale.
6. Identify and verify your customers. By using captchas or requiring email verification before purchase, you can deter fraudsters from taking advantage of your service. 

How Paddle can help you manage chargebacks

Preventing chargebacks is key to the health of your business. Paddle’s team can help you minimize chargeback risk. What we do for you:

Paddle helps you optimize your comms

The Paddle team offers support and advice to help you avoid chargebacks, guiding and educating you on best practices. This can include everything from explicit billing descriptors, to transparent communication, and prompt customer complaint resolution.

Paddle protects you from fraud

We leverage a combination of human expertise and technology to identify and prevent fraud before it happens. We implement a variety of fraud detection and prevention tools that help to identify high-risk transactions and take action to mitigate the risk of chargebacks. 

Paddle fights your corner

We challenge a chargeback and provide evidence to the card issuer on your behalf to prove the transaction was valid. This must be done within a certain timeframe and requires detailed documentation to support your case. 

Chargeback FAQs

How to calculate your chargeback ratio

You can calculate your chargeback ratio by dividing the number of chargebacks by your total number of transactions for a given period.

For example, if your business had 1000 transactions in a month, and received 10 chargebacks during that time, your chargeback rate would be 10/1000 = 1%.

What is a good chargeback rate?

A good chargeback rate is as close to 0 as possible. In general, a chargeback rate under 1% is considered good for most businesses. If you’re at 1% or higher, it’s likely that you’ll be considered “high risk”. It’s worth noting though that chargeback rates can vary by industry and payment processor.