Take the fictional case of Freddy who is reeling from a string of puzzling chargebacks levied against his online fishing photo business. First there is the credit card chargeback from John who apparently claimed never to have received the beached big mouth bass poster he ordered, even though it was indeed sent. Then, there is the chargeback from Sally who booked a non-refundable photo-shoot for her daughter’s 10th birthday fishing boat party but then didn’t show at the dock. Steve got the skiing shark photo he ordered, but claimed it was supposed to be a juggling jellyfish and called his credit card company instead of Freddy—yet another chargeback. Anthony, he uploaded a photo of himself into the “Put Your Face on a Fish” designer on Freddy’s website and bought 6 copies, yet he told his bank the debit was never authorized. And, Susan has been a long time Catch of the Quarter subscriber, but according to her chargeback report (and unbeknownst to Freddy) she canceled her subscription 6 months (and 2 fish photos) ago and wants a refund. By Freddy’s count, he’s on the hook for 5 chargeback fees (at $25 each), $2000 deducted directly from his bank account, and $2000 in lost time and inventory.

What is a poor fishing photographer to do?

Assuming that Freddy was completely above board in all of these transactions– shipping product on time, sending the correct items, clearly disclosing cancellation and return terms and conditions, and properly obtaining transaction authorizations—then he is the unfortunate victim of friendly fraud.

Also known as chargeback fraud, friendly fraud occurs when a consumer purposely makes a claim to their bank or credit card issuer with the aim of getting an undeserved refund. It may not get the press associated with major breaches of credit card data, it may not have the cloak-and-dagger drama of rings of foreign criminals committing large-scale bank fraud, and it may not spark the type of consumer outrage that stolen credit-card shopping sprees do. However, all those types of fraud typically result in losses for card issuers, not the merchants who get caught-up in the fraud. Friendly fraud has a hugely disproportionate impact on merchants, and particularly small merchants who cannot afford to (or do not even have the opportunity to) defend themselves against these duplicitous claims.

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Friendly Fraud Statistics

Friendly Fraud is most likely to occur in Card Not Present (CNP) environments such as e-commerce and Mail/Telephone ordering (MOTO), though it does on occasion affect Card Present (CP) merchants as well. And, according to recent studies, the friendly fraud statistics are alarming:

  • Visa estimates $11.8 billion was lost to friendly fraud in 2012, and is growing at 41% annually (source)
  • A Global Risk Technologies report (based on EU data) estimates that:
    • 86% of chargebacks are fraudulent, and that many consumers bypass merchants to directly file complaints with card-issuing banks.
    • Only 14% of cardholders contact merchants prior to charging back
    • 58% of cardholders do not contact the merchant at all – filing the dispute directly with the bank
    • 40% of consumers who file a fraudulent chargeback will do it again within 60 days.
      (Another report puts it at 50% within 90 days)
  • A Kansas City Federal Reserve report found that merchants prevail in only 20-30% of chargebacks they defend.
  • Credit card chargebacks are rising at a rate of 20% per year, and friendly fraud rose 41% over the last two years. (source)
  • According to the LexisNexis 2016 True Cost of Fraud report, “This year, every dollar of fraud cost merchants $2.40, up from $2.23 a year ago.”
  • Chargeback.com uses the Lexis Nexis data, in addition to other data, to calculate that Ecommerce will lose $6.7 billion in 2016 to fraud, and that 71% of that ($4.8b) will be due to friendly/chargeback fraud.

 

Why Legitimate Chargebacks Help Small Businesses

Fraud in general is growing, and fraud leading to chargebacks is a problem for businesses of all sizes. (For example, the Lexis Nexis report found that large e-commerce merchants lost 1.39% of their revenues to fraud in 2015, compared to 0.6% of their revenues in 2012.) And, one of the biggest drivers for consumer adoption of using , debit cards, and ACH payment methods is guarantees from banks and issuers that they will not be liable for fraudulent transactions. In the case of credit card use, it also provides a guarantee that the consumer will be given a degree of third-party protection if a purchase never arrives, is significantly different from what was ordered, or is defective.

This guarantee is extremely beneficial to small businesses—particularly those competing in e-commerce markets with large companies—because it gives the consumer a relatively risk-free way to take a chance on a small or unknown company.

A new customer will likely not know whether they are dealing with a reputable company dedicated to customer service or a fly-by-night fraudster. Knowing that a bank or card issuer with which they have an established relationship will make them whole in the event of disaster can be the difference between a small businesses’ new biggest customer and its most tragic lost opportunity. For example, without this guarantee, a start-up might lose a customer unwilling to trust a small business with their bank account information because of a security concern, and a small local service company might lose a client unwilling to provide a credit card number to secure a reservation for fear of being charged if the provider never shows.

 

All Consumer Chargebacks Are Not Malicious

If a consumer experiences true fraud (such as fraud resulting from stolen credit cards or account credentials) it benefits everyone for them to report it immediately, even if it results in chargebacks against completely innocent merchants—and in this case the loss will likely be absorbed by the issuer (as long as the merchant can show that they obtained proper authorization to submit the charge). In other cases, a consumer may in complete good faith improperly report a chargeback.

Common causes of such chargebacks are consumer forgetfulness and consumer confusion. This occurs when a consumer doesn’t recognize a charge on their credit card bill or a debit on the bank statement. It could be that there are two users on an account and that the person who made the charge is not the one who disputed it. It could also be that the company name on the statement is unfamiliar to the consumer. In these cases the merchant can typically prevail in the end by providing a receipt or proof of authorization. However, there is definitely a business cost even if the charge stands—a chargeback fee will typically still apply, time and resources will be expended to respond to inquiries, and the customer relationship may be damaged.

Another common cause of chargebacks is pure consumer laziness. As noted above, the Global Risk Technologies report found that in 86% of cases consumers go directly to their card issuer to complain instead of to the merchant directly. This may be because card issuers are available 24/7 while most small businesses are not. It may be because each transaction displayed in online banking systems is accompanied by a big, readily available, easy to use dispute button. It may be because the consumer wants to avoid conflict and finds it easier to complain to a third party than to the merchant directly.

In some of these cases the consumer may have a legitimate complaint that could be resolved by speaking directly to the merchant, but they just don’t want to bother with what they deem an “extra” step. And while this attitude may seem malicious to small business owners, it truly may be a result of both consumers not understanding how chargebacks affect businesses and the natural inclination to follow the path of least resistance.

 

How Friendly Fraud Affects Small Businesses

First and foremost, friendly fraud costs businesses money both as reversed transactions and as essentially stolen goods and services, (as noted above, an estimated $4.8 billion in 2016). Add to that the cost of researching claims, producing documentation, and paying chargeback fees, to say nothing of the cash flow issues that may arise from ill-timed debits by processors, and the efforts required to repair severely injured customer relationships.

Additionally, if merchants experience a significant number of chargebacks they risk higher processing fees, longer funds holds, and potentially suspension or termination of credit card and ACH merchant accounts.

Fraud also has psychological effects on small business owners. Most are passionate, dedicated individuals who strive to build strong customer relationships. Friendly fraud can be devastating and cause business owners to doubt these relationships. It can also cause severe risk-avoidance measures (such as requiring cash payments, shutting e-commerce sites, instituting onerous terms, etc) that do far more to impede business than they do to prevent fraud.

 

How Small Businesses Can Combat Friendly Fraud

Ultimately, if your customers are truly dishonest there is not much you can do to prevent them from making fraudulent claims against your company. (And unfortunately, the data shows that when dishonest people get away with friendly fraud once, they are very likely to try it again and again.) However, be certain to keep a list of these bad apples so you can be sure never to do business with them again.

In a few cases, such as a credit card chargeback where a customer claims that goods were not received, you can prevail if you provide proof of delivery. In other cases, very clearly written terms and conditions may allow you to prevail if a customer demands a refund when the terms clearly state that one is not warranted.

For ACH chargebacks, there is no recourse for the merchant within the ACH system once a consumer reports a charge as unauthorized, (though you can take your customer to court). For credit card transactions where a customer says an item is defective or not as ordered, or where the customer reports that a service was not performed or performed unsatisfactorily, the merchant typically has little recourse.

So as with most business matters, maintaining good customer relationships is the single most important thing you can do to protect yourself from all chargebacks, and especially from friendly fraud. If customers call you first, you can refresh their memory about authorizations, or if a mistake was made you can correct it. Even if you end up refunding a transaction that you think is valid, it’s a smart move to do it yourself before the bank or credit card issuer gets involved. Taking preemptive action will save you chargeback fees, protect your processing record, and hopefully enhance customer satisfaction.

 

Best Type of Small Business Merchant Account for Successfully Defending Credit Card Chargebacks

As a small business owner you probably want the right to defend yourself when you’ve been accused of wrongdoing—such as when a customer charges back a credit card transaction. If you have a dedicated merchant account provisioned specifically for your business (such as those PaySimple merchants use) you will always have that opportunity.

If you use an aggregated account (such as those provided by PayPal) that use a single merchant account to provide credit card processing for an entire portfolio of companies, then in many cases you’ll be at the mercy of your provider and may never get a chance to respond to a fraudulent claim– you’ll just be penalized with no recourse.

As noted above, it takes time and money to defend a chargeback. Big merchant account aggregators like PayPal simply don’t want to bother; and they also want to maintain good relationships with the consumers who use their services. Thus, it is often easier and more cost effective for these companies to simply absorb all chargebacks without question– particularly because in most cases they can pass the loss directly to the merchants instead of bearing it themselves. (Also, with an aggregated account it is more likely that the company name on your customer’s statement will be unfamiliar which may lead to a higher chargeback rate.)

With a dedicated merchant account, credit card processing rules require that you have the opportunity to defend your business. In many cases, particularly where the disputed amount is small, it is not worth the cost, time, and effort to do it. And even if you do decide to defend your business, the Card Issuer may decide in the customer’s favor in the face of what you believe to be a strong defense (for better or worse, the customer is truly presumed to be “right” in most cases). However, it is also possible that the Card Issuer will absorb the loss itself to promote good customer relationships on both sides of the transaction.

Thus, in the case of defending a chargeback, you are almost always better off with a dedicated merchant account than with an aggregated account. (Though for some businesses there are advantages to using aggregated accounts. See old Tip post Credit Card Processing: key points to consider when choosing a merchant account for a detailed comparison of the pros and cons of each merchant account type.)

 

Chargeback Prevention Resources

The following resources provide more information about the chargeback process, legitimate chargeback reasons, and steps you can take to prevent both Credit Card and ACH chargebacks.

Credit Card Chargeback Prevention Resources

The Visa E-commerce merchants’ guide to Risk management is a great resource for both learning about the chargeback process itself and for learning about steps your small business can take to reduce chargebacks.

The American Express Dispute Management and Prevention center provides help with preventing and defending chargebacks, as well as detailing their new programs for chargeback reduction.

The PaySimple Credit Card Chargeback Guide provides detailed information about legitimate reasons for credit card chargebacks and how you can head them off. It is geared towards PaySimple customers, but most of the guidance is applicable to any business processing credit card transactions.

ACH Chargeback Prevention Resources

While fraudulent chargebacks are not as big a problem for ACH as they are for credit cards they are significant for merchants because once issued they cannot be reversed within the ACH system. (According to NACHA, in 2015 24 billion ACH transactions were processed, with an unauthorized debit return rate of just 0.03) If ACH chargebacks (unauthorized debits—typically returned with an R10 code) are a problem for your business, you might want to invest $150 to view NACHA’s Webinar Recording: Is it an Unauthorized ACH Debit or Consumer Fraud? Biller Best Practices.

Also check out the (free) PaySimple ACH Chargeback Guide. While designed for PaySimple merchants, this guide provides information useful to any small business processing ACH transactions.

 

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Lisa Hephner

Lisa Hephner

My name is Lisa, and I’m the Vice President of Knowledge, responsible for the management of corporate, product, competitor, marketplace, legal, and regulatory knowledge, and creation and dissemination of knowledge tools using these assets to PaySimple prospects, customers, employees, and partners.

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