Customer Chargebacks and How to Mitigate Their Impact on a Subscription-Based Business

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Chargebacks are an ugly business. At the minimum, a chargeback is an inconvenience and a nagging fee but in extreme cases, chargebacks can plunge a business into bankruptcy. For businesses being dinged with a chargeback, it’s often ‘guilty until proven innocent’ because these fees are set up to protect the consumer, in accordance with the Electronic Fund Transfer Act as well as the Truth In Lending Act.

So, what exactly are chargebacks? And how can your business mitigate the risks of chargebacks?

As a business providing an item for sale or a service to provide, you charge a fee for that item. Your customer then issues payment, you fulfill what they paid for and the transaction is complete. A chargeback occurs when that consumer opens a dispute with their bank or credit card issuer. They will request a repayment, versus contacting you, the business owner, directly for a refund.

Sometimes, you may not even remember the transaction, but suddenly the money is pulled from your account, and to rub salt in the wound, you get whacked with a fine. Ouch. “Once it goes to the chargeback stage, there is little we can do,” Arjun Ramakrishnan, Risk Policy and Consulting Manager for WePay explained.

“In most cases, they are going to side with the customer, because that is who matters to them.”

ArjunArjun is no stranger to investigating fraud. Prior to working with WePay, an online payment service provider and Fusebill partner, he spent about 5 years working for PayPal where he used risk analytics to reduce fraud. In this capacity, he “applied mathematical models to understand and stop fraud.”

“Overall,” he says, “chargebacks are not good for any business, be it an online store, or a brick-and-mortar store.”

While there is often little a business can do when a chargeback takes place, there are some things that you can do to reduce the number of incidences.

Know your chargeback types.

You can’t really reduce the risk of chargebacks if you don’t know what they are. There are a handful of different types of chargebacks, but four primary ones that comprise the majority of occurrences.

  1. A card was used without the owner’s permission. This makes up a huge percentage of chargebacks, and is outright theft. If a card is compromised, the owner may not even notice a charge until they review their billing invoice the following month, and discover that $1,000 in concert tickets was charged to their card at a venue halfway across the country.

    Unfortunately, this practice so commonplace now, Arjun said that transactions are in the hundreds of thousands of dollars every day.
  1. The purchase was legitimate, but the customer was dissatisfied with the service. In this situation, the burden is placed on the business because if a customer is unhappy with the service provided, or if the product purchased is defective, they may automatically request a chargeback without talking to the business at all.

    For example, a gourmet monthly club such as AmazingClubs has a variety of offerings, from bagels to hot sauce. However, if a customer doesn’t like the monthly selection, they might elect to seek a refund. Unfortunately, instead of contacting the company directly, they reach out to their bank and request a chargeback.

    Another example of customer dissatisfaction is when the product is not received at all. When working with small business owners via e-commerce websites such as Etsy or Amazon Handmade, a customer is automatically charged as soon as a purchase is made. However, the purchase may never end up in the hands of the customer. This might be because the store owner closed shop in the interim between the purchase and the order fulfillment.

    Even with the best intentions and a product quickly shipped, there can be issues that arise after shipment. For example,  a SaaS software company that sends out supporting hardware components like their GPS devices, which could get lost in the mail.
  1. A card was charged due to a technical error. Glitches happen, and they aren’t the fault of either the business or the cardholder. For example, you may make a payment on your utility bill, but the payment was credited to the resident at 134 Main Street instead of 143 Main Street. As soon as the mistake is caught, a chargeback is issued to recover the funds.

  2. A card was charged due to a clerical error. SaaS companies such as Dropbox and Slack know all too well that there is going to be a certain degree of churn, when a subscriber opts out of a recurring purchase. Unfortunately, the charges may inadvertently continue, and that customer will request a chargeback for a subscription charge that was made after the subscription termination.

    Another situation that falls under this category takes place when the customer returned a product but they are still waiting for a refund. Instead of continuing to wait, they will contact their credit card company to start the chargeback process.

As the Latin saying goes, praemonitus praemunitus… or ‘forewarned is forearmed.’

It does help to know the different types of chargebacks as a business owner, so you can better prepare yourself. It might be in double checking that your shipping department fills an order within a specific number or days, or that you improve communication with customers so that they know as soon as that oh-so-tempting box of chocolate-covered raspberries was delivered on their doorstep.

However, even in the best-laid foundation to ensure customer satisfaction, issues will likely find their way into the cracks.

Be aware of the chargeback process.

By the time you are aware that a chargeback request has been issued against your business, your customer is long past the Liz Lemon phase of, “What the What?” and is in full recovery mode.

What takes place in the entire chargeback process? Let’s take a look at it from a SaaS perspective, such as Toast, a platform for restaurant owners. The customer in question is Henrietta’s Diner, which uses the SaaS company to manage its Point of Service (POS) terminals as well as its inventory management.

Everything was going fine, until a glitch brought down the POS system for several days, forcing them to go back to a manual process. Consequently, Henrietta canceled the contract, and requested a chargeback for the final month of service.

What happens in the process?

  1. The customer became aware of the billing issue, and has contacted the financial institution to issue a formal charge dispute. In this case, Henrietta felt she lost business so she wants a chargeback of $350, her monthly fee, immediately.

  2. Depending on the circumstances of the charge, the bank will investigate the claim. At this point, the bank will issue a provisional refund to reimburse the full charge. The provisional refund of $350 will be removed from Toast’s merchant account.

  3. To cover the provisional refund, the bank will issue the full chargeback, as well as a non-refundable fee which often ranges between $15 and $25. This fee can fluctuate, depending on banking policies and the amount of chargebacks a company has had. The chargeback plus the fee are both deducted from the merchant account. Now, that chargeback is up to $375.

  4. If the merchant account cannot cover the chargeback and fee, the bank will go to your banking account on file to secure the funds. A large, successful company such as Toast has enough in their merchant account to cover this, but a smaller SaaS startup might not. In that case, the bank that is tied to the merchant account is dinged for the $375.

  5. Only then, can a business opt to agree to the chargeback or argue the process. If the business agrees, the chargeback amount and the fee are not returned and they formally accept responsibility for the failed transaction.

However, a business has the option to challenge the chargeback. When this happens, you have the option to present evidence, such as a signed delivery receipt or image of the package delivered to the correct address. In the case of Toast, they would have documentation to prove that the system was offline for, say, 20 minutes, as opposed to the 5 business days in the original chargeback claim.

When a business successfully wins this challenge, the refund is reversed, although the chargeback fee is likely not going to be returned. So Toast would have the $350 returned to its merchant account, while the $25 chargeback fee is lost forever.

If, as a business, you opt to dispute the chargeback, there is another level of steps to be aware of. While they can be tiresome, keep in mind that between 20 and 30% of chargebacks are successfully disputed.

Know your rights when disputing a chargeback.

Let’s say you own a property maintenance company. Each month, you take care of many different properties and charge your clients on a recurring basis. Throughout an entire season, your company was maintaining a property for a large estate while the homeowner was out of town. Now, that homeowner is back and unhappy with the service. At the end, communication totally breaks down and the homeowner issues a chargeback claim.

Now, you are fighting not just to hold on to the payments you earned, but he was your largest client and that chargeback alone is half of your monthly income. If you can’t recover the funds, you will likely have to close your business.

What do you need to do to start the dispute process?

  1. Move fast. A payment processor like Fusebill Payments (powered by WePay) will send an email to a business to alert that there has been a chargeback filed. From the point of the notification, the customer has two business days to determine if the chargeback will be disputed.

  2. Prepare and provide evidence. The email notification of a chargeback will provide details of the transaction in question. It will also detail what documentation is necessary to dispute the chargeback.

    This documentation may include sales receipts, proof of delivery, a customer relationship and purchase history and other measures.
  1. Be patient. As soon as Fusebill/WePay is given the requested documentation, it will contact the bank and contest the chargeback for you. It can take some time but Fusebill/WePay will contact you when it learns the outcome of the dispute. If the outcome is in favor of the business, it will release the funds into your account.

As Arjun stated earlier, chargebacks can be devastating for a business so, while it’s a pain to contest them, it isn’t something to ignore. “We work with a lot of SMBs (small to medium businesses),” he said. “They can’t sustain a $5,000 or $10,000 chargeback.

“Regardless,” he continued, “that business is going to take a hit.”

There are two significant ways that a business is impacted by chargebacks.

  • Reputationally. First, institutions monitor chargeback frequencies against a business, much like individuals and companies are monitored with credit ratings.

  • Financially. Chargebacks are expensive and the fees continue to increase. For example, the LexisNexis study released in July 2018 estimates for every $1 of fraud costs for medium- to large mobile commerce merchants, the fees are an average of $3.29, a 24% increase over 2017 figures. Sadly, in the most extreme cases, a business may be forced to declare bankruptcy.

While chargebacks continue to be a rising trend, there are processes in place to protect merchants. For example, Arjun’s experience with risk analysis works to prevent fraud before it happens. “The first thing our fraud department will do is to flag big transactions for further investigation.”

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The financial institution’s focus.

These solutions are different depending on transactions. For example, if a customer travels to a foreign country, a transaction may trigger a fraud investigation, where the card will be put on hold until the cardholder can personally verify that he is in that situation and legitimately using the card.

For larger transactions, Arjun said that they are looked at with a different amount of vigor. A capital investment of $50,000 for a SaaS product with 25 licenses is going to be looked at with a different level of caution than a $50 SaaS subscription with one license.

Regardless, with their fraud analytics, he said that they try to investigate potential purchases as quickly as possible so there isn’t a huge delay for a legitimate purchase. “A merchant needs this money right away,” he said. “We want to make sure our models are strong and accurate.”

The flagged transactions, though, prove to be worth the rigorous attention when it proves to be fraudulent and is caught before any financial transactions were completed and a costly chargeback issued.

The business owner’s focus.

While financial institutions are working to prevent fraud and accompanying chargebacks before they happen, Arjun said that there are other things that a business owner can do to protect himself.

Document everything. “There are best practices with what you should or should not be doing,” Arjun said. “Proper documentation is essential.” In the case of a service provider such as a landscape company that bills on a recurring basis, he suggested having the customer sign invoices, indicating their satisfaction along the way. “Prove that they are satisfied with the work.”

Provide exceptional customer service. Provide a quality product or service and keep customer service paramount in your business. If a customer is dissatisfied, give them ample opportunity to request a refund that you, as the business, handle yourself. If a customer is dissatisfied, imagine the level of frustration if he has to wade through a complex phone tree or wait 5 business days for an email simply acknowledging receipt of a complaint. If it’s easier for that customer to contact his bank and request a chargeback instead of working with you, he is likely going to take the path of least resistance.

Keep your shipping process efficient. If you are a company like BarkBox that delivers goods every month, make sure your shipping process is satisfactory and will meet your customers’ expectations. Communicate delivery estimates and provide tracking numbers. The more you communicate the steps with your customer, the more confident he will be in your product.

Make sure you have good communication. When a transaction is complete, communicate all the information with your customer. Let them know what your merchant name will look like on their billing invoice. Companies that partner with WePay will notice that all transactions will be something like: “WPY*companyname”. The more informed your customer is, the more likely a legitimate transaction will not be mistaken for fraud.

 

As a business owner, you never want to have to issue a return or face a chargeback. With the right steps in place, though, these occurrences can be greatly reduced. And when they do happen, have a plan in place to protect yourself from costly chargebacks.

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Tags: payments

Mariah Patterson

Mariah Patterson is a former journalist with diverse writing interests. Enjoying fiction and nonfiction alike, she has published a children’s book and will be publishing her first novel later this year. Mariah lives in Maine and captures her family’s exploits in her blog.

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