Breaking Down Chargeback Fees
Chargebacks are a major threat to businesses big and small. In fact, the total costs of chargebacks exceed $30 billion per year, which is more than the revenue of many Fortune 500 companies, like McDonald’s and Netflix. Chargeback fees make up a big chunk of the total costs, so we’re going to take a look at them. That said, chargeback fees aren’t the only factor, so we’ll also look at the total, true costs of chargebacks.
Before getting into costs, let’s discuss what chargebacks are. Chargebacks result from disputes, typically between customers and merchants. Rather than going through a company’s refund process, however, the customer turns to the bank that issued their credit or debit card. They then ask their bank to reverse the payment and essentially issue a refund.
If the bank agrees with the customer, they’ll take money from the merchant and pass it to their client. Importantly, banks don’t need the merchant’s permission to do so. And on top of losing revenue from the sale, the seller will also lose any products sold but not returned. On top of that, they’ll have to pay chargeback fees.
As you can imagine, costs quickly pile up and if merchants aren’t careful, they could end up facing chronic revenue loss. Further, the fees and costs associated with chargebacks aren’t limited to single transactions. If your chargeback ratio gets too high, payment processors may start charging you higher processing fees. Some may even decline to work with you altogether.
Sounds messy? It is. Seems like a major threat? Chargebacks most definitely are. That’s why we’re going to cover the true cost of chargebacks.
Chargebacks Result in Lost Revenues From Your Sales
First, if you get hit with a chargeback and are unsuccessful in disputing it, you lose revenue and product alike. the payment you received for the product or service will get clawed back. Chargebacks work sort of like refunds, meaning the business loses money, and the customer gets the money back. Unlike refunds, however, customers usually are not compelled to return the products received.
So if you sold a $200 pair of shoes, you’re out $200 and the shoes to boot..
Examining the Costs of Chargebacks
In some cases, you may get hit with a partial chargeback. Let’s say someone ordered four $75 pairs of shoes from your online store, but only three ended up delivered. In this case, the customer might pursue a chargeback for $75 to account for the missing pair.
Importantly, a partial chargeback still counts as a full chargeback when card networks calculate your chargeback ratio. We’ll cover this topic later, but keep the above in mind. Meanwhile, your financial woes are just beginning, with lost revenue making up only a portion of the total true costs.
Lost Merchandise Means Lost Money
Besides losing revenue from the sale, you’ll likely lose the money you spent on merchandise or to provide services. Let’s continue with our example with shoes. Those $200 shoes weren’t free for the merchant. The merchant may have spent $50 or more to stock the shoes, and with chargebacks, that investment is often lost.
Unlike with refunds, customers typically are not compelled to return items if they file a chargeback. For this reason, some cardholdersscammers actually abuse chargebacks simply to score free products. This is referred to as “friendly fraud” and some estimate that up to 80 percent of chargebacks are the result of friendly fraud.
Examining the Costs of Chargebacks
As you can see, the costs are quickly adding up, and we’re far from calculating the full cost of chargebacks.
Breaking Down Chargeback Fees Further
Besides lost revenue and the costs of the merchandise or services rendered, you’ll also have to pay chargeback fees. These fees can vary substantially based on your chargeback ratio and the financial institutions you’re working with. Fees typically range between $20 to $100 and as you incur more chargebacks, costs typically rise.
Chargeback fees are charged by the business’s “acquirer,” which is the financial institution working on behalf of the merchant. The merchant will have an account with this acquirer, which will accept payments for products and services. Terms may vary from acquirer to acquirer, so you’ll want to read the fine print.
Why do acquirers levy chargeback fees? Part of it simply comes down to costs. Managing chargeback disputes eats up labor hours for the banks involved. Processing transactions also costs money. Thus, acquirers levy chargeback fees, in part, to cover expenses.
Acquirers also want to incentivize merchants to take proactive steps to reduce chargebacks. While acquirers do get some income in the form of chargeback fees, they’d generally rather avoid disputes in the first place. Merchants can use a variety of methods and tools to combat chargebacks, including:
Unfortunately, you’re going to get hit with chargeback fees even if you win the dispute. Even if the customer was trying to scam you, and you fought back AND won, you’ll still have to pay the chargeback fees. Your chargeback ratio will also take a hit, which could result in higher fees later on. Owing to this, some merchants will refund a purchase even if they think they have a strong case for disputing the chargeback.
Continuing with the shoe example, you can see that the true cost of the chargeback is climbing.
Examining the Costs of Chargebacks
We’re now well past the original $200 sale that sparked the chargeback. And even so, costs continue to rise.
Payment Processing Fees Explained
When you work with an acquirer, they will take a cut from each sale in the form of interchange fees. Interchange fees are a bit convoluted, but typically your acquiring bank will first pay the issuing bank while accepting the transaction. Then your acquirer passes the cost onto the merchant.
The interchange fee usually ranges from between 1 to 3 percent. However, these fees can be impacted by the industry you operate in, your chargeback ratio, and other factors. If a payment processor deems you or your business to be a higher risk, they may charge higher fees.
These card transaction fees come out of the revenue from the sale. However, if the charge is reversed and the money is sent back to the customer, the merchant will have to pick up the cost of the interchange fee.
Let’s assume that our shoe retailer pays their acquirer 3 percent for transactions.
Examining the Costs of Chargebacks
Thankfully, interchange fees typically cost only a few percent of the order. Regardless, with many merchants operating on low margins, every bite into your margins hurts. .
Also Consider Operating and Marketing Costs
Running a business is hard work even on the best of days and requires a lot of resources. Merchants will have to set up storefronts, including online and/or brick and mortar. Many online merchants have to stock inventory, then pay for packaging and shipping products to customers.
Costs will vary from business to business but as a general rule of thumb, operational costs amount to about 20 percent of the merchant’s revenue. Of course, more-efficient businesses may enjoy lower costs, while others pay more from various complications..
Marketing costs are one of the most common “complications.”. Many online merchants rely on digital ads, which can get rather costly per click. Indeed, many businesses spend somewhere between 25 to 40 percent of their revenue on marketing. This might be in the form of ads, SEO, social media, or whatever else. No matter the channel, marketing can be quite pricey.
What do these costs have to do with chargebacks? Whenever you sell a product, you’ll need to consider the resources spent to make the sale. If someone clicked on a search engine ad, you’ll pay per click. With shoes, you’ll likely pay $3 or more simply for the click. Your product may be part of a larger campaign, and what you lose on the chargeback comes out of your overall ROI.
Once the product is sold, then come the fulfillment costs. You’re going to have to pay someone to pick and pack it, perhaps spending another $1 on wrapping, and $3 on a shipping box, plus labor. Then you’ll print a label and pay for shipping. If you later get hit with a chargeback, all that resources you spent on marketing, inventory, fulfillment, etcetera will go to waste.
Let’s assume our shoe merchant’s operational and marketing costs each amount to 20 percent of revenue, and thus 40 percent in total.
Examining the Costs of Chargebacks
We’ve now accounted for the most common costs associated with chargebacks. That dispute over $200 would end up costing our shoe merchant nearly double the initial sale. And there may be other costs as well, such as paying someone to draft a rebuttal letter to try fighting the chargeback.
Chargebacks and their true costs are complicated, but the general outcome is plain enough: chargebacks cost businesses a lot. What’s more, our shoe merchant may have actually gotten off lightly. Visa reports that for every dollar disputed, merchants can expect to pay another $1.50 on top in the form of fees and management expenses. To break down the costs for specific merchants and products, however, you’ll have to break down the costs like we did above.
And sadly, chargebacks today may cost you more in the future, adding even more to your overall expenses.
Your Chargeback Ratio and Increased Fees
Chargebacks can cost your business a lot of money right now. As we saw, costs may increase two-fold or more. In addition to these immediate costs, chargebacks could also cost you later on. Merchants are assigned a chargeback ratio, and the more chargebacks you get hit with, the higher your ratio.
If your ratio becomes too high, your acquirer may designate you as a high-risk merchant and could increase chargeback fees and processing costs. In some cases, acquirers may simply refuse to work with you. And if you find a new acquirer willing to partner with you, they may charge much higher fees.
You don’t need to incur many chargebacks to earn a high chargeback designation. With Visa, if just .9 percent of your transactions result in a chargeback, you’ll get put in Visa’s chargeback monitoring program. If your ratio exceeds 1.8 percent, you’ll get put in their excessive chargeback program and will have to pay excessive fees as a result. With Mastercard, if your chargeback ratio rises above 1 percent, you’ll get put in their monitoring program. Above 1.5 percent, you’ll end up in their excessive program.
The programs offered by Visa and Mastercard aim to encourage merchants to reduce chargebacks. And remember, if your ratio gets bad enough, you may eventually find that payment processors and/or acquirers simply won’t work with you at all.
By the way, your chargeback ratio will rise even if you win the dispute. Even if a customer is clearly acting in a fraudulent manner, and the merchant proves this in the dispute, their chargeback ratio will increase. This makes preventing chargebacks all the more important.
Merchants now all but depend on payment processors. The U.S. Federal Reserve found that in 2020, 28 percent of transactions were made with debit cards while credit cards accounted for 27 percent. Cash accounted for less than 20 percent. Thus, any merchant who doesn’t accept credit or debit cards could lose out on a lot of customers. And the same is true for any merchant that card networks and/or acquirers refuse to work with.
So as chargebacks accrue, keep in mind that they can cost you not just right now, but well into the future.
Take Away: The True Cost of Chargebacks is a Lot Higher Than Many Merchants Realize
Chargebacks are a major threat to businesses. And often, many of the issues are out of their hands. If a consumer fails to protect his or her credit card information, and someone else uses it for a shopping spree, , the merchant is liable. Likewise, if a customer targets retailers with friendly fraud, the seller could still end up bearing the costs, and those costs will quickly exceed the original sale.
It’s vital for merchants to prevent disputes and chargebacks. Fortunately, there are tools that merchants can use to prevent chargebacks and win disputes when they do emerge. This will help you lower the cost and impact on your business. Merchants can also leverage a variety of strategies to proactively reduce the risk of a chargeback getting filed in the first place. So make sure you’re proactive when combating chargebacks and friendly fraud.
