The True Cost of a Chargeback
By Chris Alarie on Jul 1, 2021
Chargebacks are expensive. That may seem like an obvious statement but the full extent of chargeback costs are significant enough to warrant a thorough examination. Payments solution provider Ethoca estimates that the average chargeback cost ends up being approximately 2.5 times the original transaction amount, factoring in lost revenue, chargeback fees, and operational costs. Beyond these sorts of quantifiable expenses, there are additional, more intangible costs as well as the possibility of severe, long term consequences.
Ambrose Bierce defined a corporation as “an ingenious device for obtaining profit without individual responsibility” and, facetiousness aside, there is a large degree of truth in the fact that making a profit is central to a business’s essence. Accordingly, the chargeback costs that are usually the most significant cause of concern for merchants are the ones that directly affect their income.
These direct costs generally fall into three categories:
A chargeback is a form of returning payment from a merchant to a cardholder. As a result, it literally costs the merchant a portion of their revenue. The amount of lost revenue obviously varies wildly from merchant to merchant and transaction to transaction. Included within this particular category are the ancillary costs of the business that are factored into each transaction, such as marketing costs and the transaction fees that merchants pay to payment processors.
Merchants can choose to fight a chargeback if they feel it is illegitimate. Should that effort prove successful, the merchant can recover that lost revenue.
Unlike lost revenue, chargeback fees can not be recouped, even in circumstances where the merchant successfully disputes a chargeback. Chargeback fees are assessed as a flat fee on a per-chargeback basis. These fees generally range from $20-per-chargeback to $100-per-chargeback, depending on the policies of the acquiring bank and the merchant’s chargeback ratio.
Whether managed in-house or outsourced, manually or with automated tools, chargebacks require operational resources. This includes the resources expended to fight, process, and prevent chargebacks.
Pliny the Elder wrote, “ It is generally much more shameful to lose a good reputation than never to have acquired it.” Reputation monitoring and brand management are essential aspects of running a business, especially in the digital age.
Thanks to the internet, consumers have a number of ways to express dissatisfaction through social media as well as consumer reviews and ratings. The unsatisfied consumer who requests a chargeback may very well become the unsatisfied consumer who posts a widely viewed, negative product review on Amazon or Google.
Chargebacks arise from a number of different sources, including both fraudulent and legitimate sources. Legitimate chargebacks ostensibly signal some sort of consumer dissatisfaction. It could be the result of such issues as merchant error, a product that does not match its description, obstacles preventing access to customer service reps, defective merchandise, recurring billing issues, currency problems, or delays in payment, delivery, or service. Not all of these errors are the fault of the merchant but they can all potentially reflect poorly on the business.
These costs are less easily quantifiable than the ones in the previous section but they are no less real and no less damaging. Too many chargebacks can be a sign of significant flaws within a business and, left unrepaired, those flaws can erode the business’s reputation over time.
Long Term Costs
An individual chargeback costs merchants money directly. Chargebacks, in aggregate, can cost merchants in reputational value. But excessive chargebacks over a period of time can cost merchants significant financial damage.
The key metric for determining whether or not chargebacks are occurring at an excessive volume is chargeback ratio. Different card brands calculate chargeback ratio slightly differently but the basic calculation is to take the number of chargebacks over a particular period of time, divide it by the total number of transactions, and multiply by 100 in order to present it as a percentage.
Card brands begin assessing consequences if the chargeback ratio surpasses 1%. The specifics of the consequences depend on the card brand and the circumstances. For example, some card brands have monitoring programs—the Visa Chargeback Monitoring Program (VCMP) and Mastercard’s Excessive Chargeback Program (ECP)—that they impose on merchants who are exceeding or coming close to exceeding chargeback limits.
The most severe long term consequence for a merchant that regularly exceeds a 1% chargeback ratio is placement on a terminated merchant file (TMF) such as the MATCH list. The MATCH list is a kind of blacklist for merchants that warns financial institutions against working with them. Placement on the MATCH list lasts for five years, prevents merchants from opening new merchant accounts, and is effectively a death sentence for the merchant during that time period.
How to Avoid Incurring These Costs
Chargeback management has many different facets but the most valuable one, particularly with regards to reducing the sorts of costs discussed in this article, is chargeback prevention. After all, an ounce of prevention is worth a pound of cure.
An effective chargeback prevention program includes a number of different facets, tailored to the specifics of each business. Some of the most important are: