How to Fight Chargebacks – Part 1, The Causes of Chargebacks

Ahhh, the chargeback. The most hated word in the lexicon of the modern entrepreneur.  A chargeback is when a customer contacts his or her issuing bank to dispute a charge rather than to go directly to you, the merchant, to resolve the matter.  Chargebacks can occur for many reasons, including poor customer service, unrecognized charges, uncancelled subscription billing, slow shipping, unauthorized charges, friendly fraud (more on this later), and more. They are particularly challenging for ecommerce merchants, where the card holder is not present for the transaction.

Chargebacks have become a difficult (and costly) minefield for online merchants to navigate. They are more than just an expense, they are an existential threat to your business. If your merchant account receives too many chargebacks, or your chargeback ratio is too high, your merchant account can be shut down and your funds held for up to six months. So, it is vital to manage this key part of your business, to improve your margins and ensure the continuity of your business.

The Chargeback Cycle

The chargeback cycle begins with (1) the customer contacting her bank (the issuing bank) to initiate the chargeback. (2) The customer’s bank will locate the transaction and attempt to validate the customer’s claims based on the information provided. (3) If the customer’s complaint appears to be valid, the issuing bank will file a chargeback. The merchant’s acquiring bank (the bank that issued the MID), receives the chargeback case and forwards it to the merchant, along with a deadline for the merchant’s response (also known as representment). (4) The merchant then compiles the transaction information (the invoice or receipt, tracking information, records of communication with the customer, etc.) and submits the representment to the acquiring bank. (5) The acquiring bank submits the chargeback representment to the cardholder’s bank for review. (6) The issuer reviews the case and will decide to either award the customer with the chargeback or decide in favor of the merchant. (7) If the merchant is victorious, the funds from the transaction are returned to him. If the customer’s bank decides in favor of the customer, the merchant can (8) initiate a second chargeback, or pre-arbitration, contesting the chargeback again. The merchant (9) compiles even more information supporting his case and a second presentment is sent to the card brand (Visa/Mastercard), instead of the issuing bank. (10) the card brand reviews the information submitted by the acquirer and the issuer and (11) issues a ruling in favor of one of the parties.

This process can take time and be a distraction from activities (like monitoring your KPIs, listening to support phone calls, etc.) that can actually reduce chargebacks. Most experienced advertisers outsource their representment and chargeback management to third party companies. Feel free to contact us if you need help finding the right team to help you represent and manage your chargebacks.

What Causes Chargebacks?

Friendly Fraud
The cardholder right to dispute a charge is vitally important to the credit card payment process, because it ensures consumer trust in credit card payments. However, some unscrupulous consumers have been gaming the system for years with ‘friendly fraud’. Friendly fraud is when a consumer places an order for a product online, receives the product and then disputes the charge with her bank.  In this scenario, the customer has no intention of returning the goods to the merchant and is opening a chargeback with the bank to get the transaction refunded, thereby getting the goods for free. Estimates on friendly fraud put the percentage of friendly fraud related chargebacks somewhere between 17% and 32% of all chargebacks.

Bad Traffic
While affiliate networks and affiliates can help you scale extremely fast, it can come at a price. Affiliates are driven by CPA commissions (Cost Per Action), and some affiliates may make deceptive and even false claims to get a sale. Misleading customers about the true cost of the product may generate quick sales, but it inevitably leads to refunds, chargebacks and higher customer service costs. This is not to say that all affiliate traffic is low quality and to be avoided. However, as an advertiser, you must guard your business (and your hard-earned MIDs) against affiliate fraud. This means checking KPIs, like refund rate, chargeback rate and partials ratios must be done regularly (daily and weekly). When you spot a bad affiliate, cut them immediately and address the situation with your manager at the network. A quality network will work with you to cease traffic from bad pubs (publishers, aka affiliates), and credit you for the bad sales. With a system of checks in place, you can confidently scale using affiliates.

Shipping
Slow shipping and lost packages can not only cause customer service headaches and reputational damage, but can also lead to chargebacks. Advertisers should be shipping with tracking, and monitoring delivery carefully. Each week, you should be checking your shipments to ensure their arrival and addressing any issues with your fulfillment house.

Customer Service
Long hold times, off-shore customer service and (even worse) automated customer service lines can wreak havoc on an advertiser’s bottom line. Nine times out of ten, if a customer is calling your 800 number, they are not happy. This point in the customer experience is crucial – a make or break moment that can turn into a chargeback, or a friendly resolution. Yet so many advertisers overlook the interconnection between customer service and chargebacks. As an advertiser, your customer service is most likely outsourced to a third-party call center. That’s fine, as long as you pay attention. Listening to calls and monitoring KPIs by customer service agent can help to spot problems before they erupt.

Chargebacks and the chargeback process are changing, but not going away any time soon. For the sake of your bottom line and the future of your business, make a pledge today to treat chargeback disputes with the same time, attention and resources as you do to other parts of your business. Not sure where to start? Contact us, we’re happy to provide additional guidance.

Up Next: What Can I Do to Reduce the Impact of Chargebacks On My Business?

In the next installment of our series on chargeback management, we’ll go into further detail about outsourcing your chargeback management and tools you can use right now to cut your chargebacks significantly.

The Payment Processing Glossary

While completing a transaction is a relatively simple thing, pricing and terminology surrounding payments can be confusing and complicated. We’ve created this glossary as a guide to help you understand how payment processing pricing works.

Account set up fee: A setup fee is an additional charge that covers the cost of setting up an account for you.

Authorization fee: An authorization fee is charged each time a business authorizes a credit card transaction.

Alert (Ethoca/Verifi): An alert is a notification sent to a merchant when a customer initiates a chargeback. Ethoca and Verifi are two third-party vendors that listen to the card networks for disputes, and alert subscribed merchants when a chargeback is filed. By contacting the customer to resolve the chargeback, or refunding the transaction, a merchant can avoid the pending chargeback and black-mark on his reputation.

BIN (Bank Identification Number): A BIN is a number issued to both issuing and acquiring banks, used to identify the banks associated with a transaction.

Charge back fee: A chargeback fee is imposed by banks in an effort to recover incurred costs while handling consumer chargebacks and disputes associated with your account.

Discount fee: fee paid by merchants to credit card processors as a fee associated with accepting general-use credit cards (such as Visa, MasterCard, American Express and Discover).

Electronic AVS: The Address Verification Service (AVS) is a tool that enables merchants to detect suspicious credit card transactions and prevent credit card fraud. AVS verifies that the billing address entered by the customer is the same as the one associated with the cardholder’s credit card account.

EMV 3D Secure: 3D Secure is an additional level of authentication that reduces ‘friendly fraud’ by generating a digital ‘fingerprint’ of the customer, to confirm that the customer (and not someone else) is completing an online transaction. For European merchants, using 3D Secure can help to achieve PSD2 Compliance.

Gateway: For e-commerce merchants, a gateway is a program that links the merchant’s merchant account with the merchant’s online shopping cart. It is the virtual equivalent of the payment terminals used by retail merchants to allow customers to swipe their cards to complete a transaction.

Industry non-compliance fee: Some merchants may also be charged a PCI non-compliance fee, if they fail to maintain proper security standards and procedures as outlined by the PCI DSS (Payment Card Industry Security Standard).

MATCH List: The MATCH list is a list of terminated merchants, used by Mastercard and American Express for screening during the merchant approval process.

MID (Merchant ID): A MID is a number issued to a merchant upon approval of a merchant account. The merchant’s acquiring bank BIN is used for the first 6 digits of the Merchant ID.

Monthly fee: Monthly Fee is a monthly recurring charge that you will be billed each month.

Monthly minimum: Often referred to as just a “Monthly Minimum,” most merchant account providers charge a Minimum Transaction Fee if the total transaction processing fees for the month do not add up to a minimum amount.

Retrieval fee: A retrieval fee is charged when a customer or the customer’s issuing bank requests a copy of a sales draft in order to substantiate a transaction.

Reserve account: A reserve account, is a non-interest bearing account, into which a percentage (typically 10% of net transactions) is placed for a period of time (usually 6 months). A reserve account is used by the merchant’s bank as a way to offset the risk associated with chargebacks and refunds.

TMF (Terminated Merchant File): A terminated merchant file, is a shared list of merchants that have been terminated by their acquiring bank. The terminated merchant file is used for screening merchants before approval for a merchant account. See also MATCH List.

Transaction fee: A transaction fee is a per transaction fee that a business has to pay every time it processes a customer’s electronic payment.

Virtual terminal: A virtual terminal is a way to manually enter credit card transactions. Usually a merchant’s gateway will provide a virtual terminal, in addition to the API gateway, to allow the merchant to place transactions manually.

Voice authorization: Voice Authorization is a security measure used by the credit card industry to ensure that a particular purchase is being authorized by the actual card holding customer.

Voice AVS: The fee applies whenever you access the address verification system (AVS) when processing a transaction at your business.

CCSalesPro Interview with Josh Ewin from Helios Payments

Josh Ewin, President & COO at Helios Payments, explains how Helios has built a strong book of business around high-risk businesses, like ecommerce, CBD and subscription services. Plus, Patti reports on growing demand for Buy-Now-Pay-Later services, and James offers insights on selling technologies and POS solutions.

The LEAN Process – Streamline Your Payment Processing and Increase Your Net Profits

TLDR: Using the Six Sigma LEAN process on your payment processing system can help reduce cost and ensure the longevity and ROI of your merchant account.

”Business as usual” is often used like the best/normal/desirable solution but can we improve this statement? Have you ever heard of the LEAN process? What does it mean and how can we apply it?

Long Story Short

If you have heard about Toyota – then you know about the impact of the LEAN process. In the middle of the 20th century, this concept appeared in Toyota’s Production System. It is based on the philosophy of defining value from the PEOPLE, and I am referring for the customers and employees.

LEAN = Purpose + Process + People

You can apply the LEAN process for every activity – for example when you are cooking at your home – look over the process and see if there are things that could be done faster, better, or if that are things that can be eliminated.

The same principles apply to your payment processing system. Look at your workflow now, identify your steps, implement simplicity, eliminate activities that are not productive, make your payment process easy for the customer, and productive for your business. Regularly checking your processing activity, outsourcing your chargeback response and alerts to a reputable vendor, and reducing fraud with 3D Secure should all be a part of your process. By following the LEAN process, you can build your payments system to withstand chargeback spikes, reduce loss from friendly fraud and ensure the longevity of your merchant account.

From my point of view, LEAN process instruments that can be easily adapted to your process flow are :

  • Check in meeting
  • Feedback session / Coaching session
  • Weekly meetings

Let’s take a quick look:

A check in meeting refers to a day to day morning meeting that can help you and your processing system by having a quick look at your goals for that day. Let’s say that today you want to find out the source of your chargebacks – find it and save it on the white board.

Take your feedback from your customers after they are buy your product – create a NPS (Net Promoter Score) that can help you see where your strengths and weaknesses are. Are your customers satisfied with the presentation of your product? Is your customer satisfied with your checkout process? What do they think of your customer support?

A weekly meeting gives you the opportunity to see how your business performed last week by checking the results, and also offers you the opportunity to plan the next week. For example, you can look at that customer feedback and how your NPS is trending, and correlate that with the decisions and actions you made. After examining the results, you can now plan what you will do over the next week.

Using the LEAN process will help you eliminate or minimize WASTE, increase productivity & customer satisfaction, improve the quality of your work, reduce cost and in the end improve your profits.

When high risk processing is our day to day business we get in touch with different situations/countries/owners/business types/products and much more. The most consistent request I see is “I need more processing volume”. You can’t always treat issues like this with direct actions. LEAN helps us to take that overall view of the business and gives us a process by which to make the right decisions. Make your payment processing system generate value for you and for your customer. Take LEAN ideas and adapt them to your processing system.

If you are in a ‘high risk’ business, like nutraceuticals, you always have to:

  • Analyze your statements – manage your chargebacks – see alerts, impact, Return On Investment (we will have an article based on this subject)
  • Use 3D Secure
  • Take care of your MID because it is the lifeblood of your online business

You can prepare the plan and action from a well organized business that has a LEAN process in place. Of course you have to work on your SOP (standard operating procedure) and the PLAN / DO / CHECK / ACTION methodology. Think about how your process can be improved. Are there any steps that can be done more efficiently? If you need help implementing LEAN with your payment system, feel free to contact us.

Managing Your MID’s Reserve Account

What is a reserve account?
For merchants in higher-risk verticals (nutraceuticals, subscription billing , etc), many banks will require a reserve account to off-set the risk to the bank. To fund the account, a percentage of every batch will be deposited into the reserve account. Processing fees, refunds and chargebacks are deducted from your business checking account, not the reserve account. Funds are only deducted from the reserve account if your business is closed and the bank is unable to pull these liabilities from your checking account. 

A typical reserve requirement might be 10% for 6-months on a rolling basis. This would mean that 10% of your gross credit card processing for today (Nov 18, 2019) would be held in the reserve account for 6 months and then released back to you on Monday May 18, 2020. Unless your business folds and you close your checking account, your reserves will remain intact. Reserves can be a hit to cashflow, but… can they be a savings account too?

There are variations in the reserve requirement, which vary from bank to bank and merchant to merchant. Some banks may ‘cap’ the merchant account at a specific amount. For example, you may have a reserve cap requirement of $50,000. When your reserve account reaches that cap amount, reserves are no longer pulled out of your batches. Other banks may require a reserve up front, before allowing the merchant to process credit cards, for merchants viewed as particularly high risk.

For merchants with particularly slim margins, the reserve requirement can be a burden and needs to be considered when calculating cash flow and budgeting. However, when you hit that 6-month point and reserves start returning to your account, the burden eases and reserve releases can be helpful in managing cash flow.

When do I get my reserves back?
If your reserve is a rolling reserve, you’ll start to see some funds released from your reserve account into your checking account at the end of the rolling period. As part of your monthly accounting, you should be keeping tabs on your reserves for your merchant account, how much was processed and put into reserves each month. Keep a running record of your reserve deductions. Be prepared and know how much is in your reserve account. If you are unsure of your reserve balance, your processor’s risk department can provide you with your current reserve balance. 

Can I eliminate my reserve requirement?
It is possible to remove your reserve requirement with some proven track history. Around 90 days after your first sale, most risk departments will consider reducing your reserve requirement. To get there, your chargeback ratio and chargeback counts need to be in good shape. To request a reserve reduction, your chargeback ratio should be below 1% and your chargeback counts (number of monthly chargebacks) should be under 30, depending on your volume. To request an adjustment to your reserve requirement, you need to know your numbers. See below (Reserve releases) for the math behind reserve requirements. 

As the saying goes, there’s more than one way to skin a cat. As opposed to having your reserve requirement reduced from 10% to, let’s say 5%, you could ask your bank to cap your reserve. If you request a capped reserve, expect the cap to be roughly equal to your monthly volume. This does lock up some capital indefinitely, however it eliminates the monthly grind of having reserves pulled from your batches. 

As for eliminating your reserve requirement, expect to show your bank’s risk department 12 months of solid history before requesting to have your reserve requirement eliminated. The better option may be to request that your reserves are capped. If you hit a rough patch, with a month or two with abnormally high chargebacks due to unforseen circumstances, your bank may have more patience in dealing with the temporary spike in chargebacks if you have a well funded reserve account.

My batch was moved into reserves, what does that mean?
Occasionally, your bank’s risk department may move additional funds into your reserve account. Usually this happens when a particularly large batch is processed (i.e. a batch over the weekend, which includes multiple days of processing). Usually the batch is held, while the risk department runs an inquiry. When the risk department sees an anomaly like this, they may hold the batch and then move it into the reserve account.

Reserve releases.
You may need to request your reserves to be released, if your bank hasn’t started releasing reserves, or, if your merchant account was closed. The following is a step by step guide for requesting reserve releases.

  1. First, find the current reserve balance. An authorized contact from a company representative (usually the company owner) will need to make the request with your processor’s risk department. 
  2. Double check the reported reserve amount with the sales volume processed on your merchant account to verify that the amount is correct. If there is a significant variation (+/- 5%), contact the risk department.
  3. Next, calculate the number of chargebacks you had during the past 6 months. You can find your chargeback counts on your monthly statements. 
  4. Now, calculate the amount of risk on that merchant account: 6 month’s net sales (gross sales – returns) x (chargeback % + refund %). 
  5. You’ll probably find it easier to request multiple releases, rather than requesting the full reserve balance to be released. To succeed in getting a reserve release, you need to provide justification and data. Don’t just ask the risk department to release your reserves. Ask for a specific amount and show the supporting math. Some processors will request a notarized reserve release request, so be prepared.
  6. If your merchant account was closed, expect to wait until 6 months after your last sale to request a reserve release. Although, you may be able to request a partial release before the 6-month mark. If your MID or bank account is closed, you will need to provide a new bank letter with the new account information.

While the reserve requirement may place additional burdens on you as a merchant, it can be manageable. By tracking your reserves each month, and keeping your chargebacks low, you put yourself into the best position possible down the road. Know what the bank’s risk exposure is, using the math in this article, and request releases and modifications to your reserve requirement as you build history and credibility with the bank. When managed well, your reserve account can be used to support your relationship with the bank, offset mid-term cashflow short-falls and can help even the un-disciplined business owner be disciplined about saving.

EMV 3D Secure and PSD2 Compliance

What is PSD2?
PSD2 is the latest version of the Payment Services Directive, which was intended to establish a Single Euro Payments Area (SEPA). The original regulation was established over a decade ago, and the PSD2 update is intended to better align payment regulation with the current state of payments technology and the payments ecosystem. If your e-commerce business is operating in the EU, then your business is more than likely subject to the PSD2 regulations.

While most transactions in the EU must be PSD2 compliant, there are some exemptions to the requirements. For our purposes, the most important of these is the case of recurring transactions. Recurring transactions are exempt from PSD2 as long as the consumer has already given permission to the merchant to run recurring transactions. More on this later.

SCA (Strong Customer Authentication)
One of the core principles of the new PSD2 regulation is SCA or Strong Customer Authentication. Where previously single-factor authentication was sufficient, due to advances in technology authentication using multiple, independent factors, is required for additional security. To protect the consumer, banks must now implement multi-factor authentication for all transactions. SCA is achieved by two of the three following measures: something you know (ex. password, PIN, etc), something you possess (ex. mobile phone, smart card, etc) and something you are (ex. biometric fingerprint).

PSD2 and EMV 3D Secure
Our article from last week about EMV 3DS looked at the latest implementation of 3D Secure (aka 3DS) technology. 3DS is intended to reduce fraud, increase approval rates, and enhance the online shopping experience for the consumer. When a transaction is authenticated using EMV 3DS, the liability for chargebacks shifts to the card-holder, thus preventing ‘friendly fraud’, which is the driver of a majority of online chargebacks. 3DS collects up to 150 data parameters to send to the banks to authenticate a transaction. There are 41 required data points and over 100 optional points that the merchant can choose to send to the cardholder’s bank about the transaction. These data points allow card-issuers to do risk-based authentication (RBA), giving each transaction a score based on the level of risk associated with processing the transaction.

The EBA (European Banking Authority) has not named a specific technology that must be used by merchants to achieve Strong Customer Authentication. However, EMV 3DS is the only technology available that will achieve both SCA (a core requirement of PSD2) and chargeback liability shift.

Subscription-based services and products (ex. Netflix, Birchbox, Spotify, Dollar Shave Club, etc) are becoming more and more popular. For merchants using the subscription model (or trial-subscription model), chargebacks can be a challenge. PSD2 only requires the initial transaction to be authenticated with SCA. However, the initial transaction is rarely the one that cardholders chargeback with their bank. The consumer remembers the initial signup – it is the first rebill they don’t recognize and subsequently call their bank about. By authenticating the first transaction and first rebill, merchants can reduce their chargeback ratios drastically.

Implementation
Implementing EMV 3DS on your website is very simple. 3D Secure Providers like PAAY will offer to do the implementation for the merchant. Adding 3DS authentication to your checkout page generally takes less than a day, including implementation and testing. To learn more about how EMV 3DS can help with PSD2 compliance, you can schedule a demo with PAAY.