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chargeback vs refund

Saturday, January 03, 2015

And how each affects your business

When it comes to running your small business, you may have to deal with unhappy customers from time to time. While this is hopefully an infrequent occurrence, an unhappy customer may want to get their money back from a purchase they made from you. That’s where terms like chargeback and refund come into play. Often, people use these terms synonymously. That’s because to a consumer there’s not much difference. However, for small businesses like yours, there’s a big difference between the two.

So, in this article, we’ll look at both terms to look at the difference and what that means for your business. We’ll also look at ways your business can protect itself from chargebacks and refunds. To start, let’s take a look at refunds.

What’s a refund and how does it work?

Of course, no business wants to lose money due to refunds. However, they are a necessary part of doing business. A refund is when your business gives a customer their money back. The process seems simple: when a customer returns a product that they bought from you, your company returns the money to the customer. As a business, you can refund the consumer via their original payment method or simply issue an in-store credit for the return. Theoretically, the company gets their merchandise back and the customer gets their payment back in some form.

But while this process may sound straightforward, it’s not always so. Returns can come with more expenses for the business than you may expect. There are phantom, additional fees that you may not initially consider like return shipping costs (usually paid for by the retailer), restocking fees, and even the cost of returning a defective or damaged product to the producer or distributor. Sometimes, if you can’t do that, your business must eat the cost of the product. As you can see, these phantom costs can eat into your financial bottom line. But, there’s something more damaging to your business than refunds – chargebacks.

What’s a chargeback and how does it work?

A chargeback works a lot like a refund for customers. They receive their money back from their purchase. However, the main difference is that instead of initiating the refund with you, the business, they initiate the refund with the card-issuing bank through a dispute process. The issuing bank credits the customer’s account before coming to you, the merchant. They may do this for a variety of reasons – damaged, late, or poor-quality merchandise, not recognizing certain charges on their credit card statement, or even pretending not to recognize the charges, which is known as friendly fraud – customers buying items with the intention to dispute the charges after the fact.

Another major difference is that during the chargeback process, the business rarely receives back the goods that the customer ordered. That’s because a chargeback is not a return, and so the customer has very little incentive to return the product to you.

In addition to the customer not returning the product to you, chargebacks or cyber-shoplifting can be even more costly. That’s because you as the merchant must pay all the chargeback fees. These fees can include the interchange fees you paid to process the transaction, shipping fees, and any fees incurred because of the chargeback or your business disputing the chargeback. If you as the merchant choose to fight back against the chargeback, you also can expect to lose a lot of time. That’s because the process is time consuming, with weeks or months of back and forth between you and the customer’s card-issuing bank. In chargeback customer disputes, the responsibility to prove that the disputed transaction is legitimate to the card network (aka the credit card company) is squarely on the merchant’s shoulders.

But the real damage to your business is that chargebacks increase your chargeback ratio. If your business receives too many chargebacks within a specific time limit, your payment processing provider might deem you to be a high-risk merchant. As a high-risk merchant, you’re subject to higher credit card processing fees. Even more dire, you may lose your ability to process credit card transactions at all. Now, let’s see if chargebacks or refunds are better for your business.

Which is better for my business: Chargebacks or refunds?

As you can see, the reality of business is that you’ll probably encounter both chargebacks and refunds as a merchant. While both can be detrimental to your company, chargebacks are more damaging. Again, this is because there are not only more fees associated with chargebacks, but they can also affect your ability to access payment processors. If a customer has an issue, it’s best to try to solve their complaints with a refund. Here are a few reasons why:

You might be able to keep the customer: If the customer’s complaint is legitimate, you have a better chance of retaining the consumer by working directly with them to find a solution. Whether it’s a simple mistake like buying the wrong size shirt or something more intensive like product quality, it’s always best to resolve the issue without middlemen.

You can identify the issue sooner: If the customer files a chargeback, chances are you won’t know about it for weeks. However, if they come directly to you, you’ll know instantly. This is powerful as you can resolve the issue quicker for the customer while also preventing similar issues in the future.

You can save money: As we discussed, refunds are cheaper to deal with than chargebacks. By dealing with the issue directly, you’ll save on costs and protect your financial bottom line.

What’s a double refund?

A double refund occurs when a customer requests a refund for a purchase, then files a chargeback with the card-issuing bank for the same purchase. The merchant refunds the charge, unaware that the cardholder disputed the charge and therefore received their money back twice. This commonly occurs due to timing issues. That’s because when you issue a refund, it could take a few days to show up for the consumer. If they don’t see it within a given period, they may think you didn’t issue the refund and thereby request a chargeback.

To help prevent double refunds, it’s important to notify customers when you issue a refund and convey to them that the process could take a few days. By sending a refund confirmation email, you can assure them that you’ve issued a refund for the transaction in question and lessen the probability that they also file a chargeback.

Next, let’s look at how you can protect your business from refunds, and especially chargebacks.

How can I protect my business?

While every merchant wishes all customers were happy with their purchases and never asked for a refund, that’s just not realistic. However, you can mitigate the costs associated with these refunds by reducing the number of both legitimate returns and fraudulent charges.

First, here are a few things you can do to limit the number of legitimate returns:

  • Sell high-quality products and services: By offering top-of-the-line products, you’ll likely encounter fewer unhappy customers.
  • Provide excellent customer service: With friendly and reachable customer service, you can help spot potential complaints before they hurt your bottom line. You can also step in to issue refunds to help prevent customers filing chargebacks.
  • Have an accurate merchant descriptor: It’s important to make sure your merchant descriptor matches your business name. This can help mitigate chargebacks from customers who don’t recognize your brand on their credit card statement.
  • Offer reliable shipping options: Work with a shipping partner who has a trusted reputation so that your shipped items arrive on time and undamaged.

When it comes to fraud prevention, there are a few things you can do:

  • Require users to have a login: This makes it easy to trace purchases and harder for customers to claim they accidentally made a purchase.
  • Send users a discount: Those users who utilize the discount code will have a more difficult time claiming accidental original purchases.
  • Require additional verification: In addition to credit card numbers and expiration dates, look to require verification codes for ecommerce transactions found on the credit card. Depending on the card issuer, this could be a three-digit card verification (CVV on Visa, CVC on Mastercard) or a 4-digit card identification (CID on American Express or Discover). You should also use an address verification system (AVS) to match the billing address with what the card-issuing bank has in their records.
  • Use fraud management filters at checkout: These filters can help you automatically flag purchases that are suspicious – whether it’s with stolen card information or from unverified locations – and therefore lower the amount of fraudulent transactions you encounter.

When it comes to your business, make sure that your refund and return policies are straightforward, detailed, and easy for customers to access. By having an acceptable and honest refund policy, you can help mitigate chargebacks down the road. After all, as you’ve seen, a refund is much better for your business than a chargeback. That means that when a customer asks about returning an item, it’s in your company’s best interest to direct them to your refund policy. Building trust with your consumers can lead to positive outcomes for you, your business, and your customers.


Ready to work with a payment processor who can help you prevent chargebacks?

Heartland is the point of sale, payments and payroll solution of choice for entrepreneurs that need human-centered technology to sell more, keep customers coming back and spend less time in the back office. Nearly 1,000,000 businesses trust us to guide them through market changes and technology challenges, so they can stay competitive and focus on building remarkable businesses instead of managing the daily grind. Learn more at heartland.us.