Chargebacks: Why They’re Dangerous & How to Prevent Them

Chargebacks protect customers but often hurt merchants when shoppers misuse these rights. Such abuse can cost businesses millions—or even force them to shut down. 

Here is an overview of what we will talk about: 

1. The cost and risks for chargebacks
2. Why they happen
3. How to reduce your chargeback rate

Keep reading to learn more. 

Key Takeaways

• A chargeback rate above 0.90% means you are at risk of getting into a chargeback dispute monitoring program.
• Our recommendation is to be below 0.65% chargeback rate
• Getting into a chargeback monitoring program means getting rolling reserves, fines, extra fees, and even suspension. 
• Reduce your chargeback rate with solutions like chargeback alerts, 3D Secure, and improved customer service.

Understanding the True Costs of Chargebacks

Every $1 lost to fraud costs merchants $3.35. Altogether, chargebacks cost businesses over $25 billion annually, cutting 0.47% to 1% of profits for many. These figures don’t include other consequences of chargebacks.

1. Financial Impacts

Chargeback fees range from $10 to $50 per dispute, depending on the payment gateway. These fees don’t correlate with the product's value. For instance, disputing a $2 item on Stripe incurs a $15 fee—a 650% cost increase.

Almost all gateways will not reimburse these fees, even if you win a dispute. Except for Shopify. Fighting chargebacks adds further expenses, such as staffing costs.

Then, you’ll need to consider the costs that went into the disputed product’s sale:

• Acquisition costs: Marketing eats up 7% to 10% of revenue.
• Transaction and card processing fees: 1.5% to 4% of the sale.
• Operational costs: Logistics, inventory, and similar expenses take 20% of revenue.

You also need to delegate staff toward dealing with chargebacks. Let’s say you pay an employee $20 an hour. They spend a couple of hours gathering evidence for the chargeback, writing a rebuttal letter, and dealing with responses from your acquirer. That’s $40 diverted from business growth.

This chargeback calculator suggests if you had an average transaction value of $19 and had only 12 chargebacks monthly, you’d lose more than $7,270 a year from chargeback and administrative fees.

Here is an example scenario based on our chargeback calculator. A merchant with a $19 average transaction value faces huge losses. Twelve monthly chargebacks could cost over $7,270 annually. This includes fees and administrative expenses.

High chargeback rates lead to even greater losses.

2. Chargeback Monitoring Programs

Chargeback rates of 0.90% or more trigger monitoring programs with steep fines. After a four-month grace period, Visa’s program charges $50 per dispute. Staying in the program for 10 months results in a $25,000 monthly fine.

Mastercard imposes fines starting at $1,000 per month after one month. Remaining in their program for four months adds a $5 per chargeback issuer recovery fee for accounts with over 300 chargebacks.

Prolonged participation in these programs may lead to losing access to specific card networks.

While Visa claims these programs are rarely applied, many innocent merchants still find themselves in VDMP. They say only 1% of merchants end up in their fraud monitoring program. More than 130 merchants accept Visa, meaning more than 1.3 million of them were in this program.

Visa and Mastercard have various tiers based on chargeback rates, including stricter thresholds for fraud, digital products, or accounts without 3D Secure. These often carry harsher penalties. However, VDMP and Mastercard’s ECP take precedence over other programs.

Tip: VDMP refers to Visa Dispute Monitoring Program. ECP stands for Mastercard Excessive Chargeback Program.

3. Risk of Account Holds or Shutdowns

Sustained high chargeback rates can result in:

• Reserves: Gateways classify you as “high-risk” and withhold a percentage of purchases to cover future disputes, disrupting cash flow.
• Account shutdowns: Payment processors may ban high-risk merchants from their platforms.
• MATCH list placement: This blacklist blocks access to most processors, leaving only high-risk options with steeper fees.

Such consequences can destroy livelihoods, affecting businesses, employees, and suppliers. Merchants must focus on chargeback prevention to protect themselves from bad actors.

Why Chargebacks Happen: Common Causes

In 2023, over 238 million chargebacks occurred worldwide, with projections reaching 337 million by 2026. This surge costs merchants billions annually. To develop an effective prevention strategy, you must understand what you’re up against.

You’ll typically encounter the following chargeback types:

• Friendly fraud: Accounts for up to 60-80% of chargebacks. Customers dispute legitimate purchases, often unknowingly.
• Merchant error: Happens when businesses make mistakes, like shipping the wrong product. These cause 20–40% of disputes.
• True fraud: Makes up 1% of cases. Fraudsters use stolen payment details for transactions.

The terms "friendly fraud" and "chargeback fraud" are often used interchangeably but differ in intent. Friendly fraud involves unintentional disputes and isn’t illegal. Chargeback fraud is deliberate and punishable by up to 10 years in prison, depending on the severity.

Chargeback Prevention Strategies

The average chargeback win rate across industries is 30%, meaning merchants lose most disputes. While friendly fraud will make up the majority of those disputes, you’ll need to focus on preventing all chargeback types.

1. Enroll in Chargeback Alerts

Providers like Verifi (by Visa) and Ethoca (Mastercard) provide alerts through:

• Cardholder Dispute Resolution Network (CDRN): Allows up to 40 hours for merchant response.
• Rapid Dispute Resolution (RDR): Automatically processes refunds based on preset rules.
• Ethoca Alerts: Similar to CDRN but offers 72-hour response windows.

Each service supports specific card networks. Ethoca handles Mastercard transactions and limited support for other brands globally, while CDRN is US-focused. RDR exclusively covers Visa. These enrollments have other differences that you’ll need to weigh when considering which to use.

Alerts notify merchants when a customer files a dispute. Whether you opt for a reseller like Chargeback.io or go directly through Verifi and/or Ethoca, you’ll receive an  alert via your dashboard and email.

If you’re enrolled under CDRN and/or Ethoca, you’ll have to “respond”. This entails refunding the customer and stopping the dispute in its tracks. Confident you’ll win? Choose to fight the claim and recover the item's value.

For Chargeback's client, Dropship, using all three alerts in tandem reduced chargeback rates by 91%. Before adopting the alerts, their chargeback rate was 0.86%. If this rate had persisted, they would have entered a chargeback monitoring program. Within a few months, however, the rate dropped to 0.07%.

Another client, Tim’s Coffee, faced a chargeback rate of 1.1%. This placed them at risk of having their Stripe account shut down. After implementing CDRN and Ethoca, their rate fell to 0.09%. This allowed them to shift focus back to growing their business.

The effectiveness of chargeback alerts depends on several factors. Industry type, average order value, accepted payment methods, and other variables all play a role. Despite this variability, alerts remain one of the best tools to improve chargeback rates.

However, these alerts aren’t suitable for everyone. Providers, including resellers, charge up to $40 per alert. These costs can be prohibitive for smaller businesses or those with low transaction volumes. This is where resellers offer advantages.

Such resellers typically offer:

• Volume discounts: Costs decrease as the number of alerts increases.
• Faster setup: Alerts can be activated in 12 hours or less, avoiding prolonged back-and-forth with Verifi or Ethoca.
• Unified access: A single dashboard integrates CDRN, RDR, and Ethoca Alerts, reducing complexity.
• Lower costs: Businesses can avoid expensive chargeback management services, which often cost thousands per month.

Compare your options. For access to all of the above, consider alerts from Chargeback. Chargeback offers a user-friendly dashboard that focuses on a single job (alerts) and does it well. Take a look.

2. Improve Customer Service and Engagement

Customer frustrations often lead to chargebacks, with studies showing 81% of disputes arise from convenience. Poor customer service contributes, as over half of surveyed consumers report a decline in service quality over the past few years.

Distraught customers are more likely to file chargebacks. Reaching their card issuer is simple and often yields faster results than dealing with a business directly.

This frustration stems, in part, from declining customer service standards. Many businesses fail to address issues promptly, causing customers to lose trust. In turn, this leads to canceled services or disputes.

Managing constant customer inquiries may feel overwhelming, especially with limited resources.

One way to address this challenge is by implementing cancellation flows, such as those built with Churnkey. These tools gather feedback about customer concerns without requiring direct outreach and analyze the sentiment on the fly. Churnkey also streamlines returns, reducing the likelihood of chargebacks and churn. Reduce your churn, now.

3. Consider 3D Secure

3D Secure (3DS) adds an extra layer of fraud prevention by verifying customer information, often via two-factor authentication. It has reduced chargebacks by up to 70% in some cases. Thus, businesses in regions where it’s not required may find it useful.

While 3D Secure is effective at reducing fraud, it increases friction during checkout. On average, it adds 37 seconds to the purchase process. This delay leads to 22% of payments being abandoned.

The latest version, 3DS 2.0, aims to address these issues. It claims to allow up to 95% of transactions to proceed without additional steps. However, since major card networks adopted 3DS 2.0 in 2022, its long-term impact is still unclear.

Specifically, whether it can balance chargeback reduction with minimizing churn remains to be seen. For now, the safest approach is to rely on the previous two solutions or consider alternatives.

4. Use Consumer Clarity and Order Insight

Verifi’s Order Insight (OI) and Ethoca’s Consumer Clarity (CC) combat friendly fraud by providing customers with detailed order information. These tools have reduced eligible disputes by 70% (OI) and 23% (CC).

Implementation isn’t as straightforward as chargeback alerts and improving customer service. But the results show these are (free) solutions to potentially lower chargeback rates.

Preventing just one chargeback may deter future disputes. As statistics show 45% of customers who win a chargeback file another within 90 days.

Chargeback Prevention is Essential

Chargebacks have cost merchants billions of dollars over the years. This figure is expected to rise as threats like card-not-present fraud and chargeback fraud continue to grow. To stay ahead, you’ll need to adapt by implementing effective chargeback management strategies.

These can include utilizing chargeback alerts and ensuring that terms, conditions, and product descriptions are clear and transparent.

While it’s impossible to eliminate chargebacks entirely, it is possible to keep chargeback rates consistently low.

Thanks for reading.