Examining the Financial Impact of Chargebacks on Merchants

Uncover the financial impact of chargebacks on merchants, including costs, lost sales, and mitigation strategies.
by Roenen Ben-Ami
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Published: June 21, 2023
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For businesses, particularly in eCommerce, aiming for operational resilience and financial health, understanding the full scope of financial implications associated with chargebacks is growing in importance. The costs are far from simple and extend well beyond any initial transaction values.

To better understand these costs we've broken down the ones you should be aware of.

Direct Costs: A Close Examination of the Immediate Financial Impact

The most immediate financial consequence of a chargeback is the direct loss linked with the original transaction. Upon processing a chargeback, a merchant loses the revenue from the disputed sale and bears several additional costs. These extra expenses encompass chargeback fees, processing fees levied by payment processors or issuing banks, and administrative overheads involved in managing the dispute.

These direct costs significantly inflate the overall financial loss from the disputed transaction. According to the Merchant Risk Council MRC, the actual cost of a chargeback often exceeds the disputed amount. On average, a merchant loses about 1.5 to 2.5 times the disputed dollar amount when considering fees and operational costs. This significant increment in losses can substantially affect a business's profitability.

Lost Sales: The Ripple Effects of Chargebacks

The financial impacts of chargebacks extend beyond direct costs and often manifest as indirect financial consequences. One significant indirect financial effect is the potential loss of future sales. As Nasdaq suggests, chargebacks can negatively affect customer retention rates and dissuade potential customers who rely on user reviews. Negative reviews associated with chargeback disputes can tarnish a merchant's reputation, deterring potential customers from making purchases.

A high volume of chargebacks can distort a business's sales metrics and lead to inaccuracies in crucial performance indicators such as conversion rates and customer lifetime value. Inaccurate metrics may obstruct businesses from effectively assessing their marketing strategies, optimizing product portfolios, and making data-driven decisions. These complexities add challenges in identifying growth opportunities and improvement areas.

Indirect Costs: Understanding the Hidden Financial Implications

Chargebacks also incur various indirect costs. Managing chargebacks effectively demands dedicated resources and expertise, whether the process is handled internally or outsourced to third-party providers. Square emphasizes the considerable time and resources needed to manage chargebacks, shedding light on these hidden costs.

These concealed costs trickle down to customer service departments as well. Handling chargeback disputes requires additional communication and support, stretching customer service resources thin and affecting their ability to effectively resolve other customer inquiries. The added strain can potentially slow response times and decrease customer satisfaction. Additionally, the constant negativity associated with handling disputes can impact employee morale and productivity levels, further augmenting the financial implications of chargebacks.

Chargeback Scenario: The $150 Disputed Transaction

Consider a merchant specializing in designer handbags. A customer purchases a handbag for $150 but disputes the transaction a few weeks later, citing 'unauthorized charge' as the reason. Despite the merchant's stringent security checks, the card issuer sides with the customer, triggering a chargeback.

Direct Costs: Transaction Reversal, Chargeback Fees, and Dispute Fees

The immediate financial hit for the merchant is the reversal of the transaction amount - $150 in this case. On top of this, the merchant's bank imposes a chargeback fee, which varies from $20 to $100 depending on the bank and the merchant's agreement. Let's say it's $25 for this example.

In many cases, merchants choose to dispute the chargeback if they believe they have sufficient evidence to win the case. This process usually incurs an additional dispute fee from the card issuer. Let's assume this fee is $15. Thus, the direct costs linked to the transaction reversal and the chargeback process total $190.

Operational Expenses: Labor and Management Costs

Managing a chargeback requires significant time and resources. For instance, employees must collect transaction evidence, compile a compelling representment case, and communicate with the bank and payment processors. Let's say this process takes five hours and the employee handling this earns $20 per hour. That's an additional $100 in labor costs.

Moreover, if the merchant is using a third-party service to assist with chargeback management, they'll incur those costs too. If the service charges $50 per chargeback, the total operational cost comes to $150.

Product and Logistics Costs

In this case, since the customer disputed the charge claiming it was unauthorized, it's likely the handbag was indeed delivered. If the merchant can get the item returned, they won't face a complete loss on the product. However, they will have to account for restocking and potential repackaging costs. If restocking costs $10 and repackaging costs are another $10, that's an additional $20.

Potential Costs: Loss of Future Business and Reputational Damage

Chargebacks can lead to long-term repercussions, particularly in terms of potential loss of future business. Negative experiences could lead to bad reviews, possibly dissuading future customers. Given that a Zendesk study found that 54% of customers share bad experiences with more than five people, the damage can be significant. We'll estimate the loss of one future sale, or $150, to illustrate this potential impact.

Calculating the Total Costs

Adding up all these costs could give us:

  • Transaction Amount: $150
  • Chargeback Fee: $25
  • Dispute Fee: $15
  • Operational Expenses: $150
  • Restocking and Repackaging Costs: $20
  • Lost Future Sale: $150

This means the total potential cost for this $150 chargeback could reach $510.

This startling number is a wake-up call to all merchants. It highlights just how deep the financial rabbit hole of a single chargeback can go, and underscores the importance of  chargeback management and effective fraud prevention strategies.

Strategic Chargeback Management: Mitigating Financial Impact

Despite the significant financial implications of chargebacks, adopting a proactive and strategic approach can help mitigate these impacts.

  1. Preventive Measures: Implementing clear return and refund policies, maintaining accurate transaction records, and securing payment processing practices can significantly prevent chargebacks. As Shopify highlights, these preventive measures are a crucial first line of defense.
  2. Effective Dispute Management: Establishing an organized chargeback management system can significantly streamline the dispute process and improve outcomes. This could involve training staff to understand the intricacies of chargebacks, equipping them with the necessary tools to manage disputes effectively, or using technology to automate dispute tracking and resolution.
  3. Proactive Customer Communication: Timely, clear, and transparent communication can prevent many disputes from escalating into chargebacks. Responding promptly to customer inquiries, ensuring that transaction details are transparently communicated, and providing exceptional customer service can be instrumental in preventing chargebacks.

Understanding the overall financial impact of chargebacks can seem daunting. Our chargeback calculator can help businesses gauge the financial implications linked to chargebacks and assist in making informed strategies for effective chargeback management.

Chargebacks are an inevitable aspect of business operations, particularly for e-commerce merchants. By understanding their financial impact and preparing accordingly, businesses can better position themselves to mitigate these adverse effects.

To learn more about the impact of chargebacks on business operations read my contribution to Merchant Risk Council's article on "How Chargebacks Impact Business Operations as a Whole"

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Written by
Roenen Ben-Ami
Co-founder & Chief Risk Officer at Justt. I am an all-around payments expert and a veteran commissioned officer. I previously led the Chargeback and Merchant Risk teams at the payments service provider Simplex, which now successfully recovers millions of dollars a year using the best practices I developed.
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