When a cardholder disputes a purchase on their debit or credit card, they set off a series of events called the chargeback process. This involves the customer’s card issuer (i.e. bank), the card network and the merchant’s acquiring bank working together to determine whether the dispute is warranted and whether to refund the customer’s money.
 
A chargeback is therefund a merchant provides to a customer after they’ve successfully disputed a debit or credit card purchase with their payment card issuer.

Chargebacks’ Negative Impact on Merchants’ Bottom Line

It’s important for merchants to understand the chargeback process because the high costs of chargebacks can have a significantly negative impact on their profits. Here’s why:

• They lose the revenue from sale of the item or service.
• The cost to process chargebacks (chargeback fees) can be even greater than the cost of the purchase refund, especially with digital goods and services such as video streaming and online games. For that reason, merchants selling low-cost goods can be particularly harmed by chargeback fees. 
• Ecommerce merchants are liable for chargebacks associated with card-not-present (CNP) fraud.
• With physical goods, a merchant can’t always reclaim the item that was sold. So, the cardholder disputing the purchase may already have the product in their possession while also getting their money back.

Moreover, data suggests that merchants often get stuck paying for the bulk of the chargeback process. A study by the Federal Reserve Bank of Kansas City, for example, found that merchants were found liable for 70 to 80 percent of chargebacks analysed by the researchers.
 
Merchants have an opportunity to reduce the toll of chargebacks by providing compelling evidence showing that a customer’s dispute is unwarranted. But they have to present all evidence upfront, in a timely manner and at the right time during the chargeback process. This is called representment.

Here is a step-by-step guide to how chargebacks work:

Step 1: Customer Disputes Charge 

The chargeback process begins when a customer notifies their payment card issuer (usually by phone or online form) that they want to dispute a charge on their statement. Disputes happen for many different reasons, including:

• Dissatisfaction with the quality of the product or service the merchant provided
• Genuine fraud—an unauthorised charge due to a compromised card
• Friendly fraud—the customer doesn’t recognise the charge, even though it was legitimate 

The issuer asks the cardholder for basic details about why they’re disputing the transaction.

Step 2: Card Issuer Determines Whether Dispute is Valid

The issuer makes a determination based on the information provided by the customer about whether the dispute is warranted and should proceed to the formal chargeback process. If it does proceed, the issuer assigns a chargeback reason code—a numeric code that describes the reason for the chargeback. The code could indicate, for example, that the customer claims the transaction is fraudulent, that the merchant made an error, or that the purchased item never arrived.
 
Each card network (also known as card brand or card scheme) has its own chargeback reason code system that issuers use to explain the dispute’s cause. 

Keep in mind that if the merchant and the issuer use collaborative tools to communicate early about customer disputes, the issuer can alert the merchant of the dispute before the formal chargeback process begins.
 
Here’s how collaborative tools can help: They allow the merchant to reach out and work with the customer directly to resolve the problem—such as providing a refund or an exchange—and prevent the costly chargeback process altogether.

Not only does this save the merchant money, but it also allows it to repair its relationship with the customer. 

Step 3: Customer Receives a Credit

The issuer gives the customer a provisional credit for the full transaction amount being disputed. If the customer ultimately “wins” the dispute, they will keep the credit. If the customer is found to be responsible for the dispute, the credit is removed and returned to the merchant.

Step 4: Card Network Collects Dispute Information

Next, the issuer passes along all information about the dispute, including the chargeback reason code, to the card network. The card network then notifies the merchant’s acquiring bank about the chargeback and passes along all the collected information.  

Step 5: Acquiring Bank Notifies the Merchant About the Dispute

The acquiring bank notifies the merchant about the dispute and forwards it all of the chargeback information collected so far. At the same time, the acquiring bank deducts the transaction amount from the merchant's account.
 
By this time, it’s possible that weeks have passed since the disputed purchase was made, so it’s often too late for the merchant to do much about it—whether stopping the shipment of an online good or trying to resolve the issue directly with the customer.
 
The merchant has an important decision to make: Does it want to accept the chargeback—which means taking financial liability for it—or dispute it? That often depends on whether the merchant has enough proof that the customer’s dispute is unwarranted.

Step 6: Merchant Collects Compelling Evidence

When the merchant disputes the chargeback during the chargeback representment process, they typically have about 10 to 35 days to respond and provide any compelling evidence to the acquiring bank that shows the chargeback should not be granted to the customer.
 
Compelling evidence should include anything the merchant has that proves the customer received the purchase being disputed, made the purchase legitimately or agreed to the terms of purchase.
 
Evidence may include:

• Proof of delivery
• Copies of purchase receipts
• Cardholder signatures
• Contracts
• Customer email address or phone number(s) associated with the account
• Copies of all customer communications
• IP address match (for online transactions)
• Terms and conditions agreed to by the customer

Along with compelling evidence, the acquirer or dispute processor must submit a chargeback rebuttal letter that clearly and succinctly lays out its case for disputing the chargeback as well as a formal chargeback adjustment reversal request.
 
It’s essential for the merchant to provide all of the required forms and compelling evidence by the deadline set by the acquiring bank, or they will lose their dispute by default. Most merchants have a chargeback management process for this reason—so they’re ready to act quickly when chargeback notifications come in.

Step 7: Acquiring Bank Reviews the Evidence

The acquiring bank then reviews the merchant’s compelling evidence and chargeback rebuttal letter to assess whether the chargeback is valid or invalid. It then provides its assessment of a chargeback’s validity and all evidence to the issuer.

Step 8: Issuer Reviews Compelling Evidence Received

The issuer makes the final call on whether to keep or reverse the customer’s chargeback, and the two potential outcomes are:

• If the compelling evidence persuades the issuer that the customer’s dispute was unwarranted, it will revoke the immediate provisional credit it had provided the customer—and the merchant ultimately prevails in its dispute. The merchant will then get the transaction amount refunded to its merchant account.
• On the other hand, if the presented evidence isn’t compelling enough, the customer keeps the immediate provisional credit. At this point, the merchant or acquirer can continue to dispute the chargeback in what is known as the pre-arbitration and arbitration stages. The rules and process for this stage vary by card brand and chargeback reason code, and may also incur additional fees, so merchants should verify the process with their acquirer if they decide to continue. 

The reality, however, is that the merchant pays the chargeback fee even if it successfully disputes the chargeback and doesn’t have to refund the customer’s transaction. 
 
That’s why it’s important for merchants to take steps to prevent chargebacks before they happen. Collaborative solutions are powerful tools that can help resolve disputes before the formal chargeback process is initiated.