Understanding chargeback fraud and how to prevent it
Vaishali Ravi
·May 27, 2024
Chances are, if you’ve been in business for any length of time, you’ve already encountered at least one case of chargeback fraud (otherwise known as “friendly fraud,” though it’s not exactly neighborly behavior.)
What is chargeback fraud?
Chargeback fraud is a type of financial scam that occurs when a consumer buys an item using their credit or debit card and then disputes the charge with their bank or credit card company. If the chargeback is approved, you’ll be liable for refunding the purchase price—even though the customer still possesses the product, which they may then opt to resell for a profit.
Credit card companies and other financial services providers offer strong consumer protections and chargebacks to protect customers against merchants who don’t deliver on their promises. Chargebacks can often be used for legitimate purposes—but, if the customer has negative intent, they can also be used to scam merchants like you.
Let’s look at what you can do if you end up in this scenario.
Why do chargebacks happen?
Many financial institutions and services, including major credit card companies, PayPal Goods and Services, and Klarna, offer buyer protections that help customers easily obtain refunds through issuing a “chargeback.”
These buyer protections are there to protect customers in cases such as:
- The item doesn’t arrive
If an item is marked as delivered but has not arrived, or a customer was billed for an order that the seller never gave them a shipping update on, they may file a dispute within 60 days of their credit card statement. - The item is significantly-not-as-described (SNAD)
In this case, the shopper is a victim of false advertising. For example, if a merchant marketed its jewelry as sterling silver, but the buyer receives it to find that it’s actually made of stainless steel, the merchant has significantly misrepresented the product, and the buyer is entitled to a refund.
- The item arrives broken or faulty
If the item doesn’t work as described or has significant damage from the shipping process, the buyer can make a chargeback claim. - Unauthorized transaction
This type of chargeback can occur if the order was placed by an authorized third party on the customer’s card. In this case, the card itself may have been stolen, or the third party may have simply obtained the customer’s credit card details—but in either case, the card should be immediately canceled and the customer should be entitled to a chargeback for any unauthorized purchases.
In all of these cases, except for unauthorized transactions, these situations could be effectively handled through customer support, so it’s important to provide multiple, convenient, 24/7 channels for customer support. Encourage customers to reach out to you first when they have a problem, so that you can make it right without getting their payment processor involved.
Understanding chargeback fraud
That said, when it comes to chargeback fraud, customers are abusing their payment processors’ buyer protections to take advantage of merchants—and this type of abuse accounts for about 50% of all chargebacks.
In our Consumer Fraud Report, we found that many customers misrepresent the condition or status of a product to receive a refund that they’re not entitled to. While 62% of respondents said they’d never engaged in returns fraud, those who had participated often did so frequently.
In fact:
- 26% of consumers who’d admitted to returns abuse claimed that a functional item was defective to receive a discount or refund at least once a week
- 24% of them claimed that an item never arrived to receive a second product and/or refund, at least once a week
- 25% of them tried returning an item with the knowledge that it wasn’t eligible for a refund at least once a week
Chargeback fraud can have serious consequences for your business, including lost revenue and damage to your reputation. In addition, merchants are often left to cover the cost of chargebacks and may even face additional fees from their payment processors.
To minimize the risk of chargeback fraud, it’s important to put an effective fraud prevention program in place.
How to fight back against fraudulent chargebacks
Use these strategies to protect your brand from fraudulent chargebacks:
- Use shipment tracking and signature confirmation
Particularly if you sell high-value products, customers who fraudulently claim they never received an item can cause significant losses to your business. By using order tracking and signature confirmation, you’ll have hard proof that a customer received their order, which you can use as evidence if they claim the package never arrived. - Require CVV verification
Online purchases typically require customers to enter their credit or debit card’s CVV number, a three or four-digit security code on the back of the card. This helps verify that the customer has physical possession of the card and can reduce the risk of unauthorized transactions. - Implement address verification
Address verification services (AVS) allow merchants to compare the billing address entered by a customer with the one associated with the credit or debit card used for payment. A mismatch could be a sign of fraud, and you can take additional steps to verify the transaction before shipping out any products. - Use fraud detection tools
AI fraud detection tools can analyze transactions in real time and flag any suspicious activity. These tools use machine learning algorithms and historical data to identify potential fraud and can help prevent unauthorized transactions. - Blacklist customers who frequently abuse your returns policy
If a customer has made multiple chargebacks claiming that items never arrived or arrived damaged, it’s time to stop giving them the benefit of the doubt. Block their IP address so they cannot continue to abuse your store’s policies.
Curb returns abuse with automated returns management
Using a best-in-class returns management solution like Loop can discourage customers from taking advantage of your business and help you prevent return fraud.
For instance, offering flexible returns solutions, such as Instant Exchanges, where a customer can effortlessly swap out one product for another of their choice, may deter them from choosing chargebacks to get refunded for products they don’t like. Loop also offers integrations with 3PLs, providing you with data insights to ensure that items that customers have returned are in return-eligible condition before signing off on their refund, as a way to mitigate the risk of customers returning worn or otherwise ineligible items.
By pairing a strong fraud prevention program with sophisticated returns management technology, you’ll be able to lower your risk of fraudulent returns and keep your bottom line strong.
Want to learn more about how Loop can help you reduce fraud?
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