The Costs of Chargebacks to Merchants

The Immediate Costs of Chargebacks

The cost of chargebacks to online merchants can be significant.  In fact, countless merchants have found their business efforts completely thwarted by frequent chargebacks. 

The initial cost of chargebacks is reason enough to be concerned.  Every chargeback automatically results in a loss of income due to the cancelled payment of an order.  Money a merchant already collected is suddenly (and often unfairly) taken from them.  For businesses that deal in relatively high-ticket items with lower sales volume, a single chargeback can truly devastate the bottom line.  Businesses dealing in smaller cost items that are not well financed may also have a difficult time weathering the storms that can be created by chargebacks.

Chargebacks are a margin killer.  Consider this scenario of John Acme and his widget sales site.  Each widget retails for $1,000.  The cost to Acme for a widget is $500, resulting in a profit of $500 per widget.  John has additional operating expenses of $2,000 per month.  Acme sells 20 widgets per month.  So, Acme clears $10,000 per month.  If Acme’s operating expenses are taken into account, his total cost of doing business is $7,000 ($5,000 for widgets plus $2,000 in other costs).  He makes a profit of $3,000 per month, on which he relies of living expenses. 

If Acme suffers two chargebacks in a month, he loses the $2,000 in sales after already purchasing the widgets.  His profit is now all the way down to $1,000.  Two chargebacks would crush Acme’s ability to pay rent, buy gas and eat.  Acme may or may not recover the merchandise he’s already sent out, but he will still not be able to profit from that until he processes orders for the next month.  Two simple chargebacks can turn his sufficiently profitable business venture into an outright disaster.

The impact of chargebacks can vary, of course, based on the exact nature of a merchant’s enterprise.  Regardless of whether or not a few chargebacks will destroy a venture, however, the Acme case illustrates that every chargeback creates a palpable reduction in bottom line profits.  Merchants are in business to make money—not to have it taken away.  Chargebacks, therefore, must be minimized or avoided whenever possible. 

This becomes increasingly obvious when one considers the other negative impacts of receiving chargebacks.

Thus, chargebacks don’t simply cost money of the front end with lost sales—they also jeopardize the very system by which the merchant can hope to collect any money.  Loss of a merchant account can completely devastate an online business.  During the period of cancellation, the merchant will be required to find a new processor if they hope to stay afloat and may lose countless sales if stuck “between” processors for any length of time. 

An example of the excessive chargeback “death penalty” can be found in virtually any merchant service provider.  For example, bitpass.com uses the following language with respect to accounts that have too many chargebacks:

“2.3.3 Excessive Chargebacks. If we determine that you are receiving an excessive amount of Chargebacks, in addition to our other remedies under this Agreement, we may take the following actions: (1) review your internal procedures relating to acceptance of BitPass accounts and notify you of new procedures that you should adopt (at your sole discretion) in order to avoid future Chargebacks; (2) assess or modify charges to process your Chargebacks; (3) collect from you an amount reasonably determined by us to be sufficient to cover anticipated Chargebacks and related fees and fines; or (4) terminate the Agreement upon written notice. You agree to pay any and all banking fees and fines assessed against you or against us relating to your violation of the Agreement or excessive Chargebacks under this section derived from Transactions on your web site or Transactions where you derived Net Funds.”

Clearly, generating too many charge backs can have a serious impact on one’s relationship with a service provider.

Additionally, merchant account providers are not always attracted to merchants with a track record of chargeback problems.  One may find themselves unable to find a processing partner, or may be left only with less desirable processors who charge larger fees. 

The prospect of suffering through these kinds of problems should motivate any online merchant to take action to avoid chargebacks.  Some, however, see these commonly encountered problems as unlikely worst-case scenarios and fail to take action.  Those with this opinion should rethink their perspective.

Chargeback Inevitability

If a merchant has not yet experienced a chargeback, he or she may feel as if they have no need to worry about the situation.  This is a flawed way of interpreting the matter.  If a merchant has not had a chargeback, it merely means it has not happened yet—not that it will never happen at all.

Unfortunately, the primarily rationale and reasonable internet consumer base is peppered with chronic complainers, scam artists and others who engage in the behavior that spurs chargebacks.  The anonymity and ease of use associated with internet purchasing makes online enterprises an exciting business opportunity.  Unfortunately, it also creates amazing opportunities for the nefarious, criminal and simply unreasonable.

In time, any successful online venture is likely to experience chargebacks.  Merchants simply have too little customer control to avoid it.  There will always be a low-life willing to use a stolen credit card number or an irrational customer who failed to understand their purchase prior to making it who ends up dissatisfied and willing to place a phone call to his or her credit card company.

Online merchants find themselves far more likely to be victimized by chargebacks than their traditional brick and mortar counterparts.  Chargebacks are at least ten times more likely for online merchants.  One industry study actually maintains that an online merchant is nineteen times more likely to experience a chargeback than a vendor in a traditional storefront.  Even conservative estimates put total losses caused by chargebacks at somewhere between one and a half and three percent of total revenue for online sales. 

Chargebacks are actually advocated by the media to consumers for a variety of circumstances that could be better and more fairly handled via other means.  A recent major newspaper article advised an individual who was dissatisfied with a vacation to immediately seek a chargeback and then to discuss the matter with the merchant in question.  Consumers are being actively encouraged to use chargebacks in any situation in which they are mildly dissatisfied instead of approaching merchants reasonably, discussing their concerns and looking cooperatively for a solution.

Any merchant who denies the likelihood of experiencing chargebacks should ask themselves how well he or she really knows her customer base.  In all honesty, most online merchants know little more than some scant information and a credit card number.  To believe they are insulated from the potentially devastating impact of chargebacks is folly.