News, reviews, business articles and site updates for a board games store in Canada

Fraud & the Chargeback Cycle

April 22nd, 2011 Posted in business
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Business loss is a given.   The moment you open your doors, you are going to face either theft, misplaced / mis-shiped & damaged items and worst of all, fraud.

As an online business, physical theft (“shrinkage”) is unlikely.  However, we run a higher risk of fraud than retail stores.  We regularly get a ton of scammy b2b e-mails, but consumer fraud (identity theft in particular) is what we’ll discuss here.


What is a chargeback?

A chargeback is the return of funds to a consumer, forcibly initiated by the consumer’s issuing bank. Specifically, it is the reversal of a prior outbound transfer of funds from a consumer’s bank account, line of credit, or credit card.

How it occurs is when a customer complains to their credit card company about the charge on their credit card.  Generally, this is due to a charge that is not recognised by the customer, a failure in customer service or fraudulent use of the card by a 3rd party.

What’s the Chargeback Cyle?

When a customer complains to their credit card, the card company then informs our payment gateway who then reaches into our account with them / our bank account and pulls the money from us immediately.

They then  send out a letter (not e-mail!) informing us of the chargeback and requesting we supply documents to support the purchase.  We are given 10 days to reply with the required documentation and failure to do so in those 10 days is considered grounds for the funds to be withheld.

If the evidence we supplied is insufficient according to the bank, the customer then gets the money they requested returned to them.

Issues with the Chargeback Cycle

There are a number of major issues with this proceeding.  Firstly, funds are drawn immediately from our account on the word of the customer.  Often, it’s just a matter of making a phone call to initiate this.

Secondly, the payment gateways generally charge an additional fee for each chargeback case.  Generally $10-20, no matter if you win or lose.

Thirdly, we are provided a total of 10 days (not business days); but because snail mail is used, we often only get the letter on day 8 or 9.  In a couple of cases, we literally get the letter after the deadline has passed.

Fourthly, the documentation that is requested is often; especially for fraudulent transactions are impossible to meet as an online business.  For example, they require a proof of the card presence (impossible);  an Authorisatoin Log proving the account number was not fictitious (possible by pulling the necessary IP logs), Evidence the Cardholder participated in the transaction (impossible to meet – we get your name and address but that isn’t sufficient evidence).

Potential Fixes?

Due to the recent chargeback, we’re going to have to institute some changes to how we deal with new, large orders.  It’s a series of internal controls and fraud checks, which generally won’t effect existing customers.  However, for rather obvious reasons I’m not going to list them out here. 🙂

However, the entire system is a problem and one that none of the credit card  companies or banks want to change.  It is not in their best interest to.  As a customer, you get your money back immediately so customers generally don’t care.

As the banks / credit card companies, you get to charge the initial gateway processing fee and then the chargeback fee (as above), generating additional revenue.  Since the funds and losses from the fraudulent cases come from the  merchants, they lose no revenue at all.

The only ones losing out are the merchants.  However, since credit card companies are an oligarch, there’s literally nothing that can be done about this.  It’s only if the larger merchants actively take a step and force a change that we will see some, for now, us small business just have to hunker down and hope.

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