By Patti Murphy
Merchants, still reeling from the economic fallout from the COVID-19 pandemic, now have an added problem to contend with: rising chargebacks. The implications for ISOs and merchant level salespeople (MLSs) are real and quantifiable. "It all comes down to the cost of incremental residuals, and increasing chargebacks are going to be a knock against that," said industry attorney Adam Atlas.
A 2020 report by the Deloitte Center for Financial Services put an even starker spin on the problem. "The increase in chargebacks could create a liquidity challenge among some cash-strapped acquirers and independent sales offices (ISOs) or member service providers (MSPs)," the report warned.
Chargebacks were on the rise before 2020 but have been spiraling out of control since the pandemic forced merchants and consumers to move most of their buying and selling to online venues. McKinsey & Co. estimated that consumer and business digital penetration vaulted 10 years during the first three months of pandemic-related shelter in place requirements. Consumers spent $861.12 billion online in 2020, a whopping 44 percent year-over-year increase, and nearly triple the growth recorded in 2019, according to Digital Commerce 360. The research firm estimated that online purchases by U.S. consumers made up 21.3 percent of total retail sales in 2020, up from 15.8 percent in 2019 and 14.3 percent in 2018.
"Every demographic now understands how to do business online," said Monica Eaton-Cardone, co-founder and COO of Chargebacks911. Businesses that never considered online sales had to pivot to accommodate customers with online options, like buying online for in-store (or parking lot) pickup. In fact, some of the biggest jumps in chargebacks are tied to buy online pick-up at store arrangements. Prior to COVID, chargeback rates on these transactions hovered between 1 and 2 percent; now they are north of 20 percent, according to Eaton-Cardone.
Meanwhile, consumers who never shopped online were forced to shift to online buying, and many were unaccustomed with how to protect payment card information in this new shopping environment, rendering them vulnerable to card account thefts, Eaton-Cardone noted. Others, experiencing buyer's remorse, are using the chargeback mechanism to assert unauthorized purchases or defective or undelivered items, resulting in what are euphemistically called "friendly fraud."
The social distancing policies of delivery services have played a role, too, said Alex Roy of Gateway Funnel Pros, a gateway and chargeback solution provider serving small firms using the ClickFunnels website-building platform. "It is still common for deliveries to be dropped at a doorstep without a signature—even if the company shipping the product specifically requests a signature," he said, adding that this makes it possible for buyers to claim the product was never delivered and "manipulate" the chargeback system and commit friendly fraud.
Then there were the more overt forms of fraud. "There's a continuing proliferation and availability of [ill-gotten] usernames and passwords," said Jeff Sakasegawa, trust and safety officer at Sift. He pointed to the recently revealed RockYou2021 breach that resulted in 8.4 billion customer records being compromised. (RockYou is an interactive media and entertainment company that has been breached more than once.) "As this information makes its way onto the dark web fraudsters are using it to access [payment card] accounts and making illegal payments," he said.
Some fraud is rooted in financial insecurity. "There is a huge cohort of people, particularly in service industries, who are unemployed, and their debts didn't stop rising," Atlas said. All these factors and circumstances have created a "perfect storm" for friendly fraud and other types of chargebacks, Eaton-Cardone noted.
Growth in transaction volumes inevitably leads to higher volumes of chargebacks. Disputed transactions typically represent five basis points of transaction volume, according to Mercator Advisory Group. (That's five chargebacks for every 10,000 transactions.)
In a 2020 report, Mercator estimated that 25 million credit card payments were disputed in 2019, and predicted the number will grow to 33.4 million by 2022. "As consumers switch from cash to cards for payments, the number of small transactions [disputed] increases. These small transactions can cost as much as large ones to resolve," the report noted. "Simultaneously, improvements in online and mobile banking are making it easier for cardholders to dispute transactions, accelerating the increased volume."
While credit card chargebacks are the most common types of disputes, the problem doesn't stop there, Mercator noted. Disputes can also involve payments by debit cards, private-label credit cards, mobile P2P payments, and emerging payments like real-time payments. In the credit card world, chargebacks are up 25 percent over pre-pandemic levels, according to Eaton-Cardone.
Chargeback Gurus has seen year-over-year growth in chargeback-related merchant revenue losses ranging from 15 percent to 30 percent, said Colin Eddy, the company's partner alliance guru. The number of chargebacks isn't all that's rising, either. The average chargeback amount rose from $155 to $163 between 2019 and 2020, and has shot up to $173 so far this year, according to Sakasegawa. "It's a rising tide," he said. "As more traffic moves to ecommerce, we're seeing more chargebacks."
A survey of merchants conducted by Censuswide for Chargebacks911 revealed that a majority had experienced increased friendly fraud between 2018 and 2021. Not surprisingly, larger businesses saw the largest increases. Nine in 10 of those surveyed said friendly fraud is a concern for their business.
Of the 400 U.S. and UK businesses surveyed, a majority also saw increases in criminal fraud, with an average reported increase of 21 percent. And although merchants responded to 43 percent of chargebacks, the average net recovery rate was just 12 percent, according to a report detailing survey results. "Things are probably going to get worse as we continue to experience structural changes and shifting consumer behavior," Eaton-Cardone said.
The potential repercussions of chargebacks reach far and wide. There are significant financial consequences for merchants. These include lost revenues on items sold; the costs of stocking, storing packing and shipping orders (for ecommerce sale); the processing fees paid when an item is sold; and the time and expense of challenging chargebacks. In addition, chargeback fees, ranging from $50 to $150 per chargeback, are assessed by acquiring banks. Merchants that rack up excessive chargebacks are subject to fines; these range between $10,000 and $250,000, Eaton-Cardone stated. "Merchants are much more vulnerable to having their lives turned upside down," Eddy added.
Merchants also risk being flagged as high risk and placed on the MATCH list, which makes it difficult to apply for new merchant accounts. And they risk having funds held in reserve by acquirers as a hedge against future chargebacks—or having their merchant accounts shut down.
"Processors are not taking as much of a lenient approach to chargebacks," Eddy said. "In the past year we've seen banks and processors get much more risk averse. They have no tolerance for even the slightest inclination toward chargebacks."
This means ISOs and MLSs will potentially find it more difficult to board new merchant accounts. "It's a natural push and pull," Sakasegawa said. "As chargebacks rise, [ISOs and agents] can expect more conservatism in underwriting." In fact, some acquirers are refusing to underwrite accounts for merchants with histories of chargebacks, Eaton-Cardone noted. "Merchants aren't the only ones losing money on chargebacks. Chargebacks are the enemy of everybody."
Merchants can and should fight chargebacks. But often they accept chargebacks, particularly those involving small-dollar transactions, as too costly to fight, and thus a cost of doing business.
"One of the best things the industry could do to eradicate chargebacks is to require every merchant that gets X number of chargebacks to respond to each and every chargeback," Eaton-Cardone said. She noted that many merchants drop the ball by not providing all necessary transaction information needed to challenge a chargeback. "Acquirers need to be proactive," she emphasized.
Sakasegawa pointed out that ISOs and MLSS can play an active role in educating their customers. "They should share best practices as much as possible," he said. Eddy agreed, stating that a big part of preventing chargebacks is understanding the underlying causes: reason codes, underlying problems in sales, marketing and fulfillment.
"The smartest payment [services] providers have risk rules," Eaton-Cardone said. "There needs to be real-time vision [into merchant transactions] and analytics, and that needs to be connected to their payout models and risk management routines." That way, any abnormal activity can be flagged before merchandise goes out the door, she added. Recovery strategies are also crucial. Eaton-Cardone has this advice for acquirers and their sales partners: "Require any merchant you suspect has rising chargebacks to engage a representment service or represent chargebacks themselves."
Eddy concurred, stating, "It's always better to outsource the recovery piece." Chargeback solution providers have access to more data and tools than a merchant might have at their disposal, he noted. And, according to Eddy, Chargeback Gurus' experience indicates merchants who go it alone have a recovery rate of about 50 percent; for those who outsource the process the recovery rate is 57 percent. "That can mean a difference of thousands of dollars a month," he said. For ISOs and MLSs selling chargeback solutions, the reward can be more trust and income. "You're increasing the lifetime value of a relationship," Eddy said. 
Patti Murphy is senior editor at The Green Sheet and co-host of the Merchant Sales Podcast. Follow her on Twitter @GS_PayMaven.
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