You’re always looking to minimize risks and increase revenue for your business. Unfortunately, when chargebacks happen, it’s your service-based software company who has to pay the price. By learning about chargebacks and putting safeguards in place for when they inevitably happen, you can protect yourself from fraud, preserve your bottom line, and ensure that payments will successfully go through.
What are chargebacks?
Chargebacks happen when a consumer disputes a transaction, and the issuing bank immediately refunds the consumer. The payments facilitator (PayFac) is then mandated by the card networks to debit the funds and fee from the merchant’s account to cover the cost of the chargeback. While the financial cost varies widely, the industry standard risk metric is the chargeback-to-transaction ratio (number of disputes per 100 transactions). For most sectors, maintaining a ratio below 0.9% is essential to avoid card network fines and intervention
What’s more, not all chargebacks are legitimate. These false customer disputes, called friendly fraud, account for 70% of all credit card fraud, according to Mastercard.
Additionally, criminal fraud—in which criminals intentionally do chargebacks—and merchant or customer errors can also contribute to a high rate of chargebacks.
The software industry’s high ratio (estimated at 0.66%) is due to a combination of high card-not-present (CNP) transaction volume, frequent recurring billing (which customers forget), and high susceptibility to friendly fraud.
If you are a software payments facilitator (PayFac), you bear the primary financial liability to the acquiring bank. You are responsible for recovering the chargeback amount and fee from your sub-merchant partner. If you cannot recover the funds, the loss is sustained by the PayFac. This could result in a loss of revenue, as well as time.
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Defending your software company from chargebacks
As the payments facilitator, since you are especially vulnerable to chargebacks, you need to use the right tools to protect yourself against them. If you put precautions in place, then you can save yourself valuable time and money.
When determining the cost of a chargeback, you have to look at not only the transaction amount, but also chargeback fines, lost processing fees, and labor costs for managing chargebacks. The overall financial impact of chargebacks is $130 billion each year. With more and more businesses going online, that number is only expected to rise.
To avoid and minimize the risk of chargebacks, software payments facilitators can take different steps.
1. Maintain detailed transaction records
Software vendors with integrated payment features need to maintain records of every transaction as well as customers’ data. Then, you will be able to defend yourself against chargebacks by having that evidence on hand, and you can spot fraud if you see chargebacks happening over and over again.
Maintaining detailed records can help with fraudulent cases where customers circumvent the business and go directly to their card issuer to request a chargeback.
They may claim that:
- They never received/signed up for using the software, even if they had.
- They hadn’t authorized the transaction—but had.
- The service wasn’t as advertised—even though it was.
- A recurring payment was not canceled as requested—even though they never canceled it.
2. Provide great customer service
It’s critical to offer excellent customer service that makes refunds and cancellations easy and explicit. This simple step often prevents a customer from escalating a frustration directly to their bank, which is the definition of friendly fraud.
Software users should know the exact price of the software and how they will be billed (weekly, monthly, yearly, etc.) so there are no surprises and they don’t end up disputing the charges. The software company should be clear and transparent about the charges with the sub-merchant at all times. Communicating with the sub-merchant that they should be clear and upfront about any charges will save you a lot of time and money.
3. Avoid high-risk sub-merchants
Before working with a sub-merchant, you need to do your due diligence and screen them to make sure they won’t generate excessive chargebacks. If they have had issues with customers in the past, then they are likely to have them in the future as well.
You need to ensure that integrated payment features have the ability for the software company to determine the risk levels of sub-merchant looking to use their payment features. They should also be able to flag and monitor for risky behaviors for existing users.
Not only is there a cost risk, but the greater the number of chargebacks they start to have would result in their company being flagged by the acquiring bank/card networks as “high risk.” This can lead to increased processing costs, mandated rolling reserves, and even termination. It’s a lose-lose situation for everyone.
4. Put limits on all merchants (at first)
In the beginning stages of working with a sub-merchant, you could put limits on processing and make sure you closely monitor all transactions. If you see any suspicious activity, leverage tools like velocity checks, AVS (address verification service) mismatch alerts, and geographic blocking to address it right away.
Integrated payment tools to help with software company chargebacks
When searching for an integrated payments processor to use when working with sub-merchants, make sure your payment processor offers you real-time reporting, as well as insights and analytics into your transactions. You need to be able to examine payment trends, manage your refunds, and track your customers’ payment history anytime and anywhere. If you can review the data on a regular basis, you’ll see if patterns are emerging and whether or not there are excessive chargebacks happening.
The integrated payments processor should additionally have a risk team, provide safety and security, and supply a dispute management tool.
The dispute management tool is particularly helpful because it automates the process of compiling and submitting compelling evidence (transaction records, usage logs, customer service transcripts) to the bank/card network. This efficiency significantly increases the merchant’s chance of winning the chargeback and recovering the funds.
Companies have a tendency to automatically refund payments right away and not go through a whole dispute process. This common error, known as double-debiting, occurs when a merchant processes a refund to the customer after the customer has already initiated a chargeback.
The merchant loses the funds once to their own refund and a second time when the bank/processor debits the chargeback from the merchant. A dispute management tool prevents this by showing the merchant the real-time status of the dispute.The greater the scale of their company, the higher the risk someone doesn’t realize it was already “paid out” and accidentally sends another “refund.”
Getting started with Stax
With Stax Connect’s risk management feature, you can effectively manage risk and more. Stax Connect provides you with access to an in-house risk team for monitoring and validating all of the payment transactions processed on your software platform. It offers continued PCI DSS security and compliance at every level, and the ability for users to monitor and quickly respond to chargebacks from within your platform in real-time with the dispute manager API.
FAQs about payment chargebacks
Q: What are chargebacks?
Chargebacks occur when a completed transaction gets reversed because the consumer disputes the transaction they paid for, and the issuing bank or payments facilitator refunds their money.
Q: What is the global cost of chargebacks?
While the financial cost varies widely, the industry standard risk metric is the chargeback-to-transaction ratio (number of disputes per 100 transactions). For most sectors, maintaining a ratio below 0.9% is essential to avoid card network fines and intervention.
Q: What are the common causes of chargebacks?
The common causes of chargebacks are customer disputes (also known as friendly fraud), criminal fraud (where criminals intentionally cause chargebacks), and merchant or customer error.
Q: How prevalent are chargebacks in the software industry?
The software industry experiences the highest average chargeback-to-transaction ratio, estimated at 0.66%, which is higher than the total average across all industries at 0.60%.
Q: How can software payment facilitators protect against chargebacks?
Software payment facilitators can protect themselves against chargebacks by maintaining detailed transaction records, providing excellent customer service, avoiding high-risk sub-merchants, and initially setting limits on new sub-merchants.
Q: How can integrated payment tools help with chargebacks?
Integrated payment tools can assist in combating chargebacks by offering real-time reporting, insights, and analytics into transactions, allowing companies to monitor payment trends, manage refunds, and track customers’ payment history.
Q: What features should a good integrated payments processor have?
A good integrated payments processor should offer real-time reporting, insights, and analytics, a risk management team, security and safety measures, and a dispute management tool.
Q: How does the dispute management tool help in resolving chargebacks?
The dispute management tool helps in resolving chargebacks as it discourages companies from immediately refunding payments upon a dispute, which could lead to them losing out on funds twice due to existing chargeback fees.
Q: What services does Stax’s Connect’s risk management feature offer?
Stax Connect’s risk management feature offers access to an in-house risk team for monitoring and validating all payment transactions processed on your software platform, ensures continued PCI DSS security and compliance, and allows real-time response to chargebacks with the dispute manager API.
Q: What other help is available to manage chargebacks?
There are chargeback management software solutions that help companies reduce the risk of chargebacks via real-time reporting, in-depth analysis, and other tools.
