The Merchant’s Challenge with Chargebacks

George Peabody

June 21, 2016

POF Podcast

Chargebacks are one of the card system’s great consumer benefits. If fraud happens, the merchant doesn’t deliver on what was promised, or you’re charged six times for something you bought just once, the chargeback mechanism returns your money or restores your credit. What’s not to like? Well, if you’re a merchant, a lot. While there are plenty of legitimate chargebacks, there are also consumers who take advantage of the system through “friendly fraud,” the “I didn’t do it” chargeback category abused by all too many.

Chargebacks are expensive for merchants. There’s a chargeback handling fee from the acquirer. There’s the cost of disputing the chargeback. There’s the cost if, at the network’s discretion, the merchant loses the chargeback. And then there’s the small matter of the cost of the goods or services. Take a listen to this audio primer on chargebacks with Glenbrook’s George Peabody and Chargeback’s CEO Dave Wilkes. Hear how they work, what the trends are, and how Chargeback assists merchants in the chargeback dispute process.

Payments on Fire 38


George:          Welcome to another Payments on Fire podcast.  I’m George Peabody, a partner with Glenbrook Partners, and it’s my pleasure today to have Dave Wilkes, who’s Chairman and CEO of  Welcome, Dave.  Glad to have you here.


Dave:              Thanks for being here, George.  I appreciate the opportunity.


George:          I look forward to a good conversation.  Now, for those of you who don’t know Dave, he’s really a long time entrepreneur in the payments space.  He worked with ProPay back in the day, he was also with Cofounder.  I think where I first ran across you, Dave, was you were one of the co-founders of the prepaid processor Galileo Processing.  Then there were 3 or 4 other companies in between then and today where you’re running Chargeback.  It’s a new company; it’s from last fall.  Is that right?


Dave:              Actually, the company was formed here in Utah in 2008; so it’s actually been around for quite a period of time.  It was backed by Kickstart Seed Fund in Utah, along with several of the Park City Angels, and I assumed the helm as, the board asked me to come in as Chairman and CEO the last quarter of last year.  Since then, I have brought in an entirely new team, so it feels like a new company, but the company was actually started many years ago.


George:          Got it.  Out of curiosity, in terms of the number of employees you have working for you, what’s the scale there?


Dave:              We’re at about 40-50 in terms of full time employees now, but one of the initiatives we have currently in process is we’ve raised 5 million and we were hiring 50 new employees; that will take us in about the next 12 months, to about 100 employees.


George:          Cool.  So what I want to do is backup, because we have a lot of folks who listen to Payments on Fire, and they’re maybe new to payments, new to cards, and I think having a little discussion about what the chargeback is, and how the chargeback process works, would be hugely helpful.  Out of that, I think we’re going to figure out what you’re going to do with all those people.


Dave:              Sure.


George:          So, what’s a chargeback, who initiates one, how does it flow, all those kinds of things.


Dave:              I think it’s always helpful to start from the cardholders’ perspective, and obviously the brand promise, the value of using a Visa or MasterCard is obviously zero fraud liability.  If you’re a customer, and you use your card at a merchant and someone steals your card or uses your card that’s not authorized, you’re guaranteed by the networks zero fraud liability.  So, the consumer protections are always in place to protect the consumer from unauthorized use or fraudulent use of their card, and by that very nature that means when the cardholders go and use their card with the merchant, it can ultimately go back to their card issuer – Citibank or Capital One or American Express, whoever it might be – and simply log-in to their account and click on “dispute a transaction”, and in 1 or 2 clicks, that originates a chargeback request from the issuer into the network – Visa or MasterCard – which flows through to the acquiring processor, who then notifies the merchant that this transaction has been disputed by the cardholder, and a chargeback has been initiated, and the funds are immediately net settled and reversed away from the merchant.


George:          Ok, so the merchant has probably already been paid, but in the next clearing and settling cycle the money associated with the chargeback gets pulled back.


Dave:              That’s right.  So the cardholder has a very long period of time to go back and dispute any transaction on their card account according to their Visa, MasterCard, AmEx, Discover network operating rules.  That protection is in place for the cardholder, so they can go back and select a transaction from 3, 4, 5, 6 months ago, and say “hey, I didn’t recognize this” or “I didn’t do this transaction” or “I ordered blue shoes and I received green shoes” or “the shipment never arrived” or any one of any number of reasons or scenarios, and the customer can just dispute that transaction.  That money is flowed through the network and reversed out of the merchants account, and it’s now the burden of proof on the merchant to provide the compelling evidence that it was a legitimate transaction, it occurred on this date, he visited our website on this transaction or did a transaction in our store and swiped his card maybe, and we ship the product – this is what he ordered, this is the proof of delivery, he signed for the receipt at his home through FedEx or UPS, and now the merchant has to provide all of this information about the transaction, because the cardholder has initiated a dispute and the chargeback process has begun.


George:          The network rules say, if you’re going to successfully dispute one of these chargebacks, you have to provide all that documentation to prove your point as the merchant.


Dave:              That’s right.  They have thirty days to respond to the chargeback, and if they don’t respond, they lose the window of opportunity to provide the compelling information and evidence that they did the transaction effectively.  It becomes quite a significant hassle.  It’s really easy for the cardholder, they just click, click, and boom, the money comes right back out of the merchant and fortunately today, I think there is about two-thirds of all of the chargebacks that occur through the networks are categorized as what’s known as “friendly fraud” or “chargeback fraud” rather than outright fraud, where someone has stolen the card and used it in an unauthorized perspective.  Maybe I did the transaction, and my wife didn’t recognize it when she looked at the credit card statement and decided to dispute it or whatever.  There can be a million different reasons and scenarios why the consumer chooses to do the dispute, but ultimately, once they choose to dispute it and the chargeback has begun, the burden of proof falls to the merchant to provide the compelling evidence that the transaction was done legitimately, and ultimately the network will decide who is going to win this dispute between the cardholder and the merchant.


George:          Got it.  At Glenbrook, we kind of look at this, the categorized chargebacks, in 3 different buckets:  there’s the fraud chargeback itself, which is the “I didn’t do it” chargeback, and as you say, that can contain the “friendly fraud” component; and then there’s service chargebacks, which are “I ordered red, but you sent me blue”; and then the technical chargebacks, if something goes wrong, like “I bought one of these things, but you charged me for six, so let’s unwind five of these”.


Dave:              Yeah.  In that first category, we break that down between actual fraud and what we refer to as friendly fraud.


George:          Make that distinction a little clearer for us.


Dave:              There’s really two types of fraudulent transactions, and I should say really one type of fraudulent transaction.  Fraud is when someone gains access to your account credentials – they can buy your credentials on the black market, they can receive it, maybe you have your mom’s card in your wallet and she’s not authorized you to buy a pizza Friday night with your friends, or whatever.  So fraud is fraud.  Someone has stolen my card and used my card without my permission – that is fraud.  It could be a result of a number of things.  It could be that a merchant got breached, it could be someone did a knuckle-buster and my card information was breached.  I have a letter right here on my desk, I won’t read the whole thing, but it’s basically from a state bank in Texas, talking about the particular situation where a consumer (one of their cardholders) went into an auto repair shop and did a legitimate transaction with the auto repair shop, but this scrupulous merchant took that card information that they received in a normal transaction, and then went and used that card information fraudulently to buy a $500 gift card at Michael Kors.


George:          Ok, that’s classic fraud.


Dave:              The other type of fraud, friendly fraud, is “hey I went to this merchant and made a purchase, and for some reason, my wife saw the transaction and decided to dispute it” or “my daughter got my card and made the transaction, and I just didn’t know about it; so when I saw the credit card statement, I just decided to charge it back, because it didn’t ring a bell”.


George:          So in those cases, you can argue that the cardholder broadly is responsible, either for the care and control of the card, or for the family member that’s made the error.  You’d think that someone might be responsible for their family members’ behavior.


Dave:              The problem in the industry is, you know the guy orders a Domino’s pizza, and the Domino’s pizza shows up half an hour late and half the pizza is burnt.  So what does the guy do?  He says “screw it, I’m just going to chargeback this transaction”.


George:          Absolutely.  I totally get that, because that’s significantly not as described.


Dave:              Well, it’s certainly not fraud.  The cardholder made a purchase from the merchant, the merchant delivered the goods, the customer received the goods, signed for the goods, ate the pizza, and then said “oh I’m just going to chargeback the transaction”.


George:          Okay, okay.  You have a lot to unwind here, don’t you?


Dave:              I’m just saying there’s a variety of buckets, not just the first category is fraud, the second category is too, you know.


George:          There’s a lot of nuance here inside this fraud.


Dave:              Yeah, and from our perspective, representing the merchants – and we represent Levi Strauss, Michael Kors, Twitter, Nikon Camera, and thousands of merchants all across the globe – we are seeing the effects of chargebacks in the various shades of gray that they all come in, and across our platform on all transactions, hundreds of thousands of transactions, two-thirds of all the transactions are friendly fraud.


George:          Really?  That’s really interesting.  Since that’s such a big component here, talk to me about how you unwind some of this.  It sounds pretty difficult.


Dave:              Well, it’s certainly a hassle for the merchant, there’s no question about it, because these transactions become quite painstakingly difficult to put the information together.  If you don’t do it within a timely manner, and you don’t respond with all the appropriate information, the compelling evidence, if you will, you clearly lose.  Even though the cardholder decides to just arbitrarily dispute and create a chargeback with their issuer, even though they ordered the Domino’s pizza, even though it came and they ate the pizza, and a month later they’re like “eh, I’m just going to charge this back”.


George:          So they’re just scamming the system.


Dave:              That’s exactly what it is.  In many cases, it’s online shop-lifting.  The customer has clearly ordered the goods, it was delivered to their house, they kept the goods, they posted a picture of this Nikon camera on their Facebook, taking pictures all over the place with the camera, and then are disputing the transaction with Nikon, like “oh, I never got the camera”.  Well why is it right there around your neck on your Facebook page?


George:          That sounds like a true life story that you guys have run across.


Dave:              All there are a million stories.  We can talk a lot about it, but at the end of the day, from our perspective, from’s perspective, chargebacks suck.  There’s no other way to explain it in terms of the pain point that it creates for the merchant.


George:          I totally get that for a merchant, particularly a smaller or medium-sized who doesn’t have any of this automated.  It’s manually expensive from a labor point of view, never mind maintaining all the data and signatures and that kind of thing.  Who charges who what?  I believe that the acquirer has a chargeback fee that they pass through.


Dave:              The problem here is that everybody has a fee.  A cost is assumed throughout this entire process.


George:          And all those fees roll down onto the merchant.


Dave:              That’s exactly right.  The issuing bank and the network and the acquiring bank and the acquiring processor and the network fees – all of the sudden, the true cost of the chargeback to the merchant, not counting all of the time and energy and resources devoted to gathering the information and providing that compelling information back to the processor and on to the network and on to the issuer, and the back and forth that can happen over the next 90 days, if you add all of that up, the fees, the time, the energy, the resource, it’s just overwhelmingly expensive.


George:          Can you just give me some examples of the fees; I totally get the time involved.


Dave:              A standard chargeback fee from a processor could be anywhere from $15 to $25 or $30, and then if they’re a high risk merchant, and they’ve got an inordinate number of chargeback transactions, they could be getting chargeback fees of $50 or $100 or $500 from their processor.  Ultimately, if they don’t keep these under the network rules of 1% of the transaction volume, they’re going to be penalized.  The way that they get penalized is in higher fees.  So this becomes a very, very expensive, painful, time-consuming proposition.  Let’s just talk about the average merchant right now, because I just walked into lunch today to buy one of these fruit bowls and I was standing there talking to the guy downstairs at an office, and I said “Oh, you’re using Square.  This is great.  How do you like Square?”  He had the terminal and he said “Yeah, I love Square.”  I said, “How many chargebacks do you get?”  “Oh, man, I hate those things.  Maybe 2 or 3 a month”.  And I’m like “What do you do when you get a chargeback?”  He’s like “I don’t do anything.  I don’t even know what I’m supposed to do.  I just don’t respond.  Then I end up losing those transactions.”


George:          So that might be okay for, well it’s not okay, but it’s not big money you’re talking about for a couple of fruit bowls and the fees that go down to him.  But this is pretty serious if someone’s talking about a classic, big-screen TV, for example.


Dave:              Right.  What’s interesting in this data is, take for example Michael Kors, we go through and really focus on the analytics, the reporting, and the interesting trends.  We can now pinpoint what we refer to as frequent flyers.  You have dozens of consumers who are repeatedly doing chargeback transactions across 20 or 30 different card accounts to the same shipping address, to the same naming conventions.  Now the merchant is able to get this data and this intelligence and start taking actions to prevent these transactions from happening over and over again.  They can analyze what is happening in their shopping cart checkout experience, when are they making the consumer/ cardholder agree to the terms of service and the refund policies and collecting all of the data, AVS, and the security code and expiration date, the shipping address and bill to address.  All of these things become very, very, very important for the merchant, and if they’re not following these best practices, it can be a very hard, painful lesson to learn.


George:          I bet.  Are there chargeback scenarios that are usually unwinnable for the merchant?


Dave:              Oh yeah.  Especially right now with the liability shift.  As of October, if you’re a retail merchant, and you’re not EMV terminalized or certified with your POS, and a customer comes in with a chip card, and swipes that card to make the purchase, that issuer may choose systematically, without the cardholder’s consent, to fire back a chargeback into that merchant, and make him eat the transaction.


George:          These are issuer originated chargebacks; these are not coming from the cardholder, it’s not fraud, it’s just a penalty of sorts from the issuer on to the merchant.


Dave:              Yeah, and it’s a huge pain point right now.  Obviously, there’s a lot of controversy around this.  Glenbrook, would obviously know, like two-thirds of the merchants still in the United States are not certified.  It will take months or years before we get to nearly 80% or 90% or even 100% of the merchants in the US having EMV certified terminals.


George:          The average chip time it takes in a country, not as complex as the US, is 6 to 7 years to get to a 90% chip on chip transaction rate.


Dave:              We’re probably in the 30% to 40% range now, and we have a long way to go to get to 80% or 90%.


George:          That’s painful.  I can imagine, well we already know that there are some lawsuits and regulatory moves around that particular problem.  So let’s not dwell on that one.


Dave:              Yeah, nothing we can do about that.


George:          It’s not fair, but let’s see what is going to happen.  Tell us what you do, because I assume you’re standing in the middle between the merchant and its processors or somebody.  You’re helping the merchant gather the data; how much can you automate that?


Dave:              That’s really the key; it’s the secret sauce.  First of all, our approach is unique in the marketplace, and we really like to believe that we align our interests with the merchant.  We go to partner with these guys, like Levi Strauss or Carter’s or Osh Kosh, and we say “You know what, we’re going to do all of this work, we’re going to do all of the integration, we’re going to gather all these data feeds, we’re going to be able to automate this so that this is not a pain point for your team internally, and we’re going to take this processing time down from what can be several hours for them to gather all the information and compile all the documentation and ultimately respond back to these requests – not all of them, there’s various levels of the data requests that come for a chargeback – and then we’re going to perform all of that ourselves.  We say to the merchant, “You know what, if we don’t win this chargeback, you’re not going to pay”.  So we will only take a small success fee on behalf of that merchant when we’re able to win those chargebacks.


George:          And that success fee is a percentage of the sale.


Dave:              Percentage of the recovered revenue.  If the average transaction size is $100, and we’re winning 70% of the transactions, then on 30% of the transactions, that are not winnable, or we have not won, that transaction whether it’s true fraud or EMV reason code or a number of different things, then that merchant doesn’t pay.  That’s been a great and unique characteristic and component of chargeback and really how we like to work with our merchants.


George:          Who do you connect to on the payments side?  Do you connect directly with the networks?  Do you have to go knock it down to each acquirer?


Dave:              It ultimately varies in each merchant’s situation, and who we’re working with, and how we process this information.  At the end of the day, you really need access to their internal customer files.  If it’s a receipt driven transaction from retail, maybe that image and that transaction is held somewhere, there’s a general journal somewhere that you need access to that image, you need access to their shipping partners for proof of delivery, their gateway for all the details of the transaction, the processor and the acquirer for all the merchant account details.  There’s a tremendous amount of data feeds that are important here, and honestly, the merchant community, the merchant processors and acquirers, they don’t really like to invest a lot of time and energy and resources into the tools and data and analytics and reporting.  They basically say, “Hey, look.  We can sign up as a merchant, you can use our platform”, you know whoever it is – Vantiv, TSYS, First Data – it doesn’t matter.  That merchant has to go use those tools and do all of this work to pull this information together.  Often times, it’s not automated.  We talked about it earlier, it becomes a very long, painful, excruciating process that is frankly, you know, you look at some of these larger merchants, a K-Mart or a T-Mobile, and they have teams of people all over seas, you know, 30, 40, 50 people working on these issues every single day, and it’s just a, it’s just a poor use of resource.  It really is an absolute waste and strain on the merchant organization to have to staff up the personnel that pull images of receipts.  I mean, come on.


George:          I have to believe that a fair proportion of all those folks that you’re hiring, are doing some of those same functions, but hopefully you’ve got automated data feeds to help speed that.


Dave:              So we look at ourselves as a technology driven service organization.  We ultimately become focused on the merchant, and how we align our resources and our interests with that merchant, and really think and act and work on behalf of the merchant.  Our tagline is – relax, we’ve got your back.  That’s really what we focus on, is going to bat for the merchant, and figuring out why this is happening, informing them on all of the interesting trends and details and data that come out of this information.


George:          Do you feed your analytics back into the fraud management system?  They’re a view queue?


Dave:              Yes.


George:          So you’re frequent flyers can be identified?


Dave:              Exactly.  So those can go into the negative file, and prevent those customer from doing repeated chargebacks in their e-commerce environment from buying purchases in store and vice versa or both.  If they’re using Account or Feedzai on the frontend, ultimately, the information that is available in our system, is the most important element in the fraud life cycle.  Which of these transactions really and truly resulted in a chargeback and why?  Why did the issuer ultimately process the chargeback?  Was there an account breach or did he eat the pizza and chargeback it anyway?


George:          Great.  You’ve got a front row seat to a lot of these changes.


Dave:              The information and the data become the really compelling, interesting part of our business, and beyond the service and the alignment that we do with the merchant to really make sure that this burden is lifted from the merchant in having to deal with these issues.  I think it becomes really important to analyze the information that we’re seeing, and really become an advocate of the industry.  Fraud is a cooperative component in payments.  It is not a competitive environment.  People want to share information that they’ve learned.  If we’re seeing frequent flyers of Michael Kors, Levi Strauss would probably want to know that you don’t want to sell to that guy, because he’s probably going to chargeback 62 transactions.


George:          Sure.  So have you stood up a shared data pool or do you just feed it into all the different queue management / risk management tools?


Dave:              We often don’t talk in detail about what we do to share information back and forth.


George:          I understand why.


Dave:              It’s proprietary.  But I can tell you this, the attitudes of our partners and our merchants is collaborative.  This is very, very important, compelling information for these merchants to know about, and ultimately, that’s why many of them retain our services and hire us to do this work; it’s because we sit in this intersection of all of these transactions, and it can really be a great advocate for the community.


George:          Fortunately, particularly on the merchant’s side, collaboration has been sort of the hallmark of the approach for a very long time, and there are a lot of folks out there who are aggregating data from multiple sources to help improve the determination.


Dave:              That’s right.


George:          I have to say that I’m a little distressed, almost, by the size of your friendly fraud and the story of the frequent flyers.  We’re talking about a transaction that gets backed out, but for particularly the card not present merchants, the merchant is out of the goods as well as the payment.


Dave:              Yeah.  They get hit on both sides.  If it’s the sale of a gift card, it can be even more painful.  It’s just a really painful process for the merchant to deal with.


George:          Well, Dave, before we started, I said I’d try to keep this down to 20 minutes, but that never happens, because they’re always such interesting conversations.  This is yet another proof of that.  Thanks very much for your time; I really appreciate it.


Dave:              It’s our pleasure, for sure, and we appreciate the opportunity to kind of shed some light here on what’s happening on the interesting stage of the industry that we’re in around chargebacks and I appreciate the opportunity to participate.


George:          Yeah, you bet.  Great, thanks again.


Dave:              You’re welcome.

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