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Letter from the CEO: “Chargebacks”, the Ugliest Word in Payments (MAG Quarterly- Volume Five, Issue One)

By Mark Horwedel, CEO, Merchant Advisory Group

March 2, 2017

Chargebacks are the latest assault on merchants by the networks and the card issuers. Chargebacks make a mockery of guaranteed payment to merchants and saddle merchants with what is likely the biggest single expense of issuing cards aside from cardholder rewards (which is already funded by merchants through the highest interchange rates in the world).

Merchants in the U.S. have the highest costs of payment card acceptance in the world. Interchange fees started out relatively high and have continued to rise. Most network fees, originally divided between issuers and acquirers (ultimately paid by merchants), have been gradually shifted to costs borne directly by merchants and continue to increase. The recent EMV liability shift gave issuers, historically responsible for fraud expense, the opportunity to shift one of their biggest remaining expenses, chargebacks, to merchants. According to MAG sponsor representative and former MAG Chairman, Lee Jurgens, CEO of Prociant “The implementation of EMV without the PIN has reduced some fraud but the PIN would have made it more secure and universal and would have further reduced fraud. Fraud losses are still as high as they have ever been even though merchants were led to believe they would decrease.”

There are few if any merchants who will agree that they were given an adequate amount of time to prepare for the October 1, 2015 liability shift. The U.S. is by far the most complex card payment market in the world, but inexplicably was given the shortest amount of time to convert. Technical specifications for debit cards were not provided until 2 years into the original 4- year deadline making it nearly impossible for most merchants to avoid the liability shift. Today, well over a year beyond the October 1, 2015 date, many merchants are still standing in line waiting for mission critical vendors to complete hardware and software modifications. Even those few who made the October date complain about the tremendous outlay in internal resources and costs with very little or no payback for their efforts. 

Chargebacks are the merchants’ biggest complaint and they feel powerless to do anything about them. Issuers have taken advantage of the EMV liability shift to move fraud expenses over to the merchants’ books. We suspect most big issuers likely shifted enough expense to completely cover the cost of issuing EMV cards. The card networks are fond of saying the merchants failed to uphold their side of the effort by not moving as fast as the issuers towards EMV, but the complexity of the EMV conversion for merchants and the relative simplicity of the conversion for issuers (no requirement for off-line PIN validation) made it a virtual certainty that merchants would be the ones paying for fraud.

“Without proper checks and balances, card payments and their corresponding chargeback rights beg to be disrupted. 80% of chargebacks are ruled merchant liability—a number that is both staggeringly unfair and increasing from EMV and growth in digital channels (CNP) where, from my perspective, chargeback dollars are 12X higher and merchants are guilty until proven innocent. Merchants are currently looking at an increase in lost revenue of 67% by 2020.”  said Dave Wilkes, CEO of Chargeback another MAG sponsor. 

Chargebacks are rooted in the networks’ rules and requirements for merchant acceptance. Some are based upon statutes and regulations (Federal Reserve Regulations Z and E) designed to protect consumers. Others were designed to protect the payment ecosystem from fraud or to provide a means to correct transaction processing mistakes. Historically, fraud-related chargebacks provided a means by which issuers could shift the cost of fraud to merchants who failed to comply with the rules of acceptance. While chargebacks have always been controversial, the EMV liability shift has focused greater attention on them and given rise to one of merchants’ biggest complaints about card acceptance.

Many merchants feel they have been unfairly victimized by chargebacks associated with the liability shift. Stories abound suggesting cardholders are rapidly learning how to game the chargeback system to pay for staples like food and clothing. Other stories site instances of what appear to be obvious fraud where cardholders walk away from major purchases and issuers initiate an “EMV fatal chargeback” for which merchants have no recourse. 

Merchants are suspicious of the motives of certain card issuers who regularly top their list of issuers ranked by chargebacks as a percentage of card purchases. Are these issuers gaming the system by using robotic chargeback platforms or are they simply using chargebacks as a means to relieve themselves of bad debt?

Merchants are also concerned that the card networks don’t do nearly enough to monitor the bad actors among the issuers of their cards. They point to the fact that the networks regularly measure and report to issuers every merchant location with chargebacks that exceed certain parameters. Sometimes, this enables issuers to target those merchant locations for chargebacks. At the same time, merchants have seen no evidence that issuers are policed in any way. 

The MAG suggests the networks start policing issuers in much the same way they police merchants. Issuers whose chargebacks exceed specific parameters should be disciplined by reductions in interchange. Merchants should be given broader rights to re-present chargebacks initiated by issuers with excessive chargebacks and need to be made aware of the offenders so they can take steps to protect themselves against issuers with shoddy underwriting practices.

MAG sponsor, Auriemma, suggest merchants can also help themselves by adopting a “thorough and active marketing program, increased accessibility, and improved service levels, merchants can take control of the dispute flow – preventing unnecessary chargebacks and improving customer experience in the process.”

Another point mentioned by several EMV compliant merchants is to focus on the integrity of data when completing the EMV testing and certification process. Apparently, the global networks are primarily concerned about interoperability during certification while data integrity takes a back seat. Problems with data integrity have plagued many EMV compliant merchants by enabling issuers to chargeback purchases with minor technical errors and irregularities.

When card payment systems were first launched, one of the fundamental values provided to merchants was that card issuers would underwrite their loans and guarantee payment to the merchants who accepted their cards. Chargebacks are the latest assault on merchants by the networks and the card issuers. Chargebacks make a mockery of guaranteed payment to merchants and saddle merchants with what is likely the biggest single expense of issuing cards aside from cardholder rewards (which is already funded by merchants through the highest interchange rates in the world).