The false promise of chargeback guarantee models in fraud detection

What is a chargeback guarantee solution? And is it better for merchants than a traditional payment fraud prevention solution?

Ravelin's CFO and Co-Founder, Nick Lally, explains.

Cardholder protection

A chargeback is the result of the process by which a customer disputes a transaction with their bank. Customers who make purchases with debit or credit cards are legally protected by rules which the card schemes enforce.

Disputes give consumers the right to file a complaint if they suspect any kind of unauthorized transaction on their card. Once the dispute is filed, the banks will then investigate the claim, with the merchant having the opportunity to submit evidence in their defence.

If the merchant "loses" the claim, a chargeback results. The card-issuing the bank will recover the funds from the merchant via their acquiring bank, and the consumer will get their money back.

• This means that the merchant will have both lost the item and the money it cost.

• On top of this, there are further fees handed down to the merchant by banks for processing a transaction that turns into a chargeback.

• Plus, there are dispute thresholds above which you end up on card issuers' bad books – meaning that as a merchant you will have to pay higher fees to process all transactions, including legitimate transactions.

All of this means that the cost of chargebacks can become very high very quickly for the merchant.

The promise of a chargeback guarantee is very tempting. No more chargebacks and no more stress? Is this too good to be true?

What's the chargeback guarantee model (CBG)?

Under the chargeback guarantee model, a fraud solution provider guarantees to pay the chargeback costs for any transaction they recommend to accept which nevertheless results in a chargeback due to third party fraud.

It's like the vendor is saying: I'm so confident I'll stop all fraud that I'll pay out of pocket for any chargebacks you do incur.

When choosing a fraud prevention provider it’s easy to focus only on the cost of chargebacks. The impact, however, is much greater. All payment fraud prevention systems have four costs:

• chargebacks,
• blocked good orders,
• the cost of the solution itself,
• and the people required to run it.

The promise of a chargeback guarantee model vendor is that all of those costs will be bundled into a single predictable cost that is a percentage of the revenue.

For many small businesses who can never justify a fraud team, this is a compelling offer. If your businesses is more sensitive to chargebacks than declined orders, this is also a strong proposition.

As a consequence, most of the clients that opt for chargeback guarantee products are small ecommerce sites and/or merchants that process sales of high margin goods and services.

1. Misalignment of interests between merchant and vendor

When it comes to larger businesses, the benefits of chargeback guarantee become less compelling. Here’s why.

If you consider the four costs that are built into a fraud strategy, two of them are in opposition: declined good orders (false positives) and chargebacks.

We all know that stopping all chargebacks requires a high decline rate even with an accurate detection system like machine learning (ML). Technically, in ML this is called precision and recall.

For a CBG vendor to maximise their margins, they need to minimize their chargebacks.

To do this, they have to increase the number of declined good orders. There is very little incentive for them to take on the risk as they wear the liability.

While in certain businesses this might be OK, in many more it is difficult to explain why good customers have been unnecessarily blocked due the the exposure of an external supplier to cost risk.

The true cost of declined orders is also a difficult one to measure. There is the immediate loss of an order but there is also the potential of putting the lifetime value of a customer at risk.

For businesses in highly competitive spaces, this is a real risk as a good customer goes elsewhere to satisfy their order. Having a fraud vendor that is incentivized to decline can be more costly than immediately realized.

2. Giving up agency and losing trust

Another feature of the chargeback guarantee model is that the merchant is giving up control of visibility. CBG limits the merchants ability to gain deeper insights to fraud.

CBG users have complained about a lack of control and insight. Getting accept/reject messaging, while uncomplicated, teaches a business little about the fraud risk it faces – about its unique fraud landscape.

For many merchants, losing visibility might be fine.

For smaller businesses or those with low volumes, understanding the nature of the fraud threat it faces and being able to engage on the prevention methods in place is not a priority.

For larger businesses, though, analysis and strategy are key to understanding not simply the current threat but also the emerging threatscape. After all, chargebacks are only a part of the risks that online businesses face.

3. Limited application

It’s also worth noting that the guarantee only relates to chargebacks that are as a result of third party fraud. Therefore, friendly fraud including fraudulent chargebacks, as well as other types of fraud. are still the responsibility of the merchant.

So the notion of never seeing a chargeback again... Well, is sadly not the case.

In fact, a merchant should also be resourced for a chargeback dispute process with their CBG vendor as we all know the reason codes on declines and chargebacks are rarely clear and never consistent.

At the heel of the hunt, merchants wants maximum acceptance and a CBG vendor wants minimum chargebacks. It then becomes a constant battle.

4. Chargebacks aren’t the only problem

As any business will know, the problems with fraud unfortunately don’t stop at chargebacks.

It’s likely that there will be account takeover, promo abuse, friendly fraud and more that your chargeback guarantee does nothing to prevent. Merchants will need to pull in additional technologies to strengthen business security – and then it’s maintaining multiple systems rather than just working with one fraud prevention company.

If you are a merchant that is trading at any volume or size, then you should be looking at investing wholly into your fraud prevention solution – looking at minimizing chargebacks and improve transactions across your whole dataset with all transactions to be treated equally.

Tackling the overall fraud problem once and for all

Our goal at Ravelin is to build trust, reduce chargebacks, and have a high acceptance rate because we know our models can predict which transactions will be good and bad before the sale even happens.

Working with a fraud prevention provider that is judged on accuracy rather than using a chargeback guarantee model means that the merchant will have higher acceptance rates and higher volumes of transactions.

We believe it is much better to work in partnership with a fraud vendor on the same goals of maximal acceptance and minimized chargebacks, in line with the goals of the business.

Adopting a holistic fraud solution that looks after all the transactions means greater volume of sales, reduction of false positives, insights and analytical reporting, lower chargebacks and end-to-end management of overall fraud.

Book a call with our team for more information.

Related content

• Our in-depth guide to payment fraud
• How are you counting the cost of chargebacks?
• Ravelin's machine learning Insights
• Refund vs chargeback: Why it pays to know the difference