This post has been a long time coming, but it’s one that I finally made sure I sat down and wrote because I’m sure it can save someone from getting scammed the way that we did.
What is a chargeback?
According to our good friend Wikipedia:
A chargeback is the return of funds to a consumer, forcibly initiated by the consumer’s issuing bank. Specifically, it is the reversal of a prior outbound transfer of funds from a consumer’s bank account or line of credit.
The chargeback mechanism exists primarily for consumer protection. U.S. credit card holders are afforded reversal rights by Federal Reserve Regulation Z under the Truth in Lending Act. U.S. debit card holders are guaranteed reversal rights by Federal Reserve Regulation E under the Electronic Funds Transfer Act. Similar rights extend globally pursuant to the rules established by the corresponding card association or bank network.
A consumer may initiate a chargeback by contacting their issuing bank, and filing a substantiated complaint regarding one or more debit items on their bank statement. Chargebacks are the consumer’s last line of defense against unscrupulous merchants. The threat of forced reversal of funds provides merchants with added incentive to provide quality products, helpful customer service, and timely refunds as appropriate. Chargebacks also provide a means for reversal of unauthorized transfers due to identity theft.
You can see why this would be a good thing. I’ve encountered identity theft. Mike and Greg have had fraudulent charges on their credit cards, as has my girlfriend and several other people I know. They exist to protect the consumer.
But what about when the consumer is wrong? What if the consumer, not the merchant, is committing fraud? As we’ve found out, pretty much everyone wins except the business. The consumer gets the charge reversed, and the banks take their money back from us. Not only are we out the funds, we’re also out the goods that we shipped. Despite being able to provide tracking information to prove delivery for every single chargeback filed against us, we have lost all but one case. I did a quick search of my emails and I saw 11 chargeback cases from the past year. 11 times where we shipped the items and (to the best of our knowledge) the items were received by the customer. And we won once.
Scenario 1: International Fraud
This was the big one, and a large majority of the blame falls on my shoulders.
10/31/2008 – an order comes through on Tastefully Driven for 150 bottles of Glucosamine Chondroitin. The products total an even $6,000. Due to an error with our shipping system (since fixed of course), the customer is only charged $35 to ship the order to Singapore, bringing the total to $6,035. We use PayPal Payments Pro for our credit card processing. In PayPal, the funds appeared as they normally would. For international customers, address verification doesn’t work (for domestic customers, we’re able to see if the address on the credit card matches the one that we’ll be shipping to, essentially eliminating the possibility of fraud). We discuss the possibility of fraud, but agree to move ahead because we know it will take us a long time to get the products in stock. We figure if we stall long enough and ask enough questions, that we’ll be OK.
11/3/2008 – after shooting a few emails back and forth with the customer, I place an order with our manufacturer for the supplements. The customer replied to all of my emails, albeit with broken English, and answered a few questions about shipping and the date that he needed the order by. At this point, we were still a bit skeptical, but the fact that he was in constant communication with us made us feel better. George called and I emailed PayPal to see if there was anything they could investigate to help us prove without a doubt whether or not this was fraud. The phone operator basically read PayPal’s chargeback page over the phone, and we never received an email reply. We were skeptical, but also didn’t have any real proof of fraud. On an order of that magnitude, we easily make a few thousand dollars, which is probably the #1 reason why we proceeded.
11/13/2008 – we receive the supplements in from our manufacturer, and ship them via FedEx International. As you can see from the tracking information in that link, it arrived on 11/21 and was signed for someone named “.MR KHAMIS”. The customer replies back:
My order has been delivered.
Thanks for the best product and the best service.
Here is my new order :
– Creatine Ethyl Ester Capsules Size: 120 capsules,qty 400 Btl
– Fish Oil Capsules Size: 100 capsules,qty 200 Btl
Do you have instock ?
Please give me the best discount for the order.
I look forward to hearing from you soon.
At which point, we figure that we lucked out and that the order wasn’t fraud. To be safe moving forward though, we ask for future purchases to be done via wire transfer. Of course, we never hear back from the customer.
12/8/2008 – we receive a phone call from a lady in Indiana. Her credit card is brand new, has never been used, but has a charge from our company on it. Greg took the phone call. He asked how much. We were all in the room, and our hearts all stopped when we overheard her say $6,035. Greg says he’ll get back to her. We call our lawyer, who is enraged, but informs us we’re pretty much screwed. Knowing that the chargeback is imminent, Greg calls her back and tells her that she should call her bank to investigate the fraudulent charge. We wait.
1/14/2009 – we finally receive the notification of the chargeback that we had been waiting for. We of course file our response immediately, proving that the item was shipped and received. George calls PayPal again and receives no help…again.
2/23/2009 – almost four months after the initial transaction, PayPal informs us that we lost the case and that the $6,035 has been withdrawn from our account. We had kept it there all along, suspecting the worst.
For obvious reasons, I want to make sure that I publish this customers information. Mike researched his address and it appears to be a freight forwarding company, and I’m sure his name/email are fake. Nonetheless, if someone Google’s his name or address in suspicion, I want them to find this page and read our story.
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How we’re fighting it:
Because we cannot verify that shipping addresses match the address on the credit card, and because it’s infeasible to take legal action internationally (and to a lesser extent, customs restrictions), all international orders represent a high risk to us. We ran some numbers and learned that only about 6% of our revenue comes from outside the US. After some discussion, we decided to still ship internationally…for now. We’re taking a very very cautious approach to all international orders. If an order is over ~$100 and looks the least bit sketchy, we’ve been refunding the customer and requiring a wire transfer.
I’m assuming that Sipex’s success led to us being put on some sort of fraud list, because we’ve had three other similar transactions through Tastefully Driven since that time. I actually dealt with one a few days ago. In all of the cases, I immediately refunded the customer, told them that we’d need payment via wire transfer to proceed with an order of that size, and of course never heard back again. No customer has actually ever gone through with a wire transfer, which reassures us that we’ve probably prevented some additional fraud.
The thing with international orders is that they aren’t critical to our business. At some point, it won’t be worth the time and hassle to ship internationally. There is quite a bit of programming work involved with syncing our systems up with USPS for international orders, as well as work involved correctly filing out customs forms. We’ll piss some customers off, but we’ll make our business more efficient and less risky.
Scenario 2: Domestic Chargeback Blackmail
These actually bother me more. Here’s what will happen – a customer will place an order that we fulfill and then change their mind about something and make an unreasonable request. When I say unreasonable, I mean unreasonable. We always go above and beyond to correct mistakes or even inconveniences, whether it’s giving the customer a credit, partially refunding and order, or re-shipping an item. But when sometimes, when a customer demands absurd things, we draw the line. How do they react? By threatening us with a chargeback.
They think we’ll give in and acquiesce to their demands. Of course, we don’t. And in a few cases, they’ve actually gone ahead and called their bank to initiate the chargeback. They lie and tell their bank that the charge was fraudulent. We had two of these in less than a month over the holidays where we ended up losing the funds. We decided we had to fight back. We scheduled a meeting with our lawyer. He was equally as frustrated as we were. This stuff is very hard to fight legally. Also, even on a big order, you have to weigh how much of your time you want to spend hunting down a few hundred dollars. Then again, you also can’t let people steal from you without consequence.
How we’re fighting it:
We spent a few hours brainstorming with our lawyer the appropriate response. We decided that he will send a letter to the customer, stating that the order was shipped and received, and that we have proof that the chargeback was initiated as a form of blackmail. The letter goes on to request that the chargeback be rescinded or payment sent to us, and if we do not hear from them we’ll “pursue to the funds to the fullest extent of the law”. Depending on the unique situation, we’ll go from there.
I think he’ll be sending our first letter this week. I have mixed emotions about it. It’s sad that we need to do this, but if someone doesn’t stand up to people and let them know that this is wrong/illegal it’ll keep happening.
Scenario 3: Inaccessible Customers
The rest of the chargebacks generally go the same way: customer files chargeback, we find evidence that the order was shipped and delivered, customer doesn’t respond to our emails/calls, we lose chargeback. Very frustrating as well.
How we’re fighting it:
Not a whole lot we can do here. We’ll probably have our lawyer send a letter in these cases as well, but just make it less threatening and more focusing on the fact that we cannot get in touch and to please call us ASAP.
Newegg: the Ideal Model
Address verification is a precautionary measure Newegg.com performs to ensure your safety and deter fraudulent activity. The nature of online shopping does not permit us to request a traditional form of identification, such as a driver’s license, like a standard brick & mortar store. We instead conduct address verification through your credit/debit card issuer to confirm your identify and verify the validity of your purchase, ultimately protecting your credit and privacy.
This is the ideal situation. I think for us, it’s not a question of “if” but rather “when”. We’d obviously lose that 6% of international revenue, it will undoubtedly increase customer service, and we’ll probably lose some percent of US orders. It’s a price we’ll be willing to pay for simplicity and security, but not until we’re a little bigger and a little more profitable.
What I Learned From All of This
Flashback to that day when we found out about the international $6k chargeback. We all let out a few curses, but after 30 seconds we started figuring out what we were going to do about the situation. I called our lawyer, George called PayPal, and Mike and Greg researched international chargebacks. No one got mad, no one blamed anyone else. It was the situation we were in and there was no point worrying about things we couldn’t control. We became focused on what potential recourse we had and what we could do to prevent it in the future.
More than any other event in our company history, this is the one time that sticks out to me as the time I knew I had great partners. Many people would have pointed fingers, and in this case those fingers probably would have been pointed at me. It’s only when you go through stuff like this that you really get to know people. You see their true colors and their true intentions, and all I saw in that room that day was a group of people who made a mistake and were trying to figure out what the right thing for the company was to do moving forward.
Mark Cuban tells a great story in his Success & Motivation post:
Then I learned a very valuable lesson. Martin had done a great job of setting up our accounting software and systems. I got monthly P&L statements. I got weekly journals of everything coming in and everything going out, payables and receivables. We had a very conservative process where Martin would check the payables, authorize them and then use the software to cut the checks. I would then go through the list, sign the checks and give them to Renee our secretary/receptionist to put in the envelope and mail to our vendors.
One day, Martin comes back from Republic Bank, where we had our account. He had just gone through the drive through and one of the tellers who he would see every day dropping of our deposits asked him to wait a second. She comes back and shows him a check that had the payee of a vendor, WHITED OUT and Renee Hardy, our secretary’s name typed over it. Turns out that in the course of a single week, our secretary had pulled this same trick on 83k of our 85k in the bank. As Martin delived the news, I obviously was pissed. I was pissed at Renee, I was pissed at the bank, I was pissed at myself for letting it happen. I remember going to the bank with copies of the checks, and the manager of the bank basically laughing me out of his office telling me that I “didn’t have a pot to piss in”. That I could sue him, or whatever I wanted, but I was out the money.
I got back to the office, told Martin what happened at the bank, and then I realized what I had to do about all of this. I had to go back to work. That what was done, was done. That worrying about revenge, getting pissed at the bank, all those “I’m going to get even and kick your ass thoughts” were basically just a waste of energy. No one was going to cover my obligations but me. I had to get my ass back to work, and do so quickly. That’s exactly what I did.
When you get taken like we did, all you can do is get your ass back to work.
Update 7/23/2013: I’m glad that years later this post continues to elicit so many comments and emails. This is an important topic to discuss. However, prior to emailing or commenting, please thoroughly read the comments below and take a look at my other posts on chargebacks as well as the comments on those posts. A lot has already been discussed and we’ve made quite a few improvements in the 4+ years since this post. Thanks for reading!