The Subscription Economy: Great Rewards, But Not Without its Risks
In the years since I co-founded eMerchantBroker, many merchants and businesses have moved away from the traditional pay-for-product pricing models and have begun to implement subscription-based pricing. Tien Tzuo, CEO of Zuora, coined the term "the subscription economy" to describe this paradigm shift. While this new model promises great benefits to all stakeholders, it's not without its risks.
What is the Subscription Economy?
The modern wave of subscription-based pricing models have their roots in changing customer expectations over the last 10 years. As mobile and cloud-based technologies have given consumers the ability to interact with businesses anytime and anywhere, consumers have begun to make new demands on companies. They've become more interested in good outcomes and less interested in owning things. They value service and constant improvement. And that's what they'll pay for.
What's Different About the Subscription Pricing Model?
Because of heightened consumer expectations, companies using a subscription model realize their focus needs to be on developing and monetizing long-term relationships rather than shipping products. That’s an entirely new way of operating. In the old "production" model, companies focused on one-time transactions. Continually working to attract new customers was a key driver. In the new subscription economy, however, the focus shifts to satisfying current customers and keeping them happy so they continue to subscribe.
It’s all about finding ways to deliver outstanding value to customers to ensure their loyalty. To make these long-term relationships work, businesses must understand their customers and what they want in much greater depth than ever before. This requires quality data about everything from their purchase details to payment histories, returns patterns, and browsing metrics.
Companies successful in configuring their businesses to achieve those ends have great success in generating recurring revenue from subscriptions, which gives them regular cash flow and reduces revenue volatility. It makes the business more predictable and more sustainable. And, because of the high levels of customer satisfaction and low churn, overall revenue levels are higher than in a pay-per-product company. The lifetime value of a customer is higher.
Risks in the Subscription Model
Like any pricing model, subscriptions have their inherent risks. Switching to such a model without adequately preparing the service processes needed to consistently provide value can result in an exodus of customers. Not investing in and mastering the technology needed to gather and refine customer data to better understand what customers need can have similar results. There's another risk that's not so obvious — chargebacks.
Most subscription models require customers to give credit card information so they can be automatically billed on a monthly basis. This is great for a company’s bottom line, but there's an inherent risk if the process isn't closely monitored. That’s because recurring payments have a higher-than-average decline rate. This high decline rate is, in part, the result of purposeful fraud. However, a lot of it is due to credit card information that has expired or changed, causing the transaction to be declined. The problem is, too many declines will affect your chargeback-to-transaction ratio (CTR).
What's CTR and Why Does it Matter?
CTR is an important measure used by credit card brands to determine if a vendor is high risk. The comparison of the number of chargebacks to the number of transactions tells the processor how good a job a company is doing at managing risk in its credit card processing. A lax vendor may have many declines caused by inadvertent card expirations and may not have good enough fraud prevention procedures in place. Even one or two chargebacks per hundred transactions can lead to expensive trouble.
If a company's CTR is more than 1 percent, it will be placed on a watch list and will see increased credit card processing fees. It can even lead to revocation of its account.
To reduce the risk of a subscription model creating a high number of chargebacks, it's important to first put into place systems and processes to monitor customer credit card information closely. A retailer can avoid the declines caused by expired credit cards by flagging customers with soon-to-expire cards and reaching out to them in plenty of time to update their credit information.
Sometimes customers dispute credit card charges because they don’t recognize the merchant name associated with the charge, or they just forget they've agreed to ongoing recurring payments. To avoid chargebacks in these situations, a company must make sure its merchant descriptor clearly identifies who it is, and that it's easy for customers to reach the company with questions before they dispute the charge.
Furthermore, to manage fraudulent activity, retailers must find and work with a credit card vendor with a good chargeback management system — i.e., one that notifies a company as soon as a charge is disputed so it can investigate and resolve the matter quickly. They should choose a vendor that has algorithms that can accurately determine when fraud is being attempted. They monitor transactions in real time looking for red flags such as multiple orders on a similar card number; orders shipped to different addresses but paid for with one card; or different orders from the same IP address. A good chargeback monitoring system will flag suspicious activity so that it can be investigated and action taken.
The subscription economy presents great opportunities for merchants to develop closer relationships with their customers and to capitalize on that by moving to a recurring payments model. The risks inherent in managing a subscription pricing model are real, but very solvable. Putting in place processes to resolve accidental declines and using the right procedures and technology to reduce chargebacks due to fraud will keep a company' s CTR low and allow it to avoid the card brand penalties that could be imposed. If a merchant keeps its risks in check, it can reap the rewards of joining the subscription economy.
Blair Thomas is the co-founder of eMerchantBroker, a credit card processing company.