payment failure clarified

Key macro trends driving the modern subscription economy

Consumer behavior has been transformed by the rise of e-commerce, though the payments systems infrastructure for e-commerce subscriptions is being pushed to its limits due to creaky “plumbing.”
Jan. 13, 2022
By Bill Hoppin, Butter Founder and COO
and Corey Harris, SVP Operations at BFA Industries (IPSY + BoxyCharm)
Jan. 13, 2022

Key takeaways

  • The COVID-19 pandemic accelerated a number of macro trends that were already in motion, leading to both opportunities and potential risks for subscription companies.
  • Consumer behavior has been transformed by the rise of e-commerce, though the payments systems infrastructure for e-commerce subscriptions is being pushed to its limits due to creaky “plumbing.”
  • An interconnected global economy will open up new opportunities for subscription companies but also poses increasing risks for payment failures, particularly due to challenges in cross-border payments systems.
  • An explosion in “buy-now-pay-later” purchasing has expanded the pool of potential customers but could also lead to more payment failures and shift financial risk onto subscription companies.
  • These trends all make it more likely that legitimate payments will fail as their authentication rates silently drop, exacerbating a problem that already costs companies more than $440 billion in lost revenue per year.

If you ask consumers why they chose to sign up for a subscription online—whether it’s for a streaming service or a beauty box—most would likely describe their decision as a personal choice driven by their individual interests. However, larger macro trends have a significant but often hidden impact on consumer buying decisions.

In this article, we examine how several of these longer-term trends—the continued rise of e-commerce, increasing globalization and the emergence of “buy-now-pay-later” purchase models—are likely to affect what we call the “modern subscription economy.” This refers to the ecosystem of online subscriptions that offer incredibly easy sign-up methods, deliver delightful experiences and provide frictionless service over time. The drawback in the modern subscription economy is that these consumers have very little patience for any disruptions to their experience and often blame the subscription companies—rather than their credit card providers—when their legitimate payment methods don’t work properly.

An explosion in “buy-now-pay-later” purchasing has expanded the pool of potential customers but could also lead to more payment failures and shift financial risk onto subscription companies.
Corey Harris, SVP Operations at BFA Industries (IPSY + BoxyCharm)


‍All three trends offer subscription companies significant opportunities but also introduce new risks. While these developments may open up new customer markets, they bring a higher chance of fraudulent activity, difficulties navigating clunky global payment systems and potentially greater financial risk for subscription companies.

Among this increasing complexity, there’s a greater likelihood that legitimate payments may be rejected due to overzealous fraud protection and dropping authentication rates. Revenue lost to false declines could rise from approximately $440 billion today to close to $650 billion within the next five years at the current growth rate. Just as subscription companies will need to stay on top of these trends, they will also need the tools to help keep their payment systems frictionless and maintain the loyalty—and dollars—from their best customers.

trend #1

E-commerce continues to grow—and has changed consumer behavior

In the past, in-person retail stores represented the main purchasing channel for consumer goods. Even as online options have expanded significantly, physical stores are still the preferred way for consumers to purchase goods that they need to experience in person. For instance, customers will probably always want to smell different perfumes, try on wedding dresses and test drive a car or truck before making a purchase. These are all one-time, point-of-sale purchases, with the experience being an integral aspect of the sales process.

One notable outcome of the COVID-19 pandemic was a significant shift to e-commerce purchasing. According to a report by Statista, global e-commerce sales grew by almost 30% from 2019 to 2020 as a massive number of customers spent more money on goods and services that could be enjoyed at home. While this rapid increase will likely slow a bit going forward as economies fully reopen and the world returns to “normal,” the Statista report still predicts strong growth through 2024, when total e-commerce sales are poised to exceed $6 trillion. This represents nearly five times the total of e-commerce sales in 2014.

Chart 1

Retail E-commerce Sales Worldwide
from 2014 to 2024

(Shows sales in billion US dollars)
Source
SWIPE

Traditional e-commerce transactions are easier, faster and more instant than in-person purchases that require a trip to a physical location. E-commerce remains dominated by credit cards, as seen by the more than 108 million credit card transactions that are processed in the U.S. every day. Credit cards aren’t physically present during e-commerce purchases, which brings additional complexity to the payments system. Still, traditional e-commerce primarily includes one-time purchases, so the “old” system can generally handle these transactions.

The rapid expansion of e-commerce subscription companies has pushed the limits of the traditional payments systems. Subscription companies have experienced meteoric growth in recent years. According to the Subscribed Institute, they have posted more than four times the sales growth of companies in the S&P 500 Index and broader U.S. retailers since 2014. The number and revenues of subscription companies also grew during the pandemic, and like e-commerce in general, that growth is likely to continue in the years ahead as well.

Chart 2

The Subscription Economy Index Level
Versus S&P 500 and Retail Sales Growth

Source

To be successful, subscription companies need to do three primary things. First, they must offer easy, simple access for ordering and customer service. Second, they need to prevent fraud and unauthorized activity. And third, they have to ensure that legitimate payments are processed correctly and with predictable and high authentication rates so that the subscription process runs smoothly.

E-commerce subscriptions offer access to two general types of goods: 1) consumable items such as razors, makeup and coffee that need to be replenished at set intervals; and 2) durable items such as socks and apparel that may be delivered on a less-regimented basis. Unlike one-time purchases, both of these subscription types require recurring billing and payments on an ongoing basis. However, this framework places the old “traditional” payment systems under stress, particularly as recurring payments are processed using the same “plumbing” that was designed for one-time purchases. As a result, recurring payments are often significantly mishandled.

Fighting fraud remains a top priority, as losses due to credit card fraud amounted to nearly $30 billion in 2020. However, that amount is dwarfed by the $440 billion in revenue lost from the failure of legitimate payment methods which are falsely declined because they are detected as fraud due to creaky payments infrastructure.
Bill Hoppin, Butter Founder and COO

The use of innovative technology like artificial intelligence (AI) and machine learning (ML) addresses this problem by using similar "signal sensing" technologies to more accurately identify fraud from legitimate payments with less false positives and higher accuracy. These methods keep the “pipes” running smoothly and vastly decrease the number of falsely declined payments, leading to happier customers and greater revenue for subscription companies.

trend #2

Increased globalization has opened up opportunities—and challenges

Globalization presents a golden opportunity for subscription companies as more consumers around the world gain greater wealth and broader access to the internet. While the pandemic seems to have temporarily slowed the growth of consumer purchasing power in developing markets, the longer-term trajectory of a richer middle class in emerging economies—in regions ranging from Latin America, Asia, Africa and the Middle East—is likely to persist and even accelerate. Developing economies tend to have younger, growing populations that are poised to become increasingly richer over time.

In developed markets, these younger, more urban and affluent consumers tend to represent a rich pool of customers for subscription companies. As the middle class grows in developing economies, this market could present tantalizing new prospects for subscription companies. A report by the Boston Consulting Group estimates that cross-border transactions are poised to reach $250 trillion in 2027 and that payment companies should add $1 trillion in revenues in the next 10 years. As subscription companies tap into these new markets, their revenue and profits could skyrocket.

But these opportunities bring challenges too. Companies will need to be able to handle fluctuating currencies, fight fraudulent activity and verify payments from many countries. Again, the clunky “plumbing” of the global payments systems causes issues as transaction volumes grow. The Bank of International Settlements—the so-called central bank for central banks—has pointed out that the global payments systems are slow and clunky, noting that it can take 10 days to transfer money to different jurisdictions and cost up to 10% of the transaction value just to complete the transfer. Again, new technology can help global payments systems operate more effectively and make sure that legitimate payments are processed efficiently while fighting fraud.

trend #3

“Buy-now-pay-later” has increased in prominence—with some risks attached

In recent years, financial technology companies such as Affirm and Afterpay have helped consumers purchase goods and services with little or no money down using interest-free installments. Recent estimates predict that the “buy-now-pay-later” (BNPL) market will hit $680 billion in 2025, driven by the rise of e-commerce and a desire by consumers to avoid additional credit card debt.

While the BNPL model has clear appeal for customers looking to pay for purchases over time, the growth of this purchasing mode has introduced risks for both consumers and subscription companies. Recent reports have highlighted that consumers can become overextended due to the ease of BNPL purchases, leading to fees and penalties that can add significantly to the initial purchase price. A 2021 Credit Karma study found that 34% of BNPL users fell behind in their payments, with consumers’ credit scores being negatively affected, sometimes dramatically.

The BNPL market also can pose risks to subscription companies as they look to retrieve recurring payments from less-creditworthy consumers that may fall into debt from BNPL purchases. In fact, in some instances merchants will be forced to share in the liability if a consumer defaults in a BNPL scenario. Even if that’s not the case, the growth of BNPL will likely introduce more payment failures and even more complexity into the payments landscape.

What do these trends mean for you?

These three trends highlight that the modern subscription economy is becoming more complex even as the opportunity set continues to grow. At the same time, the competition for subscribers continues to heat up, particularly as the world reaches a new normal following the COVID-19 pandemic and as inflation bites into consumer budgets.

This combination of more complexity and increasing competition will force your systems to be smarter and more agile than today to make sure that legitimate payments are coming through while still protecting against fraudulent activity. We estimate that within five years, companies could lose nearly $650 billion from declines of legitimate payments. You owe it to your loyal customers—and to your bottom line—to make sure your systems are up to this challenge.

Contact us for more information on how we can help you increase revenue and keep more of your customers by reducing legitimate payment failures.

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