Everything you need to know about chargebacks and subscription billing

In today's ever-changing economy, one thing is poised to continue — recurring subscriptions. From streaming services like Sling and Twitch to monthly boxes of dog treats, subscriptions are a huge driving force for businesses that aim to provide continuous value.

The benefits of a subscription-based revenue model can greatly outweigh the churn risk associated with one-time purchases, especially when it comes to lower margin items or services. For example, while it's great to have a customer purchase an item such as a computer, it's even better to then have that customer sign up for your gaming service on a monthly basis, delivering your company a monthly dose of revenue. Extrapolate that by tens of thousands of customers and you've got yourself a winning formula.

But there's one thing that can knock a serious dent in monthly recurring revenue. It’s far more damaging than a subscription cancellation or missed sales opportunity: chargebacks. In this article, we’ll help you understand what a chargeback is, how it affects subscription billing, and steps to minimize the potential damage it can do to your subscription business.

What is a chargeback?

A chargeback occurs when a customer disputes a transaction with their bank or financial institution and the money is returned to the customer's original payment method, usually a credit or debit card. Unlike a typical refund, this is a forced transaction on the side of the financial institution against the retailer in favor of the customer. When customers charge back subscription billing, this can negatively affect more than just that transaction's revenue and profit potential — it can quickly lead to a much larger problem.

In 1974, the United States government passed The Fair Credit Billing Act in an effort to combat consumer fear of shady merchants overcharging them. While this was a great win for consumers, a byproduct of the FCBA was the often abused act of chargebacks. Consumers often utilize chargebacks against a merchant instead of asking for a refund due to dissatisfaction with the product or service. In a rarer but no less threatening scenario, some consumers knowingly defraud a company by claiming a transaction was illegitimate when it wasn't. This is a bit more difficult to prove especially if that customer is skilled at the practice or if a proper investigation isn't conducted by the financial institution issuing the funds back to the consumer.

How do chargebacks affect my subscription business?

Unbeknownst to most consumers and businesses, there's a limit to the number of chargebacks a retailer can incur before consequences occur.

To start, each chargeback filed by a consumer against a company comes with a fee of up to $100 per occurrence. This happens even if a customer recalls their initial chargeback request. If a customer files a chargeback and keeps the disputed merchandise, the business loses the revenue from the item and the potential for any sort of profit.

Then there's the issue of chargeback frequency. If a business has too many chargebacks, they can potentially be placed on the MATCH list, barring them from switching merchant accounts for five or more years. Their ability to accept credit or debit cards can be frozen, limited, or flat-out terminated. There's also the heavy amount of fines that the business will incur, potentially up to tens of thousands of dollars. For a company with a higher customer acquisition cost, this is doubly troublesome as it can jeopardize sustainable revenue.

Though there’s no way to prevent chargebacks entirely, subscription businesses can take a number of measures to mitigate some of the damage from chargebacks. Recurly hosted a webinar that goes into more detail on the best practices for reducing chargebacks and failed transactions. A couple of tips include customizing how your business communications and reexamining the length of your company's dunning cycle.

Chargebacks also affect your overall churn rate. In a perfect world, our subscription business would grow its customer base 2x weekly and no one would leave. While this is never the case, you can do things to better understand why a customer is leaving. If it's trial-period churn, you can examine what is happening during the initial customer contact to see where the disconnect is happening. If customers aren't renewing, you can revisit your value proposition as well as perform exit interviews to see why subscribers are unhappy.

If you're experiencing a lot of chargeback churn, however, you should do your due diligence by establishing better preventative measures to lessen the blow while simultaneously not compromising the customer experience. With Recurly's powerful security measures, you can block known fraudsters, restrict transactions by geolocation, and more.

Recommended reading: Safeguarding Your Profits With Fraud Management

Recommended watching: How to Counter Fraud and Lower Chargebacks

What happens when customers charge back subscription services?

As stated above, chargebacks can be extremely detrimental to a business. Many subscription businesses process a large volume of credit card transactions. Businesses that aren't partnered with a recurring billing platform that implements various tools and safeguards against chargebacks are even more susceptible to harm. If chargebacks are left unchecked, a company's liquidity can quickly dry up, which poses risks for existing customers and the company itself.

When customers charge back subscription services, your average customer acquisition cost increases. Not only did you waste the hard work that you've put into acquiring that customer, but you'll also have to make up for the loss with more marketing to get new subscribers. This also makes it difficult to maintain revenue projection models, especially when those models count on that subscription revenue for accuracy.

If you're ready to implement subscriptions in your business for the first time or are looking for new strategies to grow your existing subscriber base even further, we've got your back. It's easy to talk to an expert or request a demo.