How Subscription Businesses Can Implement Financial Operations That Scale

As any subscription commerce business knows, recurring billing is complex and presents many challenges that billing for a one-time purchase does not. Different billing models, mid-month upgrades and downgrades, add-on charges, et cetera, all add to the complexity.

From an accounting and finance perspective, accurate reporting each month is complicated by these factors, each of which impacts revenue recognition. And as a business scales, this complexity only increases. The bottom line? Most ERP and CRM systems are not designed to handle recurring revenue.

This presents a problem for finance professionals. These staff are responsible for providing accurate budgets, forecasts, revenue reports, and the other instruments on which the business relies. Achieving these goals becomes difficult when using billing platforms that are not designed to handle the complexity of the subscription model and recurring revenue.

Understanding the Complexity of Subscription Billing

Subscription commerce is built on the concept of a long-term relationship with the subscriber. Over the course of this relationship, subscribers may make numerous changes to their account. With each change, accounting and finance teams have to make sure the subscriber is invoiced correctly and that financial reporting is accurate, all while meeting GAAP requirements and revenue recognition standards.|

Credit Invoices and Audit Trails

Subscription businesses issue credit invoices or credit memos as a result of product or plan changes requiring prorated charges or when an unsatisfied subscriber needs a refund or service credit. Or the business may decide to issue promotional credits or discounts to reward and retain its most loyal subscribers. All of these scenarios require a clear audit trail and the finance team must account for these changes accurately, both in terms of the invoice sent to the subscriber and in terms of the monthly process to close the books. Without automated workflows for billing scenarios that involve refunds and credits, managing these scenarios at scale can quickly become a workflow and reporting challenge.

Tax Compliance

Taxation is complicated across multiple jurisdictions, with different rules for different types of services and various triggers for levying the tax. Moreover, taxes on digital services such as video streaming are increasingly common, both in the U.S. and abroad. All of this results in a patchwork of tax laws by which e-commerce merchants must abide.

Integrating a tax solution with the subscription billing platform makes compliance much less time-consuming and onerous. Recent changes in VAT rules and regulations further necessitate an automated tax solution.

Fraud Management

Another key area of integration is fraud management. Fraud is an ever-present and ever-evolving threat, particularly in e-commerce. These threats, if left unchecked, decrease revenue and profits, increase operating costs, and impact customer trust. To effectively mitigate fraud, subscription businesses need sophisticated, automated, and streamlined tools to prevent card-not-present (CNP) fraud and the creation of unauthorized accounts. Reducing fraud also minimizes chargebacks.

Accounting and Financial Reporting

There are many factors that complicate financial reporting in subscription commerce. For example, recognizing revenue under a recurring revenue scenario is an increasingly complex undertaking. The business may have different billing models with different terms, have numerous customer upgrades and downgrades that need to be accurately calculated, along with many other subscriber events each month which affect billing. And many high-velocity B2C companies will process a huge volume of transactions throughout the month. All this makes for a complicated revenue-recognition process. New regulations, such as ASC 606, add to this complexity and impose additional requirements.

Integrating Accounting and Subscription Billing

Integrating the accounting system with the subscription management platform streamlines financial reporting and increases efficiency. Integrated systems provide greater accuracy in preparing journal entries and eliminate the need for manual data entry and uploads.

One of the main benefits of integrating subscription billing and accounting systems is more efficient revenue recognition and easier compliance with the FASB’s Accounting Standards. It also improves scalability as the business transitions to more granular revenue-recognition schedules, such as daily recognition. Subscription businesses using cash-based and mid-month methods often see an increase in reporting inaccuracies as their company grows and thus benefit significantly from utilizing an automated, daily revenue-recognition process.

By automating manual processes, subscription businesses can reduce their use of spreadsheets which are a cumbersome, ineffective way to complete finance and accounting deliverables.

Many companies, even though they may use accounting software such as Xero or Netsuite, may still rely to some extent on spreadsheets to calculate revenue recognition schedules. And spreadsheets are particularly susceptible to keystroke or data entry errors when fallible humans work with them. Manual processes are also time-consuming and extend the time required to close the books at the end of the month.

Having an automated revenue recognition solution eliminates the need for error-prone manual calculations. With automation and integrated data, staff can also more easily reconcile bank balances. And optimizing these processes creates a dependable audit trail, which further improves compliance.

Finally, with streamlined and efficient workflows and processes in place, finance staff have more time and energy to work on strategic initiatives rather than getting bogged down working with spreadsheets.

Choosing the Right Payment Gateway

One critical decision for any business is which payment gateway will best meet its needs—and this can be a daunting task. The wrong choice can mean lost business and lost revenue if the gateway chosen doesn’t have the right set of capabilities, costs too much, or is unreliable. And, the gateway must meet both present needs and potential future needs as the business changes and evolves.

In assessing a payment gateway, cost is a key consideration, but it’s also important to consider how reputable the gateway is and whether it has adequate levels of support and SLAs. The gateway’s ease of implementation impacts time to market. And if the business should ever need to change gateways, it will want to determine how easy it will be to leave and migrate all its subscriber data to a new gateway.

It’s also important to understand integration options. Specifically, does the gateway integrate with other systems used by the business, such as its subscription management platform?

In terms of scalability, the payment options that the gateway supports, along with the countries in which it operates, are critical factors. If expanding globally is part of the growth strategy, inquire if the gateway offers any guidance on expanding into new countries and what regulations or other requirements the business might need to meet.

A payment gateway can supply additional layers of protection in the ongoing fight against fraud, providing third-party or in-house tools to identify and prevent fraud. The gateway may also provide expertise on how to implement best practices for preventing fraud.

Finally, it’s critical to determine how granular the gateway’s error fidelity is. Error fidelity refers to how detailed and specific transaction decline messages are. There are over 100 different and very specific reasons for why a transaction might be declined, but some payment gateways only specify a dozen or so error types. This information is important for minimizing involuntary churn, as we’ll discuss next.

Recurring Payments and Decline Management

Challenges result from the recurring nature of payments, especially when credit cards are used. After the initial payment at signup, with each recurring payment there’s a risk that the payment might fail. Subscribers’ credit card information can change, cards can be lost or stolen, or subscribers may have reached their credit limit. There are myriad reasons why a card might be declined, and they all cause payment issues. When payments fail, subscribers often churn.

Repairing Failed Payments to Reduce Churn

Minimizing churn is essential for a healthy subscription business. Churn can be voluntary or involuntary, and understanding the reasons for both types of churn is key to taking the appropriate actions.

Involuntary churn generally stems from payment declines when credit card transactions fail. Credit cards are an extremely convenient way to pay for online purchases, but subscription businesses can face challenges in successfully completing recurring payments via credit cards. The most effective way to repair failed credit and debit cards transactions—and thereby “recover” this revenue which would have otherwise been lost—is to utilize a decline management strategy.

Best Practices for Decline Management

Decline management helps to ensure successful payments. Resolving payment errors before the payment fails completely will significantly reduce involuntary churn and “recover” revenue that would otherwise have been lost. And the business doesn’t just recover the revenue from that one invoice, it also recovers that subscriber’s future revenue, making this process especially critical.

In addition to minimizing revenue lost to failed transactions and bad debt, effective and efficient decline management practices can alert businesses to potential collection problems early, providing an opportunity to remediate them. Data shows that past-due invoices are more difficult to collect the older they become. The business also gains by not having to disturb or inconvenience customers in order to address the payment failure.

Effective decline management is composed of three major areas of focus: pre-emptive measures such as automated Account Updater services, dynamic retries, and a well-crafted dunning strategy. Applying these consistently and effectively is the key to minimizing involuntary churn and maximizing revenue.

Account Updater

This is an automated service offered by MasterCard, Visa, and Discover cards. It monitors subscribers’ credit and debit cards for changes and makes updates to the records whenever necessary so that recurring transactions can be processed successfully. In this way, a subscription business can avoid payment processing failures before they occur. A well-designed subscription management platform will provide integrations with these services.

Dynamic Retries

Many credit card transactions that have failed can be recovered by retrying them systematically, using the reason for the failure to determine the frequency and timing of the retries. For example, if a subscriber has insufficient funds, this may take longer to rectify than other failure types such as a temporary hold or processor decline. On the other hand, if a card was reported stolen, retrying it is not likely to ever succeed—it will simply incur additional gateway fees.

In addition to looking at the failure reason, the retry process can be made far more effective when it’s tailored to each individual transaction, based on the specific attributes of that transaction. This is because there are many variables that impact retry success—for example, the card type, the issuing bank, the amount of the transaction, etc. And, the combination of variables has an impact on the likelihood of retry success. This complexity means that a static retry model is less responsive and less effective.

A “dynamic” retry logic allows retry attempts to be scheduled when they will most likely lead to success for that specific transaction, based on the variables present. It also ensures that revenue gained through retry attempts is maximized while the fees for retrying these transactions are minimized. The most effective dynamic retry technology achieves optimum results by incorporating machine learning into its retry processes.

An important first step in managing declines is to review your average decline rates and then compare them to industry standards.

Dunning

Dunning stands for Delinquent User Notification. Generally, it refers to sending emails or other communications, on a predetermined schedule, to subscribers when their payment fails.

Different businesses or different subscriber segments will have different responses to dunning, so it's important to constantly test and optimize dunning schedules and email content. In general, subscribers are more likely to respond to dunning emails that are customized to match the brand’s voice. Conveying urgency in each subsequent dunning email and presenting a clear call-to-action are also important for encouraging the subscriber to update their payment method.

To maximize its effectiveness in recovering revenue, the dunning process should function independently from the retry process.

Dunning and Audience Type

Optimizing the dunning schedule and adjusting the cadence of each email that is sent is another best practice that can improve results. For example, B2B companies tend to benefit from a longer dunning cycle with less-frequent emails over a longer time span of retries. A longer cycle acknowledges that subscribers may require more time to submit their payment which may need multiple approval and sign-off steps.

In terms of access, B2B companies tend to continue to allow access to the product or service for the subscriber during the dunning cycle, on the assumption the business will eventually receive payment.

B2C companies tend to benefit from a shorter dunning cycle made up of frequent emails over a short time period, so as to achieve resolution more quickly. B2C companies are more likely to suspend access to their subscription product or service during the dunning cycle and reintroduce functionality once payment is received.

Dunning and Failure Reasons

The type of payment being used and the failure reason can also influence dunning schedules. If, for example, a credit card is declined for being over its credit limit, a longer dunning cycle gives that subscriber more time to pay down their balance so that new purchases can be approved. Similarly for a debit card with insufficient funds: giving the subscriber more time may ultimately result in the transaction going through when the card is replenished.

More Revenue, Less Cost, Reduced Churn

Effective decline management results in more successful transactions. This means more revenue and ultimately, reduced churn. An active decline management strategy can also lead to lower operational costs as staff time is not needed to contact customers to update credit card information or engage in other collection efforts. Since subscription commerce is built on the concept of long-term subscriber relationships, these operational efficiencies can make a significant contribution to subscriber retention.

Significant Revenue Lift

Recently, Recurly Research completed an analysis on the effectiveness of decline management. Our analysis found that subscription businesses can expect significant revenue lift from the the consistent application of decline management. A typical business in our analysis saw revenue lift of 12% with some businesses seeing revenue lift of up to 15% as a result of decline management.

Providing Insights With Analytics

Accurate analytics will help you to discern the factors driving your business—why subscribers churn, for example, or what plans are the most popular and most profitable. Robust, easy-to-understand, readily accessible, and accurate analytics are what enables subscription businesses to continually optimize their operations.

Of course, MRR is the key metric that all subscription businesses track. MRR is used to evaluate a subscription business’s revenue performance and momentum and can help a business monitor the impact on overall growth of subscriber acquisition, expansion, contraction, or churn. Subscription businesses with annual plans track Annual Recurring Revenue (ARR).

Additional metrics that provide a more in-depth understanding of how well the business is maximizing revenue and reducing churn include:

Subscriber churn and revenue churn: The concept of churn usually refers to subscriber churn, which measures the loss of subscribers. But monitoring this churn rate alone won’t reveal the monetary value of the subscribers that were lost. To determine that value requires monitoring revenue churn, which is the total recurring revenue lost from churned subscriptions.

Monitoring both rates can reveal important insights. For example, if the business is churning high-value subscribers, this will cause greater revenue loss and likely lower MRR than if average or low-value subscribers are churning.

A Billings Report calculates the total amount of successful payments, refunds, and the net of the two over a selected time-period from new vs. renewing customers. This report can help identify if there is seasonality to the business, year-over-year payments growth, and how often the business is issuing refunds to customers. This information should also be displayed according to supported currencies which can provide insights into the performance of different global markets.

Decline Management Metrics to Track

And of course, we’ve discussed the difference between voluntary churn, which is caused by factors originating with the customer, and involuntary churn, which results from failed payments. A Churn Analysis report shows the total number of subscriptions that have expired during a selected time period, segmented by whether the churn is voluntary or involuntary.

For a greater understanding of how well the business is reducing involuntary churn, these metrics are helpful:

Invoice Recovery Rate: Of the invoices that go past-due, this metric shows what percentage are ultimately recovered before the customer churns.

Subscriptions Saved: Of the invoices that go past-due, this metric shows how many subscriptions associated with those invoices are recovered before the customer churns.

Revenue Recovered: Of the invoices that go past-due, this is the total amount of revenue recovered before the customer churns.

For subscription businesses, understanding the intersection of billing, subscriber, and marketing events is the key to deriving greater insights into subscriber behavior and profitability in order to identify opportunities for further business expansion. A strong analytics capability in a subscription management platform can provide these insights.

Summary

Recurring billing is complex, and without question, subscription businesses benefit from state-of-the-art technology which is designed to reduce this complexity. Creating efficiencies, ensuring billing continuity and optimizing staff time and resources are key to scaling a subscription business.

Having the right subscription management platform makes billing a competitive advantage. This advantage will provide the critical insights that drive innovation to meet the ever-changing needs of your market and subscribers, and ultimately propel your business forward.

To learn more about how Recurly can help you turn billing into a competitive advantage, visit recurly.com or call us at 1.844.732.8759.