Involuntary Churn Will Impact All Subscription Businesses, Not Just Netflix

Netflix announced recently that its U.S. growth was lower than anticipated, due to the involuntary churn of customers from the re-issuance of credit cards

Yesterday Netflix announced its third quarter earnings for 2015, and U.S. growth was lower than anticipated. Why? Netflix said it believes the company had higher-than-expected involuntary churn, or the inability to collect payments, because of the reissuance of chip-based credit and debit cards. In a report on the story, Quartz reporter Dan Frommer said “If this is really a thing, it will presumably also affect other subscription-based services and not just Netflix.”

Yes, Mr. Frommer, it is really a thing. A big thing. Involuntary churn due to the replacement of magnetic stripe cards with chip cards will impact every subscription-based business as well as any other type of business that relies on recurring revenue and Card Not Present sales.

In fact, that’s why Subscription Insider and a host of payment processing industry experts are holding a one-day intensive in Boston next week. Among our talented experts is Paul Larsen, the managing partner for Paul Larsen Consulting LLC. Earlier this week we had the privilege of talking with Paul, the founding and host sponsor, as well as a presenter, at our Mastering Payment Processing for Recurring Revenue event on October 22.

Paul Larsen

Paul Larsen

Paul has more than 30 years of experience in the direct marketing industry. Prior to consulting, Paul held a number of fulfillment and operations positions at Reader’s Digest before honing his payment processing skills in his decade-long stint as director of operations for Synapse Group, Inc., one of the world’s largest magazine subscription companies.

Paul is also a past chairman of both the Direct Response Forum and the Payment Processors Association, and he regularly presents at conferences including the Direct Response Forum and Merchant Risk Council conferences. Paul Larsen Consulting LLC has worked with many subscription and Card Not Present companies including Audible, Disney, Condé Nast, Guthy-Renker, Ipsy, JustFab, Roku, Shutterstock.com, and many others.

Next week, Paul will be talking to conference attendees to discuss the state of recurring payment processing in 2015, as well as how to select and work with payment processors. You may have previously heard us say that a storm is coming in 2016, and subscription businesses need to be prepared.  

Here’s why: As magnetic stripe debit and credit cards are replaced with EMV “chip” cards, subscription companies will be inundated with an alarming number of declined cards and lost business. Why? Because when the cards are reissued by the banks, identifying information such as the expiration date or the card number will change. Paul was gracious enough to share his expertise and give us a preview of his Oct. 22 presentation.

Dana: Can you tell our readers what payment trends you’re seeing in the subscription industry right now?

Paul:  We’re living in the subscription environment where practically everything is being packaged into a subscription and for good reason. A subscription represents a commitment, and hopefully, a long-term revenue stream. Subscriptions have been around for a long time, but the potential for them was not fully realized until the credit card came along.

From the beginning, failed payments have been part of the payments equation but the travail of those former days pales in comparison to the perilous minefield that is the payments landscape today. Subscriptions are ubiquitous. Everyone is involved. Everyone in the revenue chain has real reasons to try to prevent what we call “involuntary churn.”

Involuntary churn happens when a subscription comes to an end, even though neither party asked for that outcome. This kind of churn is most often a result of something happening to the credit card account upon which the subscription was based, whether the card itself had to be reissued because it was lost or stolen, because of a breach like Target and Home Depot, or because it needed to be replaced with a chip card.

The confluence of conditions yielding hyper-churn is unprecedented: insufficient funds, delinquency, reissued cards, stale expiration dates, prepaid cards, etc., creating a witches’ brew of dynamics that negatively impact bottom-line results.

At next week’s event, we’ll provide data in graphic form that shows the five-year trends in approval rates, decline rates by type of failure, card reissuance – the pressure on subscription viability over time. These statistics will pave the way for following sessions in which success of incisively-used best practices that can help overcome these challenges is documented.

Such best practices have been rolled out over time because everyone from credit card issuers and card companies to processors and merchants has real skin the game – lost revenue. We’ll be discussing how to effectively use the procedures that allow us to navigate us as safely through this minefield as possible.

Dana: Let’s talk about chip cards, Paul. As magnetic stripe credit and debit cards are replaced with chip cards, how will that impact payment processing within the subscription industry?

Paul: Up until last year, the rest of the world had chips in their credit cards, and the primary reason for the chips was to mitigate fraud at the point of sale. American issuers resisted the chips, because they want as few obstacles in the way of purchasing. After all, swipe-and-go is what America is all about. Purchase, purchase, purchase.

You’ll find out as you begin to use your chip card in stores that it takes longer for a transaction to complete. If we were to go all the way like they do in Europe where transactions require a chip card and a personal identification number (PIN), transactions would take even longer. We’re doing chip and signature although some issuers such as First Niagara have decided to go all the way and just do chip and PIN now.

We are no more than midway through every card in the United States being reissued with a chip and, of course, every time cards are reissued, something about that card changes, either the account number or the expiration date or both. That’s a problem for subscription companies, because now the information associated with the credit card that was used to begin the subscription has changed.

If you don’t get the fresh information associated with the reissuance – the new account number and/or expiration date – the next time the subscription company goes to bill that card, it will fail. Up until now, reissuance has been on a case-by-case basis. For example, if you or I have our cards stolen, or we’re standing at a stadium and our credit card falls out of our pocket, we call our banks on a one-by-one basis to get our card replaced with new numbers and expiration dates.

There have also been mass reissuances of cards because of breaches like Home Depot, Target and Nieman Marcus. As horrific as those incidents were, those constituted 111 million cards being reissued. That’s just a small fraction of the entire credit card universe in the United States, which is being reissued now and over the course of the next year and a half.

Unless you have some mechanisms or methods in place in which you can automatically get the fresh credit card information, the customer relationship is likely to end because the payment will fail when you go to bill it.

This will continue because no more than half of the cards have been reissued to this point. We have the charts and graphs that confirm the impact of this reissuance, and how it’s just beginning to crescendo again after the Target breach in late 2013 to early 2014 and the Home Depot breach in mid-2014. Statistically, you could see the travail that it caused, and now because of the reissuance of all these cards, you can see that impact beginning to skyrocket again.

outdated information

Outdated credit cards are beginning to creep up again due EMV chip card reissuance beginning in May 2015:

outdated credit cards

Dana: How can a subscription company brace itself for that and to stop the involuntary churn?

Paul: In terms of the chip and the change associated with the reissuance, all of the major card companies – Visa, MasterCard, Discover and American Express, especially Visa and MasterCard which are, by far, the largest – have created a database into which they will contribute updated card information. A merchant who is engaged with an adept credit card processing company can query Visa and MasterCard to get that fresh information. It’s called Account Updater Service.

About 70 to 75% participation of issued cards are covered by the Updater programs, so it’s not perfect, but almost all of the big banks – Chase, Wells Fargo, Citibank, Capital One – participate. They provide this as a courtesy to their customers, who never asked for their subscriptions to implode.

Why should something both the customer and merchant agree is a good thing fall apart just because we’ve reissued the card? The new card that’s being reissued is based on the same parameters as the old card. It’s the same bank, and it’s the same type of card. To that end, a database has been created so the merchant can work with its processor to engage and retrieve updated information to facilitate a subscription renewal being approved.

The Target and Home Depot breaches were no respecter of card types, so American Express’s reissuance was pretty profound, especially as AmEx has trafficked more into the B2C world. There are a lot more consumer AmEx cards, and they’re also being used at Target and Home Depot, and now, of course, their cards have to be reissued with chips as well, so they have their own program called Card Refresher. Anytime a card is reissued, if a subscription is based on that card, it is now in tremendous jeopardy.

Dana: Can you estimate what the involuntary churn rate will be when credit cards are reissued en masse?

Paul: Potentially 100%, because every card is being reissued with at least a new expiry date. That’s what makes this so audacious. It’s not event-driven. It is a universal reissuance.

As a sideline, we have a lot of history that shows what happens when you move to chips. Ten years ago, when the U.K. switched to chip cards, and five years ago when other parts of the world switched, it absolutely did drive point of sale fraud down, way, way down. You know that every significant breach you’ve ever heard of, whether it was T.J. Maxx five years ago or Home Depot last year, all happened in retail sales.

All the fraud was point of sale, as something was stolen during the swipe. Middleware is there to take the information right off the stripe, and the chips take care of that. Fraud isn’t going to go away. Fraud will move from point of sale to online.

Dana: Will companies with monthly subscription renewals be at greater risk for involuntary churn than those with annual subscription renewals?

Paul: It all adds up in the end, but it would degrade sooner on a monthly subscription. The annual event would likely fail. As we look back on our world in 2014 and 2015, on an annualized basis, you’re talking about 30 to 40% of subscriptions failing. Thirty to 40% of the credit cards that were used to charge a subscription a year ago will not be viable today.

There are other issues as well. The customer is over their credit limit, they have some sort of other delinquency problem, the card was reissued, or it was a prepaid card to begin with. That’s the kind of friction causing so many failed recurring billing events – a trend could continue through 2016.

Dana: How are the banks doing the rollout of reissued cards? Will the banks do the reissuing in bulk?

Paul: Different banks have different approaches. Some are rhythmically reissuing cards over time, X per month for however long it takes to get it done. Others are doing credit this year and debit next.

Most of the smaller banks and credit unions seem to be in a delayed state, waiting until 2016, probably because the reissuance with chips is an expensive proposition. That’s another reason why it took so long to do reissue the cards. A cheap, plastic magnetic stripe card is a lot less expensive than a heavy card with a microchip.

It’s never happened like this before, where we’ve had a universal reissuance.

 


To hear more from Paul Larsen, Subscription Insider, and our sponsors and partners, sign up today for our October 22 event on Mastering Payment Processing and Growing Subscription Profits. Industry experts will show you how to combat involuntary churn and protect your company from the mass reissuance of credit and debit cards that we’ll see this year and next.

There are only a few spots left, so register now!

~ Dana E. Neuts, Subscription Insider

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