Two out of three times when a payment gets declined, FlexPay CEO Darryl Hicks said, it’s due to what he called “the month 15 problem.” Specifically, that’s when the exact same debit from the exact same merchant to the exact same card on file that was approved for the past 14 consecutive months suddenly and inexplicably gets declined in month 15.
“What happened there on month 15 is what we see as the squishiness of these risk systems that are kind of interceding and trying to analyze each transaction in real time in milliseconds on what are they going to do, and unfortunately they get it wrong sometimes,” he said.
If these random false declines weren’t causing over $400 billion annually in lost sales (and that’s 2019 pre-pandemic data), as well as generating untold sums of bad will with customers, you might be able to excuse them as just one of those quirky things. But when you add in the fact that many subscription merchants simply accept a 20 percent card decline rate as an operating norm, the need for a fix becomes even more compelling and urgent.
“We see plenty of merchants right now in their annual rebilling subscriptions that are in that low 20 percent decline area,” Hicks told PYMNTS’ Karen Webster. “To me, this is just too big of a problem to ignore now.”
As a result, he said, a new system of defense known as payment authorization management or PAM, has emerged to mitigate against some of these stressors and unpredictable fraud triggers that can turn a good transaction on its head in an instant.
As much as there are lots of things about these systems that can’t be controlled, such as merchants and customers, there are also many things that can be controlled, which is where the new PAM solution comes in, as an outsider application programming interface (API) looking in on the true nuts and bolts decision making of the payment authentication process.
That includes what time of day transactions are being processed, which merchant bank and category code is being used, whether all the data fields are correct, if a ZIP-plus-four code is needed or not, and whether a transaction has been flagged as an installment or recurring payment sent with a plain vanilla flag.
“There are all these different things you can get deep down into the weeds that are all encompassed in this new category that’s been emerging that really yields massive ROI for subscription merchants,” he said.
The Risk Ranking System
At its core, it’s just a problem of inefficiency, Hicks said, describing how every credit card transaction gets stamped with a three-digit risk score and that banks have differing thresholds on how they respond.
“Banks have variants, and they have tolerances of what kinds of risks they’re going to take, and they have certain windows of time that reset every once in a while,” he said. “So, your subscription to Netflix, Spotify or whatever, just based on the timing of that transaction and your recent transaction history, all of a sudden that can just tip over the threshold of risk based on the bank’s risk scoring system, and suddenly that payment is rejected.”
Credit card issuers have an incentive to process as many transactions as possible because that is how they get paid. But Hicks said sometimes there’s a larger and conflicting incentive to reduce fraud.
“Fraud can have consequences to the issuing bank, it can affect their insurance premiums,” he said. “If they tip over a certain threshold of fraud losses, that can be a bigger issue for them. So, a lot of times, the only thing they can do, if they need to reduce their fraud losses in a given month or quarter, is just reject more transactions. They’re constantly adjusting their tolerance thresholds; it’s very fluid and dynamic.”
Making things worse is the fact that banks’ fraud systems tend to be very fast when reacting to new risks, but much slower when it comes to reverting to the mean when a merchant has cleaned up whatever problem they had.
“We’ve tracked this with our issuing partners who share what their risk scores are by merchant, and we can see that within 15 days, there’s a massive spike in risk scores when there’s a problem,” he said. “But it can take up to six months before that reverts back to where it was before.”
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False declines cause a lot of damage. According to Hicks, they’re responsible for 48 percent of all customer churn with merchant subscription providers.
“That’s the industry average, just under half of all your churn,” he said.
Merchants need to place more emphasis on fixing these problems if they’re going to reduce churn, Hicks said. Rather than focusing on acquiring more customers, merchants ought to think more about how they can generate higher lifetime revenue from their existing user base. And that’s where eliminating false declines can make a difference.
“The irony is if you can actually generate a higher lifetime value, generate more revenue from the customers that you bring in, you’ve automatically increased your acquisition budget again, as a percentage of revenue, which allows you to compete,” he said. “It becomes a competitive differentiator and increases your ability to attract more business.”
To be sure, the business of streamlining false declines and reducing churn is complicated stuff, but the API-based PAM technology that companies such as FlexPay offer can analyze and repack customer transactions in a way that achieves the best possible risk score, Hicks said.
“The challenge for us is, we’ve got to pull back the kimono and explain to merchants what’s actually going on and why these things are happening,” he said. “Once we understand better what everybody’s incentives and issues are, we create more sharing and trust and transparency, and ultimately the entire economy gets to benefit.”