Recent months have seen failure rates for direct debits reach unprecedented highs. Failure rates in January hit 1.07%, the highest level seen since the Office for National Statistics began releasing the data at the start of 2019. 

While it’s not that unusual to see failure rates go up in January, February 2024’s failure rate of 0.90% is the third highest ever recorded.

That suggests that this increased rate of failure may not be just a blip. This development comes as the subscription economy and regular payments are highly popular, with nearly two thirds of adults holding one or more subscriptions in August 2023, according to research by YouGov. 

But should small businesses be deterred from joining the subscription economy and using direct debit as a payment method because of their seemingly rising failure rate?

Why do small businesses use direct debits?

Siamac Rezaiezadeh, VP of product marketing & insights at direct debit provider GoCardless, asserted that the popularity of direct debit is down to low cost, high success rates and strong customer popularity.

He explained: “This is why large, traditional industries that have a case for using subscription payments, like telcos and energy companies, have always pushed people towards direct debit because it’s hugely valuable.”

Subscription models have become immensely popular among consumers, and they appeal to businesses as they can offer more predictable revenue, lower customer acquisition costs and improved upselling opportunities. 

That appears to be part of the reason for the increasing adoption of direct debit. Indeed, the number of annual direct debit transactions has increased by 7% between 2020 and 2023 according to PayUK, with total value climbing by 22%.

Emma Jones, CBE, founder of small business support platform Enterprise Nation, explained via email: “Small businesses are front and centre to the emergence of the subscription economy, partly because it’s a very accessible and efficient way of developing a loyal consumer base and capitalising on marketing spend and relationships. 

“Instead of selling things once, the subscription model allows you to generate recurring revenue and it’s also better for the planet as it’s on demand.”

Why don’t small businesses use direct debits?

Rezaiezadeh pointed out there had historically been three problems with using direct debit. He explained that these are:

• High barriers to entry: Small businesses in the UK have struggled to access direct debit because they might need to post a bond to cover chargeback risk. This is when direct debit funds used for a purchase are returned to the buyer. In addition, they may have also had to provide complex information about privacy and security to customers. 
• Outdated transfer systems: The BACS-based transfer systems relied upon for direct debits don’t always integrate smoothly with the kind of cloud-based accounting platforms that small businesses have access to. 
• International hurdles: While it’s not so relevant to small businesses, direct debit systems are quite country-specific, so cross-border sales could be challenging. 

Rezaiezadeh added that this trio of issues resulted in direct debit traditionally “it’s only been really workable for large domestic companies”.

However, he noted that the last decade has seen payment companies stepping in to make it easier for small businesses to get access to direct debit, by building compliant-payment pages, spreading the risk among their customer base and offering cross-border networks.

How to tackle direct debit failure

For small business owners looking to incorporate direct debit into their arsenal, learning how to tackle failed payments is essential. Below, we’ve listed some of the best ways to tackle the problem head-on. 

1: Preempt direct debit failure

First up are the steps you can take to make failure less likely to happen in the first place.

Jones recommended “taking expert advice to make sure you develop the right pricing structure”, as well as getting advice on “how you use the model to calculate the monthly recurring revenue”.

Communication can be an important part of preempting failure too. Rezaiezadeh recommended clearly signposting upcoming payments for customers, noting that this can be more important for B2B businesses as they can have “quite different payment cycles” that make their money management more complex.

2: Understand reasons for payment failure

Understanding why a payment failed in the first place is key. Each failed payment comes with an ARUDD (Automated Return of Unpaid Direct Debit) report, which is used by banks to indicate the reason why a direct debit has failed in the form of a single-digit code. 

There are 10 codes, which include 1 (instruction cancelled), 5 (no account) and B (account closed). 

A second attempt at collecting a failed direct debit payment is called “re-presentment”. Any re-presentation effort should:

• take place within 30 days of the original collection date
• be for the same amount of money as the missed collection
• not take place if a direct debit has been cancelled
• only take place if there are reasonable grounds to assume it will succeed

3: Provide a tailored response

Correctly interpreting ARRUD codes can help businesses recover payments with greater ease and waste less time chasing payments where success is unlikely. 

Rezaiezadeh recommended interpreting results by analysing customers’ “willingness to pay” and “ability to pay” and responding based on this information. 

For example, a case of insufficient funds (ARUDD code 0) might just require a retried payment within 30 days. Remember to contact the customer with five days’ notice of this recovery attempt.

Meanwhile, reaching out via email could be sufficient to secure payment from customers who are willing and able to pay – for example, where a technical hiccup has occurred when switching banks. This would lead to an ARUDD code 3 (account transferred).

Of course, in the rare case of receiving ARUDD code 2 (payer deceased), any communications with their family should be sensitive and not aggressively chase payment. The deceased’s estate will prioritise secured loans and then any taxes owed before reviewing any unsecured loans, such as energy bills paid by direct debit. 

4: Use the right tools to monitor late payments

Some payment providers have useful tools or services that merchants can turn to when payments fail. For example, GoCardless has anti-fraud tools to clamp down on fake customer sign-ups and its Success+ tool can help customers work out the best time to chase payments.

Meanwhile, FastPay has a team in place to monitor the nature of failed payments and advise businesses on the most effective next steps they can take. 

That’s why understanding what your direct debit provider offers and knowing how to use it could be key to recovering failed payments.

Image source: Getty Images