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2015 INDUSTRY REPORT Recurly Subscription Snapshot Powering Subscription Success

Table of Contents About the Subscription Snapshot Subscription businesses are focused on customer retention and loyalty. This report examines a sample set of 25 million transactions and identifies key metrics. Through careful analysis of these metrics, we reveal how they can be used to provide guidance in product, promotions, and operations to support a subscription business' growth and success. What's Inside Introduction The Sample Set The Role of Promotions Factors Impacting Subscription Revenue Churn Credit Card Declines Recovering Lost Revenue Summary Methodology Glossary 2

Introduction From startups to global enterprises, today's fastest-growing businesses are harnessing the power of the subscription model. This business model delivers multiple benefits: predictable revenue, ongoing customer relationships that lead to critical customer insights, and the ability to automate revenue-optimizing decisions. Benefits of a Subscription Business Model One of the keys to unlocking these benefits is developing customer loyalty, forged from the predictable delivery of great products and services. As a result, subscription businesses prioritize customer retention metrics to understand loyalty trends. MILLION Number of transactions in the sample set Customer retention metrics in recurring revenue businesses are complex, especially when transactions are weighted to credit cards. Securely handling credit cards, managing failed transactions, or credit card declines, and minimizing churn, or customer attrition, are vital areas of focus, and each requires careful measurement. This report investigates a sample set of 25 million transactions generated in 2015, examining the role of promotions and emphasizing customer retention metrics. Understanding metrics such as credit card declines and reasons for customer churn are key factors to unlock economic loyalty, providing guidance in product, operational, and promotional arenas and keeping subscription businesses on the path to healthy growth. To the business: Predictable revenue Customer relationships that lead to insights Automation of revenueoptimizing decisions To the consumer: Convenience Flexibility to choose the plan/product that best meets their needs Pay-as-you-go model amortizes costs 3

The Sample Set

The Sample Set We categorized the 25 million transactions in our sample set by market either business-to-business (B2B) or business-to-consumer (B2C) and by whether the product or service was digital or physical. Ninety percent of transactions involving physical goods fell in the B2C category, a reflection of the popularity and wide variety of box-of-the month offerings, as well as consumers embracing monthly deliveries of staples like shaving supplies or pet food. Transaction Overview by Business Orientation 24.1% The digital goods category displayed more variety, with 25 percent of transactions for digital goods in our sample set originating with B2B companies underlining the rise of software-asa-service (SaaS) and cloud-based platforms. Percentage of physical goods transactions in the B2C category 72.9% B2B B2C Both B2C companies generated 72.9 percent of the transactions for digital goods in our sample set. Considering the growth of the Internet of Things (IoT) and digital delivery of entertainment as consumers cut the cord for over the top (OTT) content, this trend should continue. * Only recurring transactions included in sample set; initial transactions excluded. 5

The Role of Promotions

The Role of Promotions Sales promotions such as discounts, coupons and specials play a big part in demand generation and are always a major factor in holiday shopping. Coupons are especially attractive to consumers, as Nielsen research discovered when consumers in their September 2015 survey cited coupons as the top influence in pre-purchase decisions. THE RATE Coupon redemptions on Cyber Monday versus other days in our research period Coupons are an attractive tool for encouraging sampling, trial and adoption for subscription businesses, too. In our sample set, more than 15 percent of customers redeemed coupons in the fourth quarter of 2015, with the highest number of customer redemptions in November. In fact, earlier Recurly research found that Cyber Monday, which fell on November 30th in 2015, experienced three times the rate of coupon redemptions than other days in a two-week period that included Cyber Monday and Black Friday. Average Monthly Coupon Redemptions 18 15.1% 16.1% 15.4% 12 6 Powering Promotions With Coupons Recurly s coupon feature lets you create percentage or fixed-amount coupons and create bulk unique coupons. Read our blog series to learn more about how you can use coupons to power the promotions for your subscription business. 0 October November December 7

Factors Impacting Subscription Revenue: Churn

Factors Impacting Subscription Revenue: Churn Churn, or customer attrition, is one of the most sensitive variables impacting the value of a subscription business. Customer retention rates ultimately determine whether a recurring revenue business is growing profitably or not, and small shifts in churn rates can have major impacts on future periods. In effect, churn reflects how well products and services satisfy customers over a period of time. Dissatisfied customers cancel their subscriptions, or churn, negatively impacting revenue and overall growth. PERCENT Amount of overall churn in our sample set categorized as involuntary churn However, churn isn t always voluntary. If a subscription business is unable to collect payment, even if the customer is satisfied with the product or service, that customer is lost to involuntary churn. Credit card issues, such as outdated information which leads to failed payments, are major reasons for involuntary churn. Measuring both voluntary and involuntary churn rates is very important for subscription businesses, as each rate requires different mitigation strategies. 9

Factors Impacting Subscription Revenue: Churn 2015 Quarterly Churn Rates Involuntary and Voluntary Churn as Percentage of Total Churn 10 8 8.8% 8.5% 8.2% 8.2% 6 4 82.4% 81.7% 80.6% 79.9% 2 Q1 Q2 Q3 Q4 0 Q1 Q2 Q3 Q4 Voluntary Involuntary * Only recurring transactions included in sample set; initial transactions excluded. * Includes churned and total customers for each month; Recurly averaged rates over four quarters. See glossary for further details. In our sample, the overall churn rate peaked in Q1 of 2015 and declined by 8 percent throughout the year. Voluntary churn, reflecting customer dissatisfaction as customers cancel subscriptions or switch to different providers, represented 80 percent of churn throughout the year and mirrored the overall churn pattern. Mitigating voluntary churn requires strategies that focus on customer satisfaction, including product or service improvements. Involuntary churn, which is often caused by credit card declines or other non-payment reasons, remained steady in each quarter and made up almost 20 percent of the overall churn rate. Measuring voluntary and involuntary churn rates is important for subscription businesses, as each rate requires different mitigation strategies. 10

Factors Impacting Subscription Revenue: Churn Examining churn patterns for B2B and B2C categories revealed that the churn rate declined for both categories throughout the year. The B2C category, however, had a higher churn rate than B2B and decreased by 5 percent over the course of the year. As we saw in the overall churn analysis, voluntary churn formed the largest component for the B2C category. Given these findings, we believe that New Year s resolutions to rein in expenses and save money drove voluntary churn in the first quarter of 2015. As with many New Year s resolutions, the effects tapered off throughout the year. Churn Type as Percentage of Total Churn by Business Orientation B2B B2C B2B vs. B2C Quarterly Churn Rates 12 82.5% Q1 80.2% 10 8 10.2% 10.2% 9.8% 9.8% 6 7.9% 7.6% 7.4% 7.2% 82.0% Q2 80.3% 4 2 0 Q1 Q2 Q3 Q4 83.0% Q3 78.3% B2B B2C * Only recurring transactions included in sample set; initial transactions excluded. 81.5% Q4 77.9% Voluntary Involuntary 11

Factors Impacting Subscription Revenue: Churn Digital vs. Physical Quarterly Churn Rates Churn Type as Percentage of Total Churn by Business Type 12 10 8 6 8.7% 10.5% 8.3% 10.2% 7.9% 11.1% 7.8% 10.4% Digital 84.5% Q1 Physical 82.3% 4 2 0 Q1 Digital Q2 Q3 Q4 Physical 78.7% Q2 86.0% Comparing churn rates for digital and physical goods showed that the physical goods category, with a 10.6 percent churn rate, experienced a 23 percent higher churn rate than that for digital goods, at 8.2 percent; voluntary churn drove 80.8% Q3 81.4% the majority for both categories. 78.9% Q4 78.5% Higher churn rate of physical goods than that of digital goods Voluntary Involuntary 12

Factors Impacting Subscription Revenue: Churn Involuntary churn remained fairly constant throughout the year. As noted earlier, involuntary churn is usually caused by credit card issues. It s important to remember that many commonly experienced credit card errors can be successfully remediated with careful management, resulting in consistent and low rates of involuntary churn. Minimizing involuntary churn leads to two important Managing involuntary churn results: capturing the value results in higher customer of otherwise-lost transactions retention and lifetime value. which translates into increased revenue for the business and, more importantly, retaining satisfied customers who would otherwise have been lost to recoverable credit card failures. In our next section, we ll examine another key metric for managing customer retention, credit card declines, and how to analyze decline rates. Measuring and Managing Churn The first step to minimizing churn is to understand the difference between voluntary and involuntary churn. Voluntary churn is when a customer does some action such as canceling their subscription. Involuntary churn happens from a passive customer action, such as when a credit card problem is never resolved. In either case, churn is a critical issue for any recurring revenue business. There are different ways to measure and manage it to ensure your business success. To learn more, read our white paper on calculating churn. 13

Factors Impacting Subscription Revenue: Credit Card Declines

Factors Impacting Subscription Revenue: Credit Card Declines Credit Card Declines Each billing cycle is an opportunity to minimize a subscription business involuntary churn. Predictable revenue streams are one of the great advantages of the subscription model, and to keep the stream flowing smoothly, subscriptions are often paid by credit cards, whether corporate cards for business services or personal credit cards for consumer products. PERCENT Success rate of the 25 million transactions in our sample While most transactions are successful for Card Not Present (CNP) transactions in e-commerce and subscription commerce, if there is a problem, the customer, too, is not present to provide another payment method. Whenever a credit card is used, the risk of failed transactions, or declines, is present and needs careful management in order to ensure the transaction is successful and the customer is not lost. Designing a proper checkout flow reduces the level of declines on initial transactions, and most companies follow best practices for this critical function. However, if credit card information changes after the customer s initial sign-up, subsequent transactions are at risk, as is the customer. Repairing the situation seamlessly is critical so the customer is not lost to involuntary churn. As such, we focused our decline rates analysis solely on recurring transactions and excluded initial transactions from the data set. 15

Factors Impacting Subscription Revenue: Credit Card Declines Average Transaction Decline Rates by Volume 15 12 12.0% 12.1% 12.2% 12.5% 9 6 3 0 Q1 Q2 Q3 Q4 * Only recurring transactions included in sample set; initial transactions excluded. With an average quarterly decline rate of 12.2 percent for recurring transactions, our sample of 25 million transactions experienced a success rate of almost 88 percent. Transactions may decline for a variety of reasons, from a temporary processing glitch at a payment gateway to an overburdened credit card. Noting the small increase in declines as the year progressed, we decided to investigate the role of seasonality. 16

Factors Impacting Subscription Revenue: Credit Card Declines Does Seasonality Affect Decline Rates? From a seasonality perspective, decline rates as measured by volumes of transaction were relatively stable, indicating valid credit cards on file. However, transaction decline rates based on the value of the transaction increased by 10 percent over the course of the year, from 14.4 percent in the first quarter of 2015 to 15.9 percent in the fourth quarter of the year. Average Transaction Decline Rates by Value 16 15.9% 15.1% 15.2% 14.4% 12 The fourth quarter of any year is one of increased retail activity as consumers The fourth quarter of any shop for holiday gifts and increase the year is one of increased balances on their credit cards. However, retail activity as consumers an additional factor was at play in the shop for holiday gifts and latter part of 2015 as the credit card increase the balances on industry continued to roll out EMV, their credit cards. or chip-and-pin, cards. Card-holders received new credit cards designed with additional security measures to defeat point-of-sale fraud cards which included new expiration dates and, in many cases, new security codes. Unless this information is updated, transactions can be declined. This information can be updated smoothly and programmatically when merchants use Account Updater services, such as those provided by credit card companies or Recurly. 6 0 Q1 Q2 Q3 Q4 17

Factors Impacting Subscription Revenue: Credit Card Declines How Do Price Points Affect Decline Rates? Do price points play a role in transaction declines? To answer that question, we segmented our sample transactions into five clusters of price points and identified whether the transactions originated with a B2B or a B2C company. B2B vs. B2C Transaction Decline Rate by Price Point 21 14 7 0 8.1% 9.4% 7.6% 11.5% 8.5% 13.1% 9.5% 15.7% 11.9% $0-18 $19-28 $29-48 $49-98 $99+ B2B B2C * Price points were chosen to reflect the most common subscription fees throughout the sample set. 20.9% Decline rates in the B2C category outstripped the average decline rate for each price point, based on the volume of transactions. Decline rates increased in step with price points in both the B2B and B2C categories. However, decline rates for transactions in the B2C category outstripped the average decline rate for each price point, based on the volume of transactions. In the B2C category, decline rates for transactions valued at $99+ and $49-98 reached almost 21 percent and 15 percent respectively. The B2B category experienced much lower decline rates at those same price points almost 12 percent for $99+ and 9 percent for $49-98. 18

Factors Impacting Subscription Revenue: Credit Card Declines As noted earlier, transactions can decline for a variety of reasons, including fraud or temporarily overburdened credit cards. This factor appears to be at work as we saw higher rates of declines with the B2C category, especially when working with higher price points. Credit cards can be declined for a variety of reasons, but higher ticket transaction sizes are certainly weighted with increasing sensitivity by payment gateway and card processing participants. We have observed a distinct correlation between the transaction amount and the probability that the card will result in a declined transaction. Being able to identify these scenarios is crucial, as there are a variety of tactics that subscription businesses can use to recoup revenue which would otherwise have been lost. In our next section, we ll analyze how to measure revenue recovery and how it contributes to healthy growth. Analyzing Decline Rates To establish a baseline, compare your average decline rate to industry rates. For most businesses, a decline rate of 5-14 percent of monthly transactions for B2B and 6-18 percent for B2C is standard. Then look for trends. Sometimes, viewing month-over-month data can reveal interesting trends. Your customer service team can also be a great source of information on decline reasons and trends. Regular analysis will make clear what issues are causing transaction declines and how you can correct them. 19

Recovering Lost Revenue

Recovering Lost Revenue Unlike physical commerce, where a transaction can be saved when the customer provides another credit card if the first card has a problem, card-not-present (CNP) transactions such as those in subscription businesses require specialized strategies if the transaction fails. While most transactions are successful, the nature of subscription businesses provides opportunities to recover revenue that might otherwise have been lost to credit card declines or churn. This is especially important at renewal time for subscriptions. Recovering this revenue requires specialized logic which can vary based upon why a transaction fails. This may include re-submitting the transaction programmatically, or re-trying the transaction, at defined intervals, to avoid inconveniencing customers. Quarterly Average Recovered Revenue Rates 12 9 6 3 10.4% 12.0% 11.0% How Well Do Various Business Categories Recover Lost Revenue? Using these programmatic techniques, the businesses in our sample were able to recover almost 11 percent of revenue that would otherwise have been lost during 2015. The revenue recovery rate for B2C transactions was higher, at 12 percent. This is noteworthy since the B2C category experienced a slightly higher rate of declines and churn, too. Efficient revenue recovery can lead to significant upticks in revenue for subscription businesses. 0 B2B B2C Overall Average 21

Recovering Lost Revenue How to Calculate the Recovered Revenue Rate The Recovered Revenue Rate is calculated by taking the sum of revenue Recurly is able to recover that would have been lost otherwise and dividing that by the original revenue amount. In general, there are three types of successful transactions, and the last two cases contribute to the Total Recovered Revenue amount: Amount of revenue businesses in our sample were able to recover First attempt with existing and up-to-date credit card information. This is the bulk of most recurring transactions, where the transaction will just go through on the first attempt with the existing credit card information. The effective recovered revenue rate is calculated by dividing the total recovered revenue by the total revenue amount. First attempt with updated credit card information. This is a group of transactions where Recurly s proprietary solution, including Account Updater, will update the credit card information before processing the first transaction. Without the updated information (e.g. new credit card number), these transactions would have failed and the revenue would have been lost. Subsequent attempts on initially failed transactions. This group of transactions are ones where the initial attempt was declined, due to credit card issues such as insufficient available balance, but were successfully re-submitted programmatically at defined intervals using our service. 22

Recovering Lost Revenue Let s use a fictional company called Kale Krate to illustrate how this works. In the month of April, Kale Krate generated $950,000 in revenue. Of the $950,000, Recurly was able to successfully process $800,000 on the first attempt without any updates (case #1). Recurly was also able to update the credit information and successfully process $100,000 on first attempt (case #2). Finally, $50,000 was declined initially but subsequent programmatic attempts helped recover $10,000 of that amount (case #3) for Kale Krate. As a result, Kale Krate collected $910,000 in the month of April, including $110,000 that might have been lost. Step-by-Step: Calculating Effective Recovered Revenue Rate Follow these three simple steps to calculate your effective recovered revenue rate and see how much you could save. 1 Calculate the total recovered revenue (case #2 + case #3) $100,000 + $10,000 = $110,000 There are over 2,000 ways a credit card transaction can fail. See how much revenue you can recover by preventing declines. 2 Calculate the total possible revenue $900,000 + $50,000 = $950,000 3 Divide recovered revenue by possible revenue $110,000 $950,000 = 11.57% 23

Recovering Lost Revenue The key to revenue recovery lies in identifying the reason for a transaction decline so the appropriate action can be taken. There are scores of reasons why transactions can be declined, or fail. Each reason has a different rate of revenue recovery with some reasons generating high rates of revenue recovery and other reasons very low rates. Revenue recovery rate of our sample, attributed to proactive management Overall, our sample saw a revenue recovery rate of 11 percent, across all decline reasons. This rate is attributable to proactive management and use of Recurly s proprietary retry logic and built-in Account Updater tools. We further examined three of the more common decline reasons Insufficient Funds, Temporary Hold, and Exceeds Daily Limit that we remediate using proprietary logic. The revenue recovery rates were fairly consistent throughout 2015, demonstrating how managing declines can lead to significant revenue contributions on a repeatable basis. Quarterly Recovered Revenue Rates by Top Failure Types 33 31.5% 32.9% 31.4% 28.9% 29.8% 22 25.0% 11 14.7% 14.3% 13.7% 12.1% 31.4% 27.4% 0 Q1 Q2 Q3 Q4 Insufficient Funds Temporary Hold Exceeds Daily Limit 24

Recovering Lost Revenue The recovered revenue rate represents only one facet of value, as it represents only the money recovered from individual transactions. If a customer is lost or churns due to a credit card issue, then the subscription business not only loses the revenue from that failed transaction, the business could also lose all future revenue from that customer. Since subscription businesses are based upon the premise of customer loyalty and retention, it is critical to build revenue recovery processes into business workflows. Keys to Recovering Revenue If a customer is lost or churns due to a credit card issue, the business could lose all future revenue from that customer. Identify the reason for a transaction decline so the appropriate action can be taken. Common decline reasons are: Insufficient Funds, Temporary Hold, and Exceeds Daily Limit. Use an Account Updater function to automatically repair failed transactions. Recurly s Account Updater recovers up to 9 percent of a customer s annual revenue, on average. Read more about Recurly s free Account Updater service. 25

Summary and Methodology

Summary The recurring nature of subscriptions provides an opportunity to reinforce value for customers every time a product or service is delivered and with every billing cycle. Customer retention is key as customers who derive value reward companies with economic loyalty. Two of the factors that subscription businesses need to manage closely are credit card declines and customer attrition, or churn. Mitigating churn can provide subscription businesses with significant revenue uptick and can be achieved with modest process improvements. One of the first steps is to identify business patterns, especially as they compare to industry averages. For example, companies that target consumer audiences may see increased customer churn after the holiday period and should create proactive strategies for mitigating this hangover effect. The nature of card-not-present transactions, unlike physical commerce where both the card and the customer are present, require specialized strategies if the transaction fails. While most transactions are successful, the nature of subscription businesses provides opportunities to recover revenue that might otherwise have been lost. This is especially important at renewal time for subscriptions as credit cards may have been updated or replaced. In our sample set of 25 million transactions that occurred over 2015, Recurly was able to recover almost 11 percent of revenue for these subscription businesses, providing a noticeable, positive impact. Churn falls into two categories, voluntary and involuntary. The former category indicates customer dissatisfaction with products or services, providing a clear indication that improvements are needed in product or operational areas. Involuntary churn is usually caused by credit card issues which, when remediated, lead to two important results: increased revenue gained from capturing the value of failed transactions, and increased rates of customer retention as satisfied customers were not lost due to credit card declines. As more businesses embrace the subscription model to deliver predictable revenue and form closer relationships with their customers, customer loyalty and retention metrics such as those we analyzed in this report provide the key to automating revenue-optimizing decisions. 27

Methodology Our study examined a sample pool of 25 million aggregated and anonymized subscription transactions generated throughout 2015. We categorized these transactions by market either business-to-business (B2B) or business-to-consumer (B2C) and by whether the product or service was digital or physical, in order to identify trends, including seasonality. We also segmented our sample transactions into five clusters of price points and identified whether the transactions originated with a B2B or a B2C company in order to examine the impact of price. The sample set included paid recurring transactions only and did not include the initial subscribing transaction. 28

Glossary Transaction Decline Rate The number of declined transactions as a percentage of the total number of recurring transactions in the sample. Voluntary Churn Customer attrition based upon a direct customer action intended to terminate a subscription, for example when a customer cancels their subscription or purposefully lets it lapse without renewing. Coupon Customer Impact Rate The total number of customers who redeemed a coupon divided by the number of customers in that month for each business offering coupons. The reported rate is an average across these businesses. The time period included was the 2015 holiday season (October to December). Recovered Revenue The sum of revenue recovered by Recurly (through processes such as Account Updater, automatic retries, and dunning) that would have otherwise been lost, divided by the original revenue amount. Monetary Decline Rate The total value of declined transactions as a percentage of the total value of recurring transactions in the sample. Involuntary Churn Customer attrition based upon a passive customer action, such as a declined credit card. If the credit card information is not updated or repaired, it causes the customer s subscription to be terminated. Churn Rate The total number of customers who left due to either voluntary or involuntary churn during a given time period divided by the total number of customers at the start of that time period. Only recurring transactions were included in sample set; initial were transactions excluded. Recurly measured churned and total customers for each month of 2015 and averaged these rates into four quarters. 29