Galit Michel, VP of Payments, Forter
Today, merchants in the European Union (EU) and European Economic Area (EEA) are increasingly concerned with two things: the revised Payment Services Directive (PSD2) that came into effect on January 1st 2021, and their ability to maintain and grow their business as COVID-19 continues to change the world.
The global pandemic has changed the behavioural patterns of consumers, driving an increasing reliance on digital shopping. This alone proves a challenge for businesses, however now with the enforcement of PSD2, merchants will also have to drastically change their processing methods and integrate an additional layer of Secure Customer Authentication (SCA) to comply with the need for multi-factor authentication.
To comply with the new directive, many payment processors will route transactions through 3D-Secure (3DS). New data from Microsoft and Amazon confirms that 3DS usage increases decline rates, and so the increased use of it across all sectors is expected to lead to a universal rise in decline rates.
eCommerce brands and online merchants that want to increase revenue generation and maintain profitability levels – especially during these unprecedented times – need to take the time to evaluate their decline rates, understand if their issuing and acquiring banks are prepared for PSD2, and prepare their business for the new directive – before it is too late.
How Declines Impact Future Revenue
Decline rates don’t just impact the weekly (or even monthly) bottom line – they impact revenue generation potential for months and years to come. When a consumer experiences a decline– regardless of whether it is due to something within their control, such as having sufficient funds or correctly typing in their payment details – it negatively impacts their entire shopping experience.
Today, it is especially important to consider shoppers’ experience, as transaction volumes are twice as high as pre-COVID-19 levels, and most businesses are increasing their investment in eCommerce, stepping up overall competition. For new shoppers going online for the first time due to the recent global pandemic, a seamless purchasing experience can be the difference between retailers securing the lifetime value of a new customer – or a missed opportunity.
When new shoppers, who might not have been accustomed to shopping online, encounter difficulties, they are much more likely to abandon the process. Adding to this the fact that new customers are 5-7 times more likely to have their transaction declined as a result of over-zealous fraud prevention solutions, means it is critical for businesses to have a checkout process which is mindful of their fears and suited to their needs.
Even experienced shoppers expect frictionless transactions; a complicated checkout process may not deter an experienced online shopper from buying goods online, but it may lead them to take their business elsewhere.
Since PSD2 will inevitably lead to more declines, merchants need to implement mechanisms that reduce or recover declines and make the entire payment process as frictionless as possible.
To know which mechanism can help reduce the impact of declines on a business, it is necessary to know what a business’s decline rates are and why declined transactions did not go through.
Transaction declines occur for several reasons:
- Acquirer or issuing banks reject the transaction since they believe the transaction is high-risk and do not want to assume liability.
- Technical failure of the gateway, Payment Service Provider (PSP), acquirer, card network, 3DS provider, issuing bank or other technical issue.
- Customer-triggered issues such as insufficient funds or entering incorrect payment details.
Merchants that want to increase their approval ratio and their bottom-line need to examine their issuing bank risk policy, analyse information from their PSP and 3DS providers, and understand where in the checkout process consumers experience friction and declines.
While analysing declines is already important for overall business health, it will become critical when PSD2 goes into effect.
Declines Don’t Just Impact the Bottom Line
With PSD2 going into effect, more transactions will be processed through 3DS, and because of this, merchants will suffer from additional declines.
While the impact of declines is initially on the bottom-line, that’s not all declines do to a business.
Due to the increased verification and customer authentication mechanisms merchants must put in place, all traffic will either need to be routed through 3DS or merchants will need to get an exemption. Exemptions may be declined by the processors or by the card issuers to keep fraud rates low.
At the same time, 3DS can fail due to unsuccessful authentication, and successful 3DS transactions may result in declined authorisations due to the issuers wanting to avoid taking increased liability on themselves. As this happens, decline rates will go up, further impacting eCommerce businesses’ ability to profit.
To reduce declines and increase revenue generation, many merchants may seek 3DS exemptions. Making smart decisions regarding exemptions is critical. Both the processor and the issuer need to agree to the exemption, and if an exemption is granted and a chargeback later occurs, merchants may lose their good standing with their bank and be refused future exemption requests or even not be able to process transactions at all. That is why merchants need to ensure that exemptions are only requested for the right transactions.
One of the most significant problems merchants will face with PSD2, and increased use of 3DS is that many issuers across the EU and the EEA, despite having known about the PSD2 regulation for over two years, are still not prepared.
When an issuer, or any of the parties throughout the payment process, is not ready to process transactions using SCA via 3DS2 and under PSD2, they will do one of three things:
- Enable 3DS1 only
- Use Stand-in Processing
- Decline the transaction
If an issuing party only supports 3DS-1, the 3DS vendor or payment processor executing the 3DS will process the transaction using 3DS1 (rather than attempt to execute 3DS2). If this is not done, the transaction might be declined by the issuer. It is therefore very important for the merchant to make sure that its 3DS vendor supports fallback to 3DS1 in cases that issuer does not support 3DS2. Even when 3DS1 is properly used as a fallback to 3DS2, the result is often a poor customer purchasing experience and higher cart abandonment rates.
If the issuer is completely unprepared for PSD2 and does not even support 3SD1, or in cases where the 3DS vendor or payment processor does not have 3DS1 in place, the issuer will be forced to use what is called stand-in processing (STIP). STIP happens when Visa or MasterCard ‘stand in,’ for the issuer. They then evaluate the risk of the transaction, and decide whether or not the issuer should take liability for the chargeback. If the transaction is a low risk one, the liability shifts to the issuer. The only way for the issuer to avoid liability is to decline the authorisation. When an issuer is not ready, the merchant is the one who will suffer from more declines.
All is Not Lost
While PSD2 going into effect will significantly impact overall transaction declines, there is a lot that eCommerce brands and online merchants can do to reduce the impact of declines on their business.
Selecting a payment optimisation solution will immediately impact transaction failure rates and help merchants recover declines before it is too late. Integrating dynamic 3DS based on user profiles, maximising the use of TRA exemptions, and using behavioural analytics to determine the most frictionless verification method for each customer, can increase approvals while ensuring PSD2 compliance.
Smart processing enables businesses to minimise touch-points by pushing customers towards alternative payment solutions that do not require 3DS. Additionally, having a decline recovery solution enables seamless recovery of declines before the customer even knows their transaction was declined.
With PSD2 coming into effect, it is crucial for business with consumers in the EU and EEA to have alternative payment processing solutions in place. Alternative solutions can be local payment methods, such as online banking and various wallets, pay-later methods, or even pay-by-phone options. This is the only way to reduce the use of 3DS while reducing risk and ensuring compliance.
Merchants should consider the below questions to determine if they are ready for the impact of PSD2 on decline rates:
- Will an increase in declines impact your profitability?
- How do you plan on handling the challenges of PSD2?
- What SCA methods do you use today? And are they PSD2 compliant?
- Is your payment processor/bank/gateway ready for PSD2?
- Do you have a decline recovery solution?