The True Cost of Failed Payments

In the last piece, we estimated what failed payments cost a mid-sized cross-border platform: about $5 million a year. This is the direct cost, and also the floor of the true cost to the platform. Money movement is the platform's core service, and its failure logically has consequences well beyond the fee.

We will use the same platform to understand what the invisible costs add up to, i.e. 1.2 million payments a year, with 168,000 friction events. Also assume this platform serves 8,000 business customers, earns $9,000 of revenue from each, and has an average relationship term of four years.

Customer churn is the biggest cost

Churn is difficult to measure and directly attribute to failed payments. The institutions that do measure it report losing between 2% and 5% of their customers to the problem. But this low number is misleading, because it uses the total customer base as the denominator. Most of those customers never had a failure, yet this method of calculation counts them anyway.

Instead, if you look only at the customers actually hit by a payment failure, the number is far harsher. Consumer research finds that 41% of customers who experience a failed payment never return. The same research finds that more than half of the customers who suffer a false decline, even when they do return, transact at a much lower volume. This analysis found that these customers have 17% lower lifetime value.

The right way to measure the impact of lost customers is by their lifetime value, not a single year's revenue. With 2% to 5% churn across the total customer base and a four-year lifetime, the impact is between $5.8 million and $14.4 million a year. This one element alone is larger than all direct costs of failed payments put together.

The other invisible costs

Churn is the biggest cost, but there are several others.

1) FX loss on returns: When payments are returned, they have to be converted back to the original currency again, usually at a worse rate because they are not hedged. This round-tripping can cost between $0.2 million and $1.5 million a year.

2) Cash blocked and unused: Payments stuck in the exception queue block working capital throughout the year. The cost of that idle float can be $0.3 million to $0.7 million.

3) Lost payments: Some payments are sent to the wrong details and never recovered. They are lost. Even at a small failure rate, they cost the firm $0.5 million to $1.2 million a year.

4) Banking-relationship strain: Your performance on failed payments shapes your partner bank's attitude towards you: how they price you, how closely they feel the need to monitor you, and eventually whether the relationship continues. You can't put a price on it, but it's a high-stakes, long-term item for a payments firm.

The real cost

When you add it all up, the $5 million of direct cost becomes anything between $12 million and $23 million. These invisible costs are not a 10% to 20% surcharge over the direct costs. They can run between roughly 1.5x and 3.5x the direct costs. The invisible costs are significantly bigger than the cost number you can see.

For a problem this expensive, it is remarkably poorly understood and discussed far less than it should be. The costs are split across different teams, with no central custodian. Some indirect costs are often not even mapped. The fee paid to banks sits with the banking team. Operations has the employee cost of investigations. Customer success sees the churn. Treasury oversees the FX losses. And the banking strain is rarely tied back to failed-payment performance.

The most important and least glamorous thing you can do is put a number to the problem. Based on your volume, real failure rate, and real customer lifetime value, what is the fully loaded, all-in cost of failed payments? Most platforms are shocked by what they see.

In the next piece, we will look at how to reduce that number: how to fix the failure rate, and to what extent.