The Direct Debit (DD) and Direct Credit (DC) schemes are highly favoured by UK organisations. By automating payments and receipts, organisations can achieve high levels of efficiency, optimise cash flow and minimise risk. There are benefits too for customers in terms of improved cash management and a reduction in time spent managing personal finances.
However, there is a hidden downside to both schemes. Should a payment go awry the cost for both the recipient and consumer can be high. Not only is it expensive for both parties to resolve an error, it can lead to a sharp decline in customer loyalty and ultimately to the loss of the customer.
This article examines these key issues and questions whether the success of both schemes could be enhanced by changes that would further minimise the likelihood of automated payments failing to be applied correctly.
The cost benefits of using the Direct Debit and Direct Credit schemes for the Originator include:
- Assurance of payment;
- Excellent cash flow benefits from receiving regular payments;
- Low cost of administration compared with requesting consumer-initiated payments;
- Precise control over payment timing.
The cost benefits for the customer include:
- Easier budgeting by spreading the payment burden;
- Discounts offered by some billing organisations for using direct debit, sometimes perceived as a penalty for not using DD.;
- Immediate availability of funds via Direct Credit with no risk of cheques ‘bouncing’ and consequent charges;
- Reduced time to initiate a payment using automation of DD/DC in comparison with writing and signing cheques or paying bills via Post Office or other payment service provider.;
- Independence of the consumer recipient in payment processing means that payments can be made or received even when the customer is ill or away from home.
When things go wrong
One of the core reasons for the success of DDs is the protection offered by the Direct Debit Guarantee.
This promises that:
- “If the amounts to be paid or the payment dates change, the organisation collecting the payment will notify you normally 10 working days in advance of your account being debited or as otherwise agreed
- If an error is made by the organisation or your bank or building society, you are guaranteed a full and immediate refund from your branch of the amount paid
- You can cancel a Direct Debit at any time by contacting your bank or building society. We also recommend you notify the organisation concerned. (1)”
Inevitably, not all DDs and DCs work perfectly every time. Mistakes occur in payment amounts and timings and sometimes payments fail.
In such situations the customer turns to the Direct Debit Guarantee for protection. However, in practice, the guarantee is more limited than it might appear. In particular, it cannot simplify the challenge of proving whether a payment has been made or received in error, nor can it address the cash flow implications for customers and businesses of failed payments or receipts.
If a DD or DC is rejected and is neither paid nor received, the originator or the customer is most likely to raise the issue directly with the opposite party. Although there is a cost in resolving the failed payment the problem is relatively easy to identify and resolve.
Most organisations implement bank account validation solutions that identify many of these problems up front and thereby eliminate these errors and the associated costs. However there are scenarios that cannot be caught by validation solutions and which are the most costly to correct. Examples include misapplied payments and payments to closed or deceased accounts.
A misapplied Direct Debit or Direct Credit is one in which funds leave one party but fails to arrive at the correct destination. The funds are either paid into the wrong account or end up in a suspense account unallocated. These problems usually have one of three causes: the customer supplies incorrect data; the bank account requires data that is not covered by simple modulus rule-based validation systems (such as a reference or roll number) or the modulus rule-based validation system used by the bank is insufficiently sophisticated to handle the payment successfully. Resolving these situations is much more expensive and problematic than when a DD or DC is completely rejected.
A good example of this problem can be seen in the insurance industry. Upon maturity a pension will often pay out a lump sum but frequently to a different account to that which has been used to collect premiums. Rightly, many customers request that their pension lump sum is paid into a high-interest savings account. Many of these are Building Society accounts that require a roll number and are not validated by the normal modulus check processes. This means that any number may therefore be valid with the result that the payment either goes to the wrong account or, if the account does not exist, enters the Building Society’s suspense account.
The first the insurance company learns that there is an error is when the customer calls to complain that the payment hasn’t been received. From the insurance company’s perspective, the payment has been made correctly. Resolving the problem is expensive and complicated, partly because the recipient is rightly protected by data protection legislation and partly because when money is returned to the originator it may well be in the form of a bulk payment for a number of failures with no indication as to which payments have failed. Inevitably, there is a financial impact on the recipient and the reputations of both the insurance company and Building Society are at risk.
Currently 2% of Direct Debits and Direct Credits fail each year, equivalent to around 111m transactions (2). The cost to originators in resolving these failed payments is believed to be as much as £35 per transaction or £3 billion annually (3). This cost is so high because it is impossible, or at least highly risky, to use automation to resolve a failed automated payment. Upon discovering the error the originator, bank or customer must escalate the problem immediately and manually intervene, with many banks typically not informing their retail customers of failed Direct Credit payments.
Impact on customer loyalty
However, these monetary costs do not take the full cost of customer behaviour into account.
Failed automated payments are believed to have a significant impact on the reputation of the originator, leading to a decline in customer loyalty and a corresponding increase in customer churn.
In short, when a DD and DC goes awry, the ultimate cost may not simply be the cost of resolving the error, but the cost of replacing the customer.
Key to eliminating the risk of customer churn when a DD or DC fails is the need to restore loyalty as quickly as possible. This is helped considerably by the high level of trust that exists between the originator and customer through the Direct Debit Guarantee.
However, the role of the Direct Debit Guarantee is primarily as a safety device should something go wrong. The key component of trust in the DD and DC relationship is that the originator must trust the data provided by the customer initially, and the customer has to take on trust the processes of the originator. The originator cannot prove that the customer-supplied data - name, address and bank account details - are correct, current and are associated with one another. The customer cannot be sure that the systems in place at the originator and the banks are sufficiently secure, proven and consistently reliable to ensure the smooth processing of their payment. A bad experience with one originator is sufficient to undermine years of good experiences with many others.
Progress is being made with regard to originator and bank systems. There has been a revolution in the quality of payments systems in place within Britain’s corporate community since 2005 with most of the large originators now operating amongst the most advanced payment applications in existence.
Progress is also being made with improvements to payment processes within the banks. Initiatives like UK Faster Payments will potentially do much to enhance the reputation of banks with their retail customers.
Eliminating costly errors
However further steps are required if the cost of failed and misapplied DDs and DCs is to be reduced significantly and the DD and DC schemes given the opportunity to achieve their full potential.
Failed and misapplied Direct Debits and Direct Credits occur because the systems in place to check on the accuracy of customer-supplied personal and bank information are currently limited to checking the format validity of bank account data. This ‘rule-based’ validation is highly effective but limited in its scope.
The next step must be for organisations to be able to move from validation to absolute verification in real time. When this is possible human error will be removed from the process. This will have a dramatic and positive impact on the level of trust between originator and customer.
Two capabilities are required to reduce to an absolute minimum the number of failed and misapplied Direct Debits and Direct Credits and to minimise the volume of related customer churn:
- The ability to check that consumer-supplied bank account data is correct and current
- The ability to corroborate those data with the supplied name and address against a reliable reference for those data
If these two capabilities are introduced, then a variety of errors that are currently not picked up by rule-based validation would be identified. These include: invalid details, closed accounts, incorrect or fraudulent beneficiary as well as blocked transactions.
With these two initiatives in place fewer customers will have a negative experience of the DD and DC process and fewer will switch suppliers as a result.
The elimination of such errors would make the DD and DC schemes even more cost-efficient for originators and even more convenient and reliable for customers.
The cost of managing customers’ queries, the cost of rectifying failed payments and collections and the cost of fraud losses would all reduce significantly. Similarly, the customer experience would be enhanced and the reputation of the schemes and the originators preserved.
The question is can the industry rise to the challenge and virtually eliminate DD and DC rejections and errors to the benefit of banks, corporates and their customers?
1. http://www.bacs.co.uk/BACS/Consumers/Direct+Debit/Your+rights/?st=s0l1ztbqql2ski3jkf10py55&c= (accessed 9 July 2007)
2. UK Payment Statistics 2007, APACS
3. This cost is calculated on the basis of it taking approximately thirty minutes to investigate and resolve each error