What Are Recurring Payments and How Do They Work?

What Are Recurring Payments and How Do They Work?

Advancements in online payment processing have changed the way people pay for services. The introduction of recurring payments simplified the payment procedure for subscribers and recurring customers.

Customers using recurring payments save time and avoid additional fees. Business owners, on the other hand, benefit from recurring payments because they ensure predictable recurring revenue.

In this article, we’ll explain what recurring payments are and how they work.

Recurring payment definition

A recurring payment is a billing arrangement in which a business automatically collects money from a customer’s account based on a predefined arrangement.

Customers first need to authorize merchants to automatically charge their bank cards or debit their bank accounts for the provided goods and services.

Once a merchant gets this permission, they regularly collect funds the from customer’s account on the agreed due date. The arrangement is active until the customer stops using the merchant’s services and withdraws authorization.

Recurring payments are commonly used for paying digital streaming services, subscription box services, newspaper and magazine subscriptions, utility bills, and SaaS.

Recurring Payment Example

Let’s say that a customer lives in a house in the country and has a swimming pool. They need to treat the pool several times a week with special chemicals to keep it clean. Driving to the nearby town even once a week is not an ideal option—it’s a waste of time and resources.

Instead, the customer contacts a store selling swimming pool chemicals and arranges a delivery a few times a month. They authorize the store to collect the agreed amount of money from their account after each delivery.

Types of Recurring Payments

Types of recurring payments

Some companies using recurring payments offer significant discounts to customers who pay for a whole year of services upfront. This approach helps them predict their annual recurring revenue.

Others – primarily small businesses – prefer monthly subscription payments that ensure monthly recurring revenue.

There are two major types of recurring payments: fixed payments and variable payments.

Fixed Payments

With fixed payments, the customer is always billed the same amount. The house owner from the example above orders the same chemicals for every delivery and pays the same amount of money.

Fixed payments are typical for membership sites and subscription-based businesses, especially if they are new businesses. It’s easier for these merchants to set and calculate their revenue with fixed payments.

Note: If you’re planning to launch a venture, read our guide and learn how to start a subscription business.

Variable Payments

With variable payments, the billed amount isn’t the same every time.

The merchant has the customer’s permission to collect money from their account, but the amount charged depends on the customer’s usage of the merchant’s products and services.

Variable payments are typical for electricity and phone bills.

Note: Usage-based pricing is just one of many subscription pricing models merchants offer to give users plenty of options and convert them into customers.

How Do Recurring Payments Work?

How do recurring payments work

For recurring payments to work, the customer needs to authorize the merchant to bill them regularly for the agreed upon products or services. Then, the merchant charges the client regularly until one of these two parties cancels the arrangement.

Note: Business owners need to open a merchant account to collect recurring payments.

Benefits of Recurring Payments

Recurring payments bring the following benefits to merchants:

  • Lower churn rate. Recurring payments simplify the payment process and improve customers’ experience. This prevents churn.
  • Steady cash flow. Merchants that collect recurring payments can ensure and predict their short- and long-term cash flow.
  • Fewer late payments. With customers’ billing permission, merchants always collect recurring payments on time and avoid postponed transactions.
  • Payment automation. Once the merchant and the customer arrange the terms and conditions of recurring payments, billing is automated until the customer cancels the subscription.
  • Smooth payment experience. Customers enter their billing information only once (when making their first payment). After that, they don’t waste time entering payment details and enjoy a smooth payment experience.

Recurring Payments Use Cases

The following business types benefit from recurring payments:

  • Subscription businesses. Subscription companies from streaming services to delivery businesses use recurring payments.
  • Membership businesses. Sport and recreation clubs, gyms, and learning platforms are membership businesses that often use recurring payments. Customers are charged either monthly or annually.
  • Utility companies. Recurring payments are practical for utility companies such as gas, electricity, internet and telephone providers. Users authorize such companies to bill them automatically, but the amount collected depends on the services used.

How to Choose a Recurring Payment Provider

How to choose a recurring payment provider

Consider the following factors when choosing a recurring payment provider:

  • Decide whether to accept only recurring payments or one-time transactions, as well.
  • Ask the payment provider if they have any geographical restrictions.
  • Learn how the provider handles the billing plans for the business’s pricing model. Offering users several pricing tiers increases the chance of turning them into loyal customers.
  • Choose providers that simplify the integration procedure and customize the solution setup to meet the business’s needs.
  • Shortlist only the providers that allow free trials. Try their services before making a deal.
  • Check if the provider is PCI compliant. This reduces the time spent dealing with these regulations.
  • Inquire about security features, including two-factor authentication, encryption, and secure credit card processing.
  • Mind the provider’s small print to avoid paying additional hidden fees.

Conclusion

Recurring payments help merchants bill their customers on time and ensure steady revenue. Customers also benefit because they avoid making late payments and pay more efficiently. The information above should help you determine if your business may benefit from using recurring payments.