Collections or Debt Management is an integral phase of the credit and risk life cycle, financial institutions and other verticals like Telecom, Utilities etc. have a dedicated Debt Management Unit that deals with the unpaid dues of the customers and follows them for repayment of the arrears.
The collections phase can be segmented based on the products and policies and start with Pre-delinquent stage, Early collections, Mid collections, Late collections and Recoveries (after the accounts are cancelled). Collections as a process has evolved from the traditional idea of just collecting dues. Modern Collections is a combination of Science and Art i.e. using the science of Data, Logic and Modelling together with the Art of negotiation. Collections today besides its primary responsibility of collecting the dues is also focussing on:
a. Customer Retention: Understanding the issues for non payment, resolving customer problems with a service approach.
b. Profitability of the Business: Minimizing credit losses, saving costs by optimization, future revenues from retained customers.
c. Feedback to the Business: High risk customers to review credit sourcing strategies, overall customer experience on service improvement.
A strong and effective Collections Unit enables the organizations to take calculated risk and increase the acceptance rate of customer acquisition. Need and utility of Collections is best felt at the time of financial crisis, its when efficient and innovative collections tools have a direct implication on minimizing the losses. The value of an improvement in collections will always come from all of these areas but the relative importance of each will change depending on the situation and stage of the debt life-cycle.
Very early collections has less of a risk focus; instead because number of accounts are high there is a lot to be gained through efficiency and because customers are still largely ’good’, there is much to be gained from retention.
Mid Stage collections focusses on maintaining a balance in Risk and Costs. Strategies are oriented towards Rehabilitation of the good customers having financial difficulties and thereby Protecting assets.
In the later stages though, this is reversed: fewer accouts mean that operational savings are less important as is retention, since most of these accounts are probably not worth retaining, however any prevented write-offs will minimize the Gross Credit Losses.
The need of effective Collections strategies can be explained with the help of Pareto’s law of 80:20. This law when applied to collections reflects that 20% of the accounts comprise 80% of the collections volume, does that mean that these 20% are High Risk accounts? Or the corollary the 80% accounts comprising the 20% collections volumes are Low Risk. This brings the necessity of scientific techniques required to identify the risk hidden in every account of the porfolio and treat accounts appropriately based on the risk levels.
Strategies driving collections can be classified into:
a. Business Strategies comprise of Scoring Models and Retention Strategies ( covered primarily in the Credit/ Collections Policies)
b. Operational Strategies : Operational strategies include diverse strategies classified under STO (Strategy Tree Optimization) like self curing strategy, dynamic risk segmentation, risk based treatments, dialer strategy, outsourcing strategy, simulation models, Champion Challenger etc.
These strategies individually or with combination of others at appropriate collections phases and risk level of accounts can completely turnaround the way Collections works, thereby leading to higher efficiency and productivity by optimally using the available resources.
Scoring models are the key Business Risk strategies. The scorecards at different phases of Collections (i.e. Pre-Delinquency, Early-Mid-Late Collections, Recoveries) determine the risk levels and the payment propensity of unique accounts based on delinquency levels, dynamic customer behavior profile, payment patterns, seasonal trends etc.
The communication with potentially delinquent or delinquent customers can and should be heavily tailored to these risk levels. The strategic collections decisioning system should have the powerful segmentation capabilities to drive the appropriate treatments. A comprehensive communication content and treatment that is frequently reviewed and refreshed can mean the significant difference between average and exceptional collections performance.
The score cards should feed the Collections Workflow System that follows the account treatment path.The first action could be any one of the “Decisions” like “No Action”, Letter, SMS, Phone, Collector or DCA. “NO ACTION” is applicable to Low risk but not applicable to High Risk accounts, this can be managed by other treatments like SMS, Emails, Post, Dialler Messages, Telecalling or Debt Collections Agency.
Collections path (these could include many types but would be all grouped and tagged, if they went through one collection path). The sequence and frequency of the appropriate treatments act as the Game Changer to the Collections Unit and this is where Science and Art join hands leading to best of class performance.
Risk based collections strategy is created by combining a business strategy (inspired by analysis and scorecards) and an operational strategy (affects the day-to-day operational activities of the collections department). However, in many organisations the two parts of this process are disjointed, with a gap between the analytical competency and the operational competency. In order to move from the theoretical to the practical needs to affect operational strategies – using the three Ts (Treatment, Timing and Tone)
The first step is to use a scorecard to segment customers into groups of similar types and to understand how each of those segments is likely to behave in the near future: the simplest of these would be a scorecard segmenting customers into groups, each with an attached probability of default/ recovery.
The first strategy variable is “Treatment”. Treatment refers to the type of action/ contact channel that will be used. The two axes to consider are the cost of the treatment being considered and the effectiveness of that treatment: effective treatments are more expensive, is spending more money a good investment or will it be better to use an economical albeit less effective treatments. The most economical treatment, at least in terms of direct costs, is to do nothing – a self cure strategy but it is also the least effective in customer segments that present genuine risk. The next cheapest treatment is SMS, these canbe automatically sent to large numbers of customers at low cost but can lead to other costs if the contacted customer calls in. Letters are typically more expensive to send but harder for customers to ignore and therefore more effective while outbound phone calls and DCAs are even further along the continuum.
The next factor is ”Timing”: when and how often in a cycle should a delinquent customer be contacted? The longer you wait to make the first contact, the greater the chance the customer will self-cure and thus save on the contact costs, however there is a risk, the customer will pay off any other debts with what little money they have available. A similar principle applies to the frequency of contacts; after each contact, its impact will diminish with time so as the gap increases the probability of a repayment drops, however as frequency increases so do costs.
The final factor is ”Tone”. The tone of the message which relates to the tone of the message itself and the convenience of when it is delivered. A harshly worded message is harder to ignore, but also increases the probability of attrition, as does a message that is communicated at a time that is inconvenient to the customer – after hours, on week-ends, etc.
All three factors can be overlaid to create a guideline for the setting of operational strategies. Low risk customers with small balances can be allowed a long self-cure period followed by a cheap, softly-worded SMS reminder.On the other extreme customers should be contacted immediately and direct communication channels should be leveraged early.
Every collections strategy should include champion/ challenger experiments at each key stage – testing the impact of a change in treatment, timing and tone. Does an SMS work well enough to justify its cost? How does making the first contact a day earlier or a day later change the outcome? Which contact scrips are more affective?
Strategies are effective only when implemented using appropriate and efficient systems
Host system acts as the primary system
• Data from the Primary system needs to be stored in a suitable system
• Data from this system must be accessible to the other systems.
• Data should be available for Reporting
Data management leads to Scorecards
• Scorecards should be built by trained statisticians
• Scorecards require advanced software tools
• Scorecards should also be monitored on an ongoing basis
Scorecards should be fed in the Strategy Management System
• System is needed to assign and manage strategies
• System should facilitate Champion Challenger and Simulations
• System should be flexible to changing needs
Strategy Manager will direct the actions to the Operations Workflow system
• Systems are needed to implement strategies
• System should manage timing and production
• System should ideally provide Operational reporting
Workflow System is managed by trained and experienced Workforce.
• People are vital part of the Risk based collections
• Staff should alter their actions based on Risk
• Training should be made a priority
Case Study : BMW Financials Germany : Adopting a segmented approach in Collections
Business Challenge: BMW Financials like many other organizations had the same Business Challenge to improve Profits and Cash Flow by reducing Debt Write Offs.
• New Collections Management Solution
• Differentiated Workflows with scorecard based customer treatment strategies
• Maximize collected receivables, Minimize overall cost
• Customer satisfaction and sustained customer relationship
The Solutions recommended after the Business Review were
a. On the Business side by implementing Scorecards
b. On the Operational side by implementing Tallyman, the Collections Workflow System and STO (Strategy Tree Optimization
The Benefits were overwhelming:
The Delinquency rate reduced by 50% within 4 Months of Going-Live. The reduced Flow to the Late collections resulted in saving the Provisions on Late Collections. Overall the resource allocation improved, the efficiency increased, thereby enhancing the productivity and effectiveness of the entire Collections unit. This resulted in higher collections performance and strengthened customer relationships