Module_on_Credit_Control

[pic] Author Cleven Masango {MSc Strategic Management (CUT), B Com Marketing Hons (NUST), IOBZ} Reviewed and Edited by Loyd Kazunga (MSc Finance and Investments (NUST), B Com Finance Hons (NUST), IOBZ, Cert in University Teaching) Typesetting Cumview Communications Cover Design Cumview Communications ( CCL Consulting Group 2010 All rights reserved. No part of this module may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying or otherwise, without the prior permission of CCL Consulting Group Private Limited. Tel: (263) 4 75 30 66 / 2932417 (263) 91 287 675 3rd Floor, South Wing, Pockets Building, 50 Jason Moyo Ave, Harare, Zimbabwe 8th Floor Cairo Road, Lusaka, Zambia E-mail ccl@cclint.net Website http://www.cclint.net Dear Participant Welcome to the Credit Relationship Management course delivered by CCL International Business Training. As practitioners in capacity development, we sincerely hope that this course will be of immense benefit to you. Our thrust as the facilitators is to equip you with a personal tool that enables you strategize on your relationship management programs so that you get the most out of your customers. Employing the expertise of highly qualified and experienced Facilitators, CCL offers this interactive and practical course at a time when the business landscape in Zimbabwe has become so risky and competitive that long-term relationship management becomes a real issue of survival. At CCL, we believe in making learning funny and exciting. We also believe that such a course provides a forum for sharing both best practice and worst practice. Through appropriate discussions that promote sharing of experiences, we will be able to draw upon the best possible solutions whose value will never be captured fully by this module. Situational learning and exploration therefore becomes one of the prime facilitation tools that will be employed by CCL in delivering this course. We also request you to kindly assist in the organizational learning process of CCL through filling in the Course Evaluation Form that will be provided at the end of this workshop. Your response is regarded by CCL as a fundamental aspect of its feedback process vital for continuous quality improvement of the training modules and methodologies that we employ. Please return your response to the Course Coordinator at the end of the course. We take this opportunity to wish you well in your personal and professional endeavors and firmly believe that in future, such forum for interaction will avail again in our continuous quest to provide relevant and topical training interventions for the benefit of our clients. …………………..… (Course Coordinator) 1 Introduction How can relationship managers become more proactive to prevent seemingly “overnight” failures in credit relationships with their clients' How can they become better and more effective business development executives without sacrificing risk management demands' Central to the workshop is a metaphor and visual image -“The Shape of the Curve” - which represents the desirability of a customer to the organization. The fact is that this curve is always changing, becoming more or less desirable. If the organization does not recognize this and does not change the shape of its own behavior curve, gaps will develop between the two curves, creating lost opportunities for the organization and vulnerability to competition or increased business risk. However these relationships must grow and become more profitable if the organization wants to remain competitive in its chosen markets. 2 Course Objectives The workshop intends to get participants to be able to; • Monitor borrower performance to guide both the frequency and the content of communication. • Evaluate changes in the risks and opportunities, analyze the signals, sources, and the implications of both sequential and non sequential “early warning” indicators of a deteriorating or evolving credit. • Take appropriate action, whether to expand the relationship, hold the line and preserve the organization’s position, or move decisively to reduce exposure and involvement. • Develop and manage relationships that maximise profitability • Develop strategies to retain best customers and defend against competition. 3 Relationship Approach to Business What is a valued relationship' It is any connection between two or more parties with the view of drawing from each other and mutually benefiting from the association. According to Lovelock (1996) it is one in which the customer (debtor / borrower) finds value because the benefits received from the service delivery (facility or loan) significantly outweighs associated cost. From the organisation’s perspective it is that which is financially profitable over time and in which the benefits of serving the customer (debtor /borrower) may extend beyond the revenues to include such intangibles as the learning and referral business obtained from working with the customer. Relationships are the cornerstone of business. Yet managing relationships is a subtle game of balance. Recognizing the appropriate level of service based on a client’s value helps assure consistency across all points of contact. Sharing client knowledge is also important to maintain that a client is “asked once and only once”. By doing so, you bring your entire team together and communicate a message to your clients that the right hand knows what the left hand is doing.  Traditionally the rules of the game were permanent. The road was a straight highway where driving in cruise control was possible. Life was predictable. 'Here's what we can make - who wants to buy our product'' or “We can make you a Ford in any colour for as long as it is black!” Due to the ever changing operating environment where rules are erratic, where the society is now closely networked, the new generation organisation requires a relationship approach to business management. It is no longer sustainable to have transactional but strategic based business relationship management. Progressive organisations shall be those who regard customers as partners and not adversaries. Customers are seeing their market places change, driven by rapidly advancing technology, global competition, shifting demographics, and the consequences of maturity. They are turning very discerning and elusive. Business success hinges on how successful an organisation interacts and manages this networked society. A plethora of these relationships should be developed into long term business partnerships. Peter Drucker in 1954 said “there is only one valid definition of business purpose: to create (a pool of profitable) customers.” These customer relationships must be long term. 4 Fundamentals of Relationships The following are the keys to successful relationships. ← Mutual consent Parties to a relationship must mutually agree to be in that relationship. For credit relationships these are usually contractual in nature. ← Understanding Partners to a relationship must endevour to understand the other. There is need for genuine interest to understand and then be considerate of each other. Customers are bound to be loyal to service providers who show that they understand their situation better and are willing to assist. ← Communication and information flow Lasting relationships rely heavily on effective communication and information flow. Selfishness often chokes relationships. ← Mutual trust (trust = credibility + reliability + intimacy / self orientation) Trust is central to all relationships. It takes time to build. A trusted partner is one who can be relied upon, one who has all the credibility and not self centered. Where trust for the service provider is threatened, the relationship manager should invest effort to demonstrate the organisation’s commitment to the partnership unless the relationship is not profitable ← Mutual interest and mutual benefit Parties to a relationship are driven by mutual interest and mutual benefit. The bigger the community of shared interest the more that relationship is wanted by the parties involved and the longer it will last and the smaller the region, the weaker the relationship. Commitment to win-results is the answer. ← Ethical and legal conduct Parties to a relationship must strive to be compliant with the socially acceptable and regulatory requirements. Relationships born out of illegal and unethical grounds do not last and are risky. ← Respect for privacy Is of privacy may be a cause for concern to business relationships. This is however not to say that the lender should not develop deeper understanding of the borrower. 5 Relationship Development Life Cycle Business relationships (internal and external) follow a development cycle that mimics the biological life starting from birth progressing through growth to maturity and death (decline). Every one’s wish is to have lasting life especially if it is rewarding. The strategic question is what to do at each stage to make the overall relationship rewarding and long lasting. Below is a typical life cycle of a business relationship. [pic] What characterizes each stage' New Phase ← Suspicion and self orientation ← High risk ← Minimal trust ← More learning required ← Low intimacy ← Low profitability ← Low business volume ← Prospects are migrated to customers Growth Phase ← Trust level improves and mutual benefit shows ← Intimacy improves ← Continued learning ← Upper migration ← Repeat business ← Reduced risk ← Cross and up selling ← Profitability improves ← Referral business ← Customers turn to clients Maturity Phase ← High trust levels ← Continued learning ← Upper migration ← Intimacy increases ← Profitable relationship ← Referral business ← Clients turn to advocates Decline Phase ← Low trust levels ← Customer dissatisfaction ← Low business volume ← Low profitability ← Down migration ← Customer defection or sacking 6 Why Credit Relationship Management' From the customer perspective is one relationship which the customer finds value because the benefits received from the service delivery significantly exceeds the associated costs of obtaining them. For the firm, it is a relationship that is financially profitable over time and in which the benefits of serving a customer exceed beyond revenues to include such intangibles as the learning obtained from working with that customer. It allows organizations to; ← Manage credit risk - Lending businesses need to manage credit risk pre-acquisition as well as post-acquisition of customers. Credit scoring enables better management of credit risk prior to acquiring a customer. Customer credit risk management enable management of credit risk post the acquisition of customers. Customer credit risk management should be based on behavioral scoring and portfolio management. Manage reputational risk – customers who are satisfied by a well managed relationship are a source of positive word of mouth and positive feedback that assist in managing reputational risk. ← Manage compliance risk - in compliance with the regulatory authorities regarding (KYC) know your customer requirements. Build more profitable customer relationships. Reichheld and Sasser realized that the longer customers remained with a firm the more profitable they become. The underlying profit growth stimulants are: Profit from increased purchases (the same products and other) Reduced operating costs Referral sales from satisfied customers Potential to charge premium prices Increase internal supply and demand chain communications ← Dramatically improve customer satisfaction and long term loyalty by delivering superior customized service ← Optimize lifetime value of each customer through cross selling and up selling. ← Identify high-risk and unprofitable customers and adjust service accordingly. 7 Economics of CRM and Customer Profitability The philosophy of marketing presumes that nothing starts before the customer. Any business strategy that starts elsewhere fails for overlooking the customer. Business organizations should define their ideal client profile (ICP). The philosophy subscribes to setting out an ICP that is premised on current and future customer relationship profitability. If you did not have an ICP then the starting point should be to define it. ICPs are just what they sound like – a listing of the factors that make up your ideal client. What is the ideal potential purchase behavior' What is its size or age' How much does it make in revenue each year' Who are its clients' What is its product or service' How many locations does it have' How much client service and what are the costs involved in working with your ideal client' Etc. Organizations need also to analyze their customer portfolio to ascertain their preparedness to coming into a lasting relationship with the organization, their lifetime values and purchase behavior in view of set ICPs. Customer Profitability The starting point is identifying profitable customers, understanding their needs and building a relationship based on their needs and the needs of the organisation. This raises the question. What is a profitable customer' It is a customer that overtime yields a revenue stream that exceeds by an acceptable amount the company’s cost stream of attracting, selling and servicing that customer. (Kotler 1997) There are some hard facts why every business needs to measure customer profitability, 1. About 20% of each business’ customers account for nearly 100% of its profits. 2. This top 20% group of customers poses both a threat and an opportunity to your business. The opportunity is in that once you have identified them you can easily target them for retention and cross-sell programs. The threat is that most businesses have traditionally over-taxed their best customers to subsidise other customers. This has normally resulted in the top clients being dissatisfied and thus being highly targeted by competition. The strategy therefore is for the business to identify its top 20% customers and seek to grow them. 8 Critical Aspects of the Credit Cycle Credit evaluation – this is done for the purposes of getting all the critical decision making information. Decisions to grant or disapprove a credit facility are normally based on information that is reduced to paper. There is however need to also get information that is often difficult to put in ink. Bankable proposals should be funded and there is need to look beyond the current information. Predictive power of credit relationship analytics should be the basis for decision making. Credit evaluation should be based on the following; ← Compliance with the credit policy ← Consistency of information ← Clarity of the borrowing entity or party ← Source of loan repayment ← Consistency with loan covenants ← Clearance from the deeds office where existing property is used as security ← Adequacy of security proposed Credit Scoring - Credit scoring allows you to grow your business while controlling credit risk and underwriting costs. These should; ← Facilitate credit approval that minimises long term increasing risk ← Ensure optimal approval turn-around-times ← Enable risk assessment prior to granting ← Enhances objectivity Analytic credit scoring technology can help track and learn from own portfolio, and beat the competition. Credit Risk – the probability of a loss arising from the chance that a debtor or a borrower may fail or delay to honour contractual obligations or deliver a security according to terms specified in the credit agreement. Elements of Credit risk These include: ← Time ← Inflation (loss of value) ← Collateral (the presence or absence of it and liquidity) ← Legal Considerations (e.g. in duplum rule) Credit Rating - relates to the awarding of credit scores to the credit applicant for the granting of a facility. Credit Granting – is awarding of credit facility to a successfully vetted client. Credit Servicing – payments (comprising the principal and interest) made towards liquidating a facility awarded to a client. Credit Review – relates to the analysis of the credit servicing performance shown by a facility holder over the term. This review should be done continuously so that cross and up-selling decisions can be made before competition exploits the chance. More importantly for the purposes of credit risk management it is wise to be proactive in recognising problems and consider appropriate remedial management positions. Collection Strategies & Recovery Management Scientifically designed collection strategies are a critical for consumer lending businesses, where managing collections is a tricky business with severe cost and customer relationship implications. Collection strategies need to content with the constraint of time and budgets. Therefore, collection strategies need to make optimal resource allocation and yet recover the maximum amount of dollars from delinquent accounts. Organisations should use predictive analytics technology to make accurate estimates of a customer’s propensity to repay, as well as the likely amount that the customer will repay and these help distinguish between self-cures and potential long term delinquent accounts. Predictive analytics technology create collection strategies that allow for the collection of the most out of delinquent accounts and preserve valuable customer relationships. 9 Customer Value Management Widening and deepening relationships with existing customers is a proven method for increasing revenues and profitability. Customer value management ensures that the business development strategies are designed focusing on the future rather than the immediate returns. CVM increases the scope to maximize customer’s profitability by widening the relationship across different products and optimize existing relationships. This is possible if the organisation invest effort and time to know and understand their customers. It is important to know your most profitable customers, learn from them and design auxiliary products for those segments. Customer value migration analytics assist to understand the upward and the downward migration of customers and will provide strategies for managing the migration. Customer Life Time Value Analysis Why measure profitability' • It enables the business to identify short-term profit improvement strategies that can be immediately implemented. • It can assist the organisation to nurture currently unprofitable customers toward profitability. • Analysing the relevant profit drivers can help a business to achieve that higher level of profitability faster by focusing the right tactics on the right customer segments. • The analysis also helps to identify unprofitable customers who are unlikely to ever become profitable and need sacking. • Profitability analysis helps the business to anticipate the profit potential of customers and thus enabling it to focus more on the highest profit potentials. Measuring customer profitability at the simplest level is about comparing the revenue that your business derives from each customer against the costs that it incurs in acquiring and servicing that customer. There is need to build capacity to track customer activity. Best practice has shown that the desirable approach is to build a complete income statement around each customer. Each customer can then be viewed by cost, by revenue, by contribution and by profit. Customer Life Time Value Customer profitability has to be measured over some time period. The point ultimately is that every business needs to build profitability analytics suitable to its circumstances and applying them to the relevant customer segments. This is the net present value of the profit stream that a firm stands to realize from a customer relationship over a lifetime. Customer analysis should be able to separate profitable customers from the unprofitable. FIG 2 A simple model for CLTV computation |Revenue |Year 1 |Year 2 |Year 3 |Year 4 |Year 5 | |Customer |1000 |400 |180 |90 |50 | |Retention Rate |40% |45% |50% |45% |45% | |Annual Sales (loans) |150 |150 |150 |150 |150 | |Total Revenue |150000 |60000 |27000 |13500 |7425 | |  |  |  |  |  |  | |Cost % |50% |50% |50% |50% |50% | |Total Cost |75000 |30000 |13500 |6750 |3713 | |  |  |  |  |  |  | |Gross Profit |75000 |30000 |13500 |6750 |3713 | |Discount Rate |1.00 |1.20 |1.44 |1.73 |2.07 | |NPV Profit |75000 |25000 |9375 |3906.25 |1790.36 | |Cum NPV Profit |75000 |100000 |109375 |113281 |115072 | |CLTV |75 |100 |109.38 |113.28 |115.07 | Assumptions • There is zero customer acquisition • There is no inflation • There is no customer growth • Customers have almost equal value (calculation of average CLTV) Although the model is very simplistic it gives a quantitative indication that a customer is more valuable if retained over time. 8 Customer Migration Analysis Much of the customer portfolio analysis deals with acquisition and retention, assuming that a customer is a customer. That may be true with most products and services, but it certainly is not true for all. If you study customer behaviour patterns over a period of time, you can see patterns, which can be useful in relationship management. The goal is to influence behavior. You go through a series of steps by asking questions; • What is the customer doing now' • What do we want them to do' • How might we reinforce their favorable behaviors' • How might we create other favorable behaviors' There are several migration patterns. Some move from economy class to business class to first class. Some move from buying one product to buying several different products. Some migrate by changing their lifestyle. Consider this scenario: Rating Migration The process of rating migrating clients should be done on a continuous basis. The migrating process is essential for provisioning of loan losses and assessing the quality of the loan book. There is need to closely monitor the client once their rating status has changed Case Chamu graduates from UZ and starts his first job. He lives in an apartment, eats fast food, bounces checks, and spends his money on dates. Five years later Chamu marries Matichiveyi and the first child has arrived. They spend their money on baby food, clothes, child care and health insurance. Five years later, their income is getting better, but they have taken on a huge mortgage. They have two cars now: a minivan and a beat up pickup. Give them another five years, and the two have started investing in mutual funds for their children’s education. When the children graduate from college, there will be expenses for weddings, and they will be thinking about saving for retirement. By the time they reach retirement age, they will have paid off the mortgage, have some money in their mutual fund account, and have moved places in the city. They drive a Benz. They spend their money on cruises and travel. This is a typical top class life cycle. How can we use knowledge of this life cycle to improve our relationship management' • The auto dealer who sold Chamu a couple of sports cars may not anticipate his migration to the minivan. The minivan dealer may not understand when Chamu and Matichiveyi are ready for the town car. But since car dealers seldom keep track of their customers anyway, missing the migration pattern is typical, and not unexpected. • For Chamu and Matichiveyi’s bank, however, understanding the migration pattern is essential. When Chamu bounced his first check, his bank may have dropped him. What a mistake! They will miss out on all the profitable business ahead. A second bank that gets Chamu and Matichiveyi in the baby period has to suffer through some lean years. This bank too may get discouraged. But, if they can just hang on, they may get the mortgage, the student loans, and the mutual funds. Most companies cannot take this long view. They want migration now. Their idea of migration is to start a customer with one product, and advance him rapidly to three or four products. Whether you can do this depends not on age or income, but on other factors, such as share of wallet. If a customer is spending $1,000 with you per year, is that good or bad' It depends on whether the $1,000 is all he has, or is only a small percentage of his spending in your category. To learn you have to know more about his total spending. What do you do about customers who are migrating down' When Sarah became a national sales exec, she had to fly somewhere every week. She soon became Prestige Banker with Barclays Bank. After ten years, Sarah was promoted to sales manager. Her salary and prestige went up, but she didn’t have to save as much. American soon dropped her from prestige to common man, and eventually took away her premier status altogether. Sarah felt bitter. She, the one person in the company who has the ability to swing a half a billion dollars towards Barclays, is treated like a tourist. It is so important to understand why customers are migrating down. Is it because they have defected to another supplier' Is it a behavior that we can influence and modify' When implementing migration analysis, create a system which ranks customers by spending or lifetime value. In the top quartile are your best customers who probably represent 80% or some similar high percentage of your total revenue. You may want to get these to purchase more, but, on the other hand, that could be just the wrong approach. What these people need is not marketing, but extra super service, service that promotes loyalty. You want to create a feeling of equity in their relationship with you – something that they would lose if they defected. The second quartile has the ability to migrate up to first class status with just a little more effort. It goes down the same way to all the lower levels. Very lower levels are those that may be very costly to retain as customers from a risk and profitability perspective. 9 Internal Relationship Dynamics & Management Internal relationships are pivotal to external relationship management. Often customer dissatisfaction results from failed internal customer relationship management. The idea is to ensure that the organisation does not suffer from counter productive discord. All departments and employees must be pulling in one direction avoiding the “them and us attitude”. Unit of purpose is achieved if people work in teams and not groups. The front office relies on the back office that in turn relies on service and support departments to provide a service to their customers. People and departments should be singing from the same hymn book to be able to effectively manage external relationships. Refer to the following pictorial about the service chain facing a facility providing organisation. [pic] What is crucial is for all internal suppliers to know what their internal customer requires and then strive to provide that. It is also important for the internal customer to understand the capabilities of his internal supplier to effectively communicate with his customer too. All the fundamentals of relationships are crucial eve for internal relationship management. External customers should be able to hear a single voice from all possible contact points. 10 Credit Relationship Management Tool Kit Credit analytics framework This is an analytics component of relationship management often aided by software (models) to predict the future of a relationship. These have predictive power to say foretell the likelihood of corporate failure say in 5 years. Debtors Intelligence Debtors intelligence is the process of gathering, analyzing and exploiting information of a company's credit customer base. Information is typically obtained about customer existing and future credit facilities, customer decision making processes, customer behaviour and trends as well as using data about the competition, conditions in the industry, and general economic, technological, and cultural trends. Debtors intelligence reveals the compelling strategies and practices behind success stories – and provides a dynamic forum where market leaders, business innovators and customer-focused businesses can identify valuable opportunities. It uses artificial intelligence models in predicting the potential behaviour(s) of customers or a group of customers. Such models rely on improving debt collections. An organization may need to consider the following ways of improving debt collections: Deal with the right customers An organization needs to be selective about the organizations and individuals with whom it does business with. This can be difficult if the organization is dependent on a few large customers or if the customer base is dwindling, but once the business has reached a manageable level of stability it is a good idea to research on all prospective clients. Promote a single view of the customer Customers should receive prompt service from the organisation regardless of whom they interact with or where they request to get served. Service confusion among contact people and relationship managers often affects your moment of truth. Customers may take advantage of your confusion. Make use of the power of IT to update customer accounts regularly. Make use of customised and relationship based pricing and payment plans Payment plans become necessary when the customer cannot pay the entire amount due in one installment. To avoid future misunderstanding, commit to an agreed plan on paper and ensure that both parties sign the document. Monitor frequently late-paying customers Let customers know that you can no longer tolerate late payments. Sometimes the interests of customer service and debt collection can clash, but it is important to convey, politely but firmly, that bad debts are unacceptable. Explain to clients that although you will willingly discuss matters to the full, further delays in payment will not be tolerated. Use a debt collection agency If the worst comes to the worst, do not hesitate to use a debt collection agency to enforce payment. If a debt is more than 90 days late, hand it over to an agency. Not only will this let the customer know that you are serious about the late payment, but it will allow you to spend time more productively on those accounts which are less overdue. Recruit the right employees Individuals whose jobs require them to interact with the customers must possess the right technical skills and emotional intelligence. Not everyone is good at working with customers. Gain an accurate picture of your customer categories To anticipate customer needs, improve customer retention and identify opportunities for cross and up-sell, you have to understand the unique characteristics of each market segment within an increasingly fragmented marketplace. To establish the best opportunities the organizations must adopt a much more rigorous analytical framework. 11 Turning delinquent debtors into profitable business Inability to pay is different from unwillingness to pay. Inability is involuntary and unwillingness is deliberate. It is therefore necessary to manage failure to pay appropriately. This demands relationship managers who are guided by reason and not by the book. The following is a list of suggested early warning signs for each. Indicators of inability to pay The following are some of the indicators or signs of inability to pay ← Late financial statements ← Change of auditors ← Qualified audit opinion ← Refusal to provide audited statements ← Notice of legal action against borrower ← Loss of major customers ← Undertaking a new high risk venture ← Poor organisation ← Frequent “crash” sales ← Loss of trade credit- cash purchases only ← Major lifestyle change of owner/ manager ← Notice of cancelled insurance ← Failing to pay workers’ salaries ← Cutting on employment and not filling vacant positions Indicators of unwillingness to pay ← Client is always busy when contacted ← Failure to contact the client ← Selective repayment of loans by the client ← Company recording high profits but unable to meet financial obligations ← Expansion of operations without paying debts 12 Strategies and Remedial Management Customer Knowledge – The new thinking says organisations should know their customers so well that they become relevant to their situation. This assist the business to avoid giving blanket service and credit parcels to all customers. Know Your Customer requirements in banking should be not be applied in isolation or merely as a compliance issue. It is prudent to identify and address issues relating to all the buying influences in all credit relationships especially for corporate or business to business relationships. These are the economic buying influence, the technical buying influence, the user buying influence and the advisor. Refer to the CCL International Business Training manual on Relationship Selling. Relationship pricing – this call for customised pricing given the level of risk and profit potential of a given credit relationship. This supports long range business relationships that have scope for growth. Securitisation -- refers to securing a debt through creating a special purpose vehicle that can be parceled out and used to liquidate the debt. Security taking – this is a proactive measure put to safeguard against credit risk. This is often a result of failure to due a good credit evaluation. Funding should not be given on the basis of collateral security but on the strengths of the application. Debt restructuring – where there is understanding between the lender and the borrower, debts can always be restructured to accommodate changes in the borrower situation. This is possible where there is constant dialogue, information flow and credit relationship reviews. Debt Collection – Where there is effective relationship management it is are to get the involvement of collection agencies. However in the event that a debtor has been delinquent collection agencies should be used to recover bad debts. Litigation – is often a sign of failure to manage a relationship. It can be expensive. Litigation should be used if the sums involved warrant that otherwise it can be a source of reputational risk if not managed well. 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