Collections Best Practice by mThink, May 23, 2005 Utility bad debt is increasing year-on-year according to market research group Chartwell in its 2004 report, Credit and Collections in the Utility Industry. Chartwell estimates that more than $1.7 billion in revenue was written off by North American utilities in 2003, an average of $8.50 uncollected per customer. Bad debt ratios for individual utilities can vary widely, with some utilities having net bad debt as low as 0.15 percent of revenue, while others have seen their debt rise by millions of dollars per year to well over 2 percent. In a regulated marketplace the cost of utility bad debt is borne by ratepayers, but regulators tolerance is wearing thin. Many utilities are finding themselves in the spotlight, having to reduce their bad debt, and it is not uncommon to see improvements in collections performance listed in the top five corporate objectives. Utility debt is expected to continue its rise amid a sluggish economy and an environment of rising energy commodity prices, forcing utility collection managers to revaluate their collections assumptions and processes if they are to make progress in improving collections performance. Old-school one-size-fits-all approaches are no longer adequate in todays challenging economic and regulatory environment, and collections best-practice concepts are catching on fast. Utility collections best practice is about applying collections processes appropriately to each customer account, says Bob Cooke, principal of risk strategy at specialist utility collections consultancy Bass & Company. It is founded on a deeper understanding of the credit risk of individual customers and customer segments and implementing tailored treatment paths that focus resources on customers most at risk. Collections Best Practices Multi-Jurisdiction Compliance Utilities operating in multiple states or countries require wide-ranging collections configurability to meet the varied stipulations laid out by each state or country. For example, in some states a utility is required to attempt customer contact twice before disconnection. In other states, disconnecting certain customer groups during the winter months is prohibited. Customer Segmentation Segmentation of a utility customer base for collections activities must extend beyond a traditional credit score or an acknowledgement that a customer is either good or bad. These categories, the basis for traditional utility collections practice, are too broad to be effective when measured against best-practice concepts. For example, there are customers who generally pay on time and occasionally late; others who find it difficult to pay and require payment plans; business or government customers who pay late but are a very low credit risk; and those who are continually being issued termination notices. To classify all four groups as bad and treat them equally will mean actions are too aggressive for some customers and not aggressive enough for others. Best-practice collections will classify customers into appropriate segments. In addition, some regulatory jurisdictions require detailed customer segmentation. In Pennsylvania, for example, regulations require specific collections treatments for Level 1 and 2 low-income customers during winter periods. Configurable Credit Scoring Scoring credit risk based on customer attributes, historical payment patterns and other factors affecting credit risk as opposed to traditional methods that primarily measure payment timeliness. Utilities may choose their own business-defined parameters for calculating credit scores and may choose to score customers from 1 to 5, 1 to 10, or 1 to 1,000, depending upon what best supports their business practice. Credit scores may be adjusted based not just on whether customers have historically paid on time, paid late or received reminder notices, but also on other factors affecting credit risk such as whether the customer provided identification numbers or telephone numbers at the time of sign up. Dynamic Action and Reaction Traditional utility collections operate on a cycle basis: Each customer account is checked when its cycle comes around each month. Each business day, perhaps 5 percent of the customer base is checked for credit and collection status. But the real world is not cycle-based. Circumstances can change daily. Customers may make payments or have payments dishonored. Customers may provide additional security, their credit ratings may improve or worsen, collections policies may be adjusted, or the customer account may be reclassified to a different segment. Any of these factors can dictate an immediate requirement for collection action. Best-practice collections require that collections processes not be bound by billing cycles but by a more dynamic action: to act early to collect to minimize credit risk exposure. Tailored Treatment Paths These are designed to suit the anticipated profile of each customer. This might include printed letters, email, text messages, automated phone messages, outbound call center calls, account manager escalations, disconnection work orders and website messages, when appropriate. These can be configured to meet individual customer requirements such as agreed payment structures for those struggling to pay, polite reminders for customers who normally pay on time but on occasion forget, email reminders for customers who have chosen that as their preferred communication channel, and stronger warnings and accelerated cycles for delinquent customers who regularly default on outstanding debt. Different treatment paths are required to support each classified customer segment, within the general requirements for differing treatments for types of customer for each regulatory jurisdiction. Outsourcing to Limit Exposure As the collections process for each customer moves further along each treatment path, and as arrears age, the probability of recovery decreases so does the financial value of the receivable (see Figure 1). As a customers debt ages a utility might look to factor its debt, meaning sell the receivable to an outside agency or consider whether it should simply be written off. Bass & Company research indicates that debt factoring can be applied more widely than just for very late-stage delinquencies. For example, for higher-risk customers, terminating the account earlier and outsourcing it to an agency, depending on the regulatory constraints, can reduce overall write-offs as the bad debt exposure is limited by the factoring process. It is also important to identify which groups of customers should be outsourced to which agencies some agencies might have more skill and success with business customer debt recovery than residential. Manage Cost to Collect Best-practice collections focus not just on amount collected but on optimizing the cost incurred in making those collections. Collections costs are incurred in the call center, in letter printing and mailing, in working capital costs through delayed receipt of monies, and in bad debt written off. For every dollar spent on collections activities, more than one dollar should be recovered. By managing collections with an understanding of cost-to-collect and options such as debt factoring, collections costs can be optimized. Collections Intelligence, Analytics and KPIs Best-practice collections require continuous improvement through an interactive approach. Utility collection managers should use targeted collections campaigns and adjustments to collections treatment paths, analyzing the impact and regularly refining collection treatment paths and customer segmentation based on the results. This continuous improvement process requires the ability to monitor collections performance by customer segment, and to analyze metrics, key performance indicators (KPIs) and trends, and relate them to collections campaign dates. Interactive, what-if analysis will allow a utility to model and determine the effectiveness of alternative collections policies, monitor such metrics as bad debt percent to revenue and days sales outstanding and gauge their impact on operational costs. In addition, advanced data analysis using metrics and trend displays, and collection control dashboards that illustrate KPIs such as status of overdue receivables and corresponding collections actions, will provide the necessary business intelligence to adapt and extend collections activities. Xcel-ence A forward-thinking utility responding to the industrywide best-practice collections challenge is Xcel Energy, the fourth-largest electricity and gas utility in the United States. Xcel Energy required parameter-configured collections software that would allow it to move away from static customer collections profiles that pigeonhole customers into oversimplified good or bad categories in order to deliver targeted credit and collections treatments. Today, Xcel Energy is able to advance beyond the typical utility collection model of standard reminder letters, customer calls and disconnection notices generated for all overdue customers on the same number of days after due date. Xcel Energys service territory covers 10 states, requiring wideranging collections configurability to meet the varied regulatory stipulations. In New Mexico, for example, collection cycles are allowed to be far more aggressive than in Colorado, and it makes little business sense to implement the same collection cycles in both states. Figure 2 contrasts credit treatment processes in Colorado and New Mexico. In Colorado those customers with a good credit score receive a reminder letter 33 days after their due date, a notice of disconnection on day 64 and the disconnection process starts on day 74. Customers in the others category do not receive a reminder letter at all, only a notice of disconnection on day 33, and the disconnection initiates on day 41. In New Mexico, by comparison, collections treatments differ for commercial and residential customer segments. The residential customer has 10 days more between their invoice date and due date, and the timeframe for disconnection initiation is much shorter for a commercial versus a residential customer: 10 and 39 days, respectively. Removing the Systems Barrier Cooke at Bass & Company believes there is a basic understanding in the utility industry of the concepts of collections best practices, but almost all utilities lack the technology to be able to adopt best practices. Everywhere we have taken our collections models, technology has been the limiting factor, he says. Without the right systems in place, collections best practice is an unobtainable ideal. Traditionally, collections has been the technology domain of the utilitys customer information system (CIS). Many utilities struggle with weak and restrictive collections functionality in an aging CIS. Others may have a relatively new CIS in place that boasts adequate collections support but is missing key features to support todays best-practice collections processes. Utilities collection managers, dependent upon the CIS platform to manage collections processes, have been resigned to waiting years, perhaps decades, for a full-scale CIS replacement opportunity so they can implement improved collection processes. One might suppose that good, paying utility customers are doomed to subsidize bad debt as utilities are resigned to absorbing write-offs above regulatory allowances until the day they can do a full-scale CIS replacement. But this is no longer so with the advent of new software products that can integrate with an existing CIS and deliver muchneeded collections capability to support best-practice approaches. Utility debt is not going away. There will always be customers who default on payment. But technology has caught up with the problem, and utilities now have the option to implement specialist collection software products that enable best-practice approaches. Filed under: White Papers Tagged under: Utilities