The Case for Outsourcing Collections
Don't Overlook the Strategic Opportunity Provided by Outsourcing Collections
Small and medium businesses (SMBs) have to deal with many of the same challenges as larger ones. A key difference (besides volume of transactions) is the lack of labor specialization. The employees of small companies tend to handle multiple responsibilities – the time devoted to each task can vary greatly as does the proficiency of the person handling those tasks.
Credit & Collection results suffer greatly from lack of attention and expertise. Perhaps more than any other SMB function, Accounts Receivable (AR) Management gets put on a back burner because it is nobody’s prime responsibility. The only time AR comes to the forefront is when there is economic turmoil and an increased risk of bad debt losses. Otherwise, controllers and CFOs are focused on other areas.
Hiring an experienced full-time person to perform the Credit & Collection tasks is not financially possible. Even if there is a single person credit department, or a small team with several people on the credit staff, everybody has to be somewhat of a generalist, splitting time between credit analysis, collections, deductions resolution, cash applications and other AR activities.
What else can be done? Several options exist:
Outsource the work to a company that specializes in AR Management
Sell the receivables at a discount (e.g., factoring and other forms of AR finance or invoice trading)
Purchase Credit Insurance, which will protect against bad debt losses (unpaid bills), though still requires you to handle collections, and so not directly impact your cash flow while still incurring insurance premiums
This article will focus on just the first option, outsourcing collection activities.
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Types of Collection Outsourcing Providers
The concept behind outsourcing is simple: one company offloads work that is not “core” to their mission, to another company that specializes in the work being outsourced. Clearly, collecting past due receivables fits this model. Depending on your firm’s situation, there may be opportunities for outsourcing other AR functions as well, but for most companies, especially SMBs, collections is a strong fit for outsourcing.
There are two types of companies that will outsource your collections:
1. Business Process Outsourcing (BPO) firms: These companies need to do the work for dozens of companies and hundreds of employees to make outsourcing economical for them as well as their clients. Beware of outsourcing companies that focus on all aspects of finance and accounting—they will likely under-resource credit and collections and therefore under-perform. Firms that specialize in the order-to-cash process can be a better fit, but they are typically geared to serving larger organizations.
2. Collection Agencies: These outfits are better able to serve a small company. They have a pool of experienced collectors and are always looking for additional customers, as their primary business of collecting from seriously past due customers (also known as 3rd party collections) ebbs and flows with the state of the economy, interest rates, inflation, and so forth. As outsourcing has grown, many agencies derive a substantial portion of their income from outsourcing, which is also known as 1st party collections.
Advantages of Having a Collection Agency Perform Everyday Collections
There are several advantages of hiring a Collection Agency rather than another outsourcing firm to handle all your collection needs, and not just those involving seriously past due customers (you can read more about 3rd party collections here).
Collection Agencies have existing capabilities that are ready to be put to work for you. You might want to think of them as a ready reserve.
Good Collection Agencies are professional and competent. That means you don’t have to build out your capabilities (people, IT, etc.). To help ensure you only work with a respectable agency, we recommend you only deal with those that are not just state bonded, but have also been certified by the Commercial Law League of America, the International Association of Commercial Collectors or the Commercial Collection Agencies of America.
Agencies can be very effective at managing collections for your entire AR portfolio. This is because they have the necessary infrastructure, expertise and scalability if that is required. If they are not proving effective, ensure you are supporting them fully by providing customer information, access to your AR Ledger, copies of invoices, purchase orders, shipping documents, and so forth on a timely basis. It goes without saying that if you are doing your part, and they are still not managing your AR well, change agencies.
A lower investment in AR and improved cash flow. This will manifest itself as a one time release of cash from AR followed by a steady state of enhanced cash flow from AR after you engage with an agency.
Access to the agency’s credit and collections expertise. They can provide you guidance in setting your credit and collection policies and procedures.
Bad debt risk controlled according to your risk appetite. When you engage an agency you still get to set credit and collection policies.
Leveraging of the agency’s IT tools for collection of your receivables. An agency, no matter the size of your company, is very likely to have a greater capability than your IT assets—this can provide a major savings versus any in-house capabilities
A cost basis similar to the salaries and benefits of in-house collection staff. However, you won’t need to invest in any direct employees ongoing training.
One person to deal with. If you require multiple collectors, you still only need to deal with your account manager.
Disadvantages of Outsourcing Collections
In some situations, the cost of engaging a collection agency, or other outsourcing partner, maybe higher than doing it in-house, especially if your cash flow and AR management is already performing at acceptable levels. Maybe you are blessed with a few larger, low-credit-risk customers who pay on time without follow up. Maybe your margins are very healthy and your cash flow is still adequate despite late payments from only a limited number of customers. For most SMBs, however, collections is more of a challenge and that is where outsourcing can be a good fit.
In some instances, the performance of an outsourcing partner can be disappointing. Maybe they’re just not that good (consider getting a new partner). Maybe your Sales team is telling customers they don’t have to pay on time, are overriding order holds, causing payment deductions as so forth - these are credit policy and procedure issues that need to be addressed internally. Our point is, before coming to a decision, make sure you understand the cause of the performance issues.
A common complaint is that the outsourcing partner is “too rough on customers” because of an aggressive collection effort. In our experience, these claims usually don’t hold up upon closer inspection. It is more likely that the seller has been “coddling” their customers. You want an outsourcing partner that will be firm, but professional in their efforts to extract payment from your customers—after all the outsourcing partner’s employees are identifying themselves to your customers as your company’s collection team (they are collecting in your name) and should therefore reflect your company’s standards.
In the Final Analysis. . .
A compelling case can be made to outsource collections. Most SMBs lack credit and collection expertise, and therefore collections is a distraction from the core competencies of the organization. Large enterprises may also outsource collections for strategic and tactical reasons. Acquiring collection expertise from an outsourcing partner should therefore be considered a viable option, unless you have:
A customer base that pays on time or close to it, and consists of low credit risk customers.
Collection talent on staff who can devote sufficient time to collections.
An inability to support your outsourcing partner’s information and escalation needs.
Employees within your company that will undermine any outsourcing partner’s efforts.
Most companies need to have collection capabilities, the size of which is determined by industry practices, customer base, transaction volumes, ticket size, receivables size and so forth. These factors define your collection needs and are fundamental in determining if collections outsourcing is a viable option for your company.
With this in mind, collections outsourcing does not need to be an all or nothing proposition. One proven model involves outsourcing the collection of specific segments of your AR portfolio. For example, by outsourcing long-tail accounts (e.g., the 80% of customers that only account for 20% of revenue) companies can free up in house staff to focus more on key customers. Companies facing rapid growth may also find outsourcing some or all of their collections preferable to having to scale up an internal collection function.
In the final analysis, it comes down to what is best for your bottom line. That requires a thorough understanding of not only your AR portfolio, but also your firm’s operating environment, in order to determine how outsourcing collections can provide a strategic and tactical fit for your organization.