Credit Disconnect

  The great uneasiness accompanying the current interest-rate upturn is that many American households will quickly lose their ability to service a growing mountain of debt, including credit cards, mortgages and auto loans. This anxiety is not without good cause. At midyear 2004, total consumer debt equaled a hand-wringing 114% of disposable personal income, up from 97.5% in 2000 and 87% in 1990.
  In an era already beset by soaring bankruptcy filings and high chargeoffs, rate-fueled payment hikes surely will provoke more problems. So what are credit card companies going to do about this? All too often, the answer is that they will work harder, not smarter, for fewer remittances. That's right-card companies, which have taken target marketing and customer insights to new heights in acquisition and cross-sell, have neglected to build equally smart credit collections capabilities.
  As a result, issuers are exposed to new types of repayment risk in a borrowing environment that is quite different from years past. Before the exodus of more affluent customers to home-equity lending, cards were the No. 1 choice for revolving credit, allowing issuers to more closely target the most-creditworthy customers. Now issuers have turned to higher-risk borrowers who often have fewer resources and options, and who are more likely to have difficulties with multiple creditors in times of duress.
  The upshot is that the collections group is being thrust into a transition from an aggressive recovery exercise to a nuanced negotiation process that depends on the use of marketing principles for best success. Even today, virtually 100% of defaulting cardholders owe multiple parties. In almost every case, some of the parties recover much more than others, largely by finding ways to "move up" in the borrower's remittance prioritization.
  Leaders move to the front of the line by understanding borrowers' attitudes and motivations as much as their resources and circumstances. In essence, they stop "collecting" debt and start "selling" repayment propositions. It is a new, more stressful form of competition in which issuers compete not only for share of customers' purchase volume and balances, but also for share of remittances.
  As the stakes continue to rise, the winners in this game will be the institutions that broadly incorporate the best marketing practices into collections. Instead of just "hiring the best and hoping for the cash," issuers will need to build comprehensive new collections approaches that systematically incorporate fundamental marketing principles.
  One of the key arguments for a changed approach to collections is that consumers are more widely obligated than before, increasing the odds that issuers will have to compete heavily with multiple creditors when borrowers have trouble meeting payments.
  As a percentage of disposable personal income (DPI), for example, card debt rose from 5.2% to 8.9% between 2000 and mid-year 2004. Simultaneously, mortgage debt skyrocketed from 67% to 83% of DPI. Overall, total household payment obligations rose by 16.5 percentage points to 114% of DPI in just 42 months.
  Often overlooked in this phenomenon is the fact that the composition of the card market has changed as well. With the proliferation of home-equity lending, many of the most creditworthy borrowers have migrated away from card debt, leaving issuers in the position of having to tap higher-risk market tiers in order to sustain balance growth.
  Increasingly, issuers are providing lifeline credit to striving households, many of which are falling behind on payments even as they amass additional debt. Among households in the lowest quartile of net worth, the proportion of families with payments past due at least 60 days grew by 10% between 1998 and 2001, according to the Federal Reserve Board, compared with a 68% reduction among households in the highest quartile of net worth.
  While more difficult to quantify, attitudes among many consumer borrowers also are changing. There is more of a tendency to accept multiple solicitations of credit, to engage in new borrowing to bridge current repayment problems, and to repudiate debt.
  Over the past 10 years, more than one in 10 households has sought debt "relief" through bankruptcy, often finding that the consequences were not nearly as dire as feared. As the experience becomes more common, the stigma decreases and word-of-mouth grows.
  Indeed, bankruptcy counseling is a vibrant industry, fueling a growing constituency with new attitudes about debt repayment. During the 1980s, there were an estimated 200 nonprofit credit-counseling agencies registered in the U.S. By 2000, that number had grown to more than 1,000. No wonder that in the past three years, non-business bankruptcy filings rose by 30%, as opposed to a roughly 3% rise in the general population count.
  Combined with a stodgy economy, these changes help to explain why card issuers remain guarded in their outlook. On average, the number of large U.S. commercial banks that reported increased underwriting risk in their card portfolios outnumbered those reporting decreased risk by a margin of nearly 2.5-to-1 between 2001 and 2003, according to the Office of the Comptroller of the Currency. And this deterioration occurred even as the banks reported tightening underwriting standards for credit card loans. From a variety of perspectives, the quality of card debt has degraded.
  In the face of these developments, the pressure tactics emphasized in traditional collections no longer suffice. Issuers increasingly will be dealing with people who are 1) heavily in arrears with multiple creditors; 2) in lower tiers of income and net worth; 3) less sophisticated in managing finances; and 4) less disposed to cooperate and less fearful of the consequences. These debtors can't be bullied; they must be sold.
  This is why the very best marketing and customer insights need to be incorporated into the collections process. Nothing less will do in an era where one creditor's recovery increasingly comes at another's expense and outcomes hinge on nuanced negotiations.
  Clearly there is much to be done to transform collections into a marketing-driven process, beginning with customer information. The new marketing mindset calls for substantially deeper, systematic insight into delinquent customers than is common today.
  Credit card companies are renowned for their ability to analyze markets and develop a detailed understanding of customers, ranging from major segments down to small splinter groups. Equipped with computer-distilled insights on demographics, needs, attitudes and behaviors, they do an excellent job of crafting offers and marketing messages from the customer's point of view.
  Yet these same principles have yet to be fully applied in collections. In all forms of marketing, a basic question is motivation-what drives the customer's decisions and behavior? Modern research techniques can help parse the circumstances, tradeoffs and perceptions that most strongly influence distressed borrowers in their negotiations with creditors. In turn, this knowledge can be used to craft a suite of treatments and offers that move the issuer up the remittance ladder.
  Allocation of Funds
  With improved insights on decision factors and tradeoffs, collectors can do a better job in negotiations with debtors. Keep in mind; it is not that distressed borrowers have no funds. With most it is a case of limited funds, and the collections question turns on where they will be disbursed. Thus the need for a variety of approaches that will help creditors lift their individual standings in the contest for repayment dollars.
  Central to this exercise is an ability to capture the essence of customer conversations-particularly those over the phone-in a way that can be analyzed. In the old approach to collections, each transaction was conducted for its own sake and negotiating knowledge was either discarded or shared only episodically. In the new approach, transactions are viewed as a critical source of customer insight and negotiating knowledge, and interactions are systematically compiled and analyzed for widespread usage.
  Research conducted by Novantas shows that electronic tools can be effectively used by reps in the course of customer conversations to track responses, refine dialogues, create tailored offers and discover segment variations. In turn, gleanings from negotiations can be used for customer research and to formulate and test new offers and approaches. The goal is to determine the most effective approach in each stage of customer interaction.
  Typically, the process begins by identifying a broad range of negotiating techniques, both proved and unproved, for a given type of debtor situation. Ideas often are culled through focus-group meetings of experienced collectors and marketing personnel. A specialized team then converts the chosen techniques into structured dialogues and screen prompts, and codes the dialogues into desktop and dialer systems.
  As the techniques are tried on the phones, negotiation outcomes are clicked into the system for analysis and dialogue refinement. Combined with remittance records, these data enable the analytical team to determine which approaches work best. The team then rolls out a suite of proven techniques and dialogues to guide all collectors toward the best practice in each situation. The process of testing and refinement is repeated continuously.
  In the marketing wars among credit card issuers, the "champion-challenger" developmental process is standard practice in customer acquisition, cross-sell and retention. But the collections operation has only scratched the surface.
  Major Changes Needed
  Reaching the full potential of scientific methods will require major changes in collections practices at many institutions, where the current emphasis is more on recruiting, training, and motivating staff. While intuitive practices at traditional shops have been honed by years of experience, issuers who refine them through research and testing stand to achieve double-digit increases in remittances.
  What is more, the insights derived through disciplined testing represent true intellectual capital for the institution. In today's collections shops, the best insights reside with individuals, typically star performers, and not within a system that can be readily shared by all. And given the rapid turnover among collections reps-typically, from 30% to 50% annually-any insights not captured at the institutional level are soon lost forever.
  The collections function is a highly complex operational machine, representing from 20% to 35% of the operational cost for a typical issuer. Consequently, management attention tends to be riveted on opportunities to improve efficiency, typically by streamlining current methods of doing business. Questions about the effectiveness of the methods themselves tend to get short shrift, as do the metrics.
  In fact, many of today's most-watched collections performance measures are simply out of touch with what matters. The delinquency rate, for example, is the end result of a variety of factors, each of which must be carefully investigated and interpreted if sense is to be made of the overall trend. By looking at outcomes and not causes, there is a risk of drawing grossly misleading conclusions.
  In one recent case study, a leading U.S. issuer discovered that a 16% improvement in the effectiveness of early-stage collections activities could reduce chargeoffs by an amount greater than the entire cost of the collections operations. With such enormous sums at stake, management can no longer afford to put off initiatives aimed at improving operational effectiveness. The path to distinctive performance is paved with a masterful understanding of customer motivations and behaviors, and "share of remittances" is the new critical measure of success.
  Marketing Culture
  At the center of the transformation of collections is the infusion of marketing culture and staff into the operation. The management center of gravity must shift. Marketing staff members currently consider the world of collections a foreign land, but in the future rising stars in marketing will be tapped for a critical rotation in collections.
  Marketing executives will approach delinquent customers like any other "segment" of the market, and they will bring a fresh, customer-centric perspective to the function. Importantly, their assignment will not become a black hole that dooms the career they seek, but will simply become one step in that career.
  Also, more senior executive time will be spent investigating the repayment "market," probing to understand distressed borrowers and how to compete for remittances. It is likely that traditional collections views will be slow to change, and that is why senior management must be active in sponsoring new ideas, methods and metrics.
  The day-to-day management of collections also will change. Instead of relying disproportionately on star performers, the emphasis will shift toward developing a comprehensive "selling" system designed to make the average collector more effective.
  As salient aspects of negotiations are captured electronically, more of the knowledge that formerly resided with individuals becomes institutionalized. While continuing to exercise their own initiative and good judgment, collectors also will use electronic tools in countless new situations, and the results will be analyzed to improve responses. There will be a constant distillation of knowledge, made available to all staff, and training and incentives must change to encourage its proper and productive use.
  To be sure, transforming collections into a marketing-driven process is a big endeavor and may even seem out of reach to executives immersed in the moment-to-moment intensity of this activity. Yet it is already underway at a handful of major institutions, typically with pilot programs.
  As with many areas of marketing and development, a focused initiative often will be the best way for institutions to begin revising their collections practices. Equipped with a select blend of people, concepts and systems, credit card issuers can roll out and test new negotiating approaches while comparing results with traditional processes. Results can be compared with traditional processes using standard metrics such as balance recovery ratios and collector productivity. As the new system begins to bear fruit, all of its salient aspects can be identified and mapped, providing the basis for larger conversions.
  Often within industries, new approaches can improve the performance of most, if not all, competitors. But realistically, the marriage of marketing and collections probably will benefit some institutions at the expense of others. In a world where multiple creditors are standing in line for repayment from distressed households, the ones standing at the front of that line likely will win and the ones standing at the end likely will lose.
  Through marketing insights, leading institutions will make their way to the front of those lines more consistently, and this will tilt the plane of competition in collections.
  Jim Bramlett (left) and Dave Kaytes are managing directors at Novantas LLC, a management consultancy based in New York City. They can be reached at jbramlett novantas.com and dkaytes novantas.com.