Please do not ask for credit as a refusal often offends.
Sign seen in Australian businesses
Neither a borrower nor a lender be: for loan oft loses both itself and friend
William Shakespeare making a similar point in "Hamlet"
Right or wrong, the customer is always right.
American retailer Marshall Field
Problem #1 - customers are delicate creatures, easily offended
Virtually all modern management fads and theories have at least one common theme running through them: focus on the customer. We need to understand customers so we can increase their satisfaction and therefore keep their business. What this means in terms of credit is that as well as reaching our financial credit targets we must also make our customers as happy as possible with our processes. We need to achieve a compromise.
Most readers will have applied for consumer credit at some time. Here's a story that the collections supervisor at a hospital told me recently. She went to buy furniture at a large, specialist furniture store, and found a suite she wanted to buy. Normally, she buys consumer goods using cash or her credit card. However, the store was offering three months free credit, so she decided to take advantage of this.
She filled in the credit application form. However, there were some fields she couldn't fill in. In particular, she didn't have any credit references to provide from businesses who had previously given her credit. She offered the credit card company, but that was apparently not acceptable to the sales-person. "I'm sorry," she was told. "We need three references." She ended up getting so angry with the situation that she left without buying, went down the road to another store, and bought a suite using her credit card.
I believe businesses often lose customers through their credit approval process. This applies to trade credit as well as retail credit. In my experience, business customers better understand the need for credit approval but, on the whole, expect a higher standard of service than consumer customers.
For anyone who argues that "no-one has ever complained about our credit approval process therefore they must be happy with it", there is plenty of research which shows that - as in my example - most unhappy customers don't complain. They just leave.
I look at application forms from many types of businesses and shake my head in disbelief. In most cases, when we produce these forms, we either:
- don't think about it from the customer's point of view, and therefore
- don't know what the customers want from a credit application form, or
- don't care, or
- do think about it from the customer's point of view, do know what they want, and do care, but decide that giving the customer what she wants and giving the business what it wants are mutually incompatible goals.
To my way of thinking, all of these answers are unacceptable. (We'll look at application forms in more detail in a later chapter.) Understand too, that more and more customers feel the same way. Customers recognise their power. They know that "the customer is king", and "the customer is always right", or supposed to be.
Compared to other books on credit, more of the focus of this book is on what customers want from the credit process. We, as credit professionals, tend to be very focused on what we want from customers, to the exclusion of any thought of what they want. Well it's a customer-oriented world out there and we need to wake up to that fact.
Leading writers on service quality, Berry, Zeithaml, and Parasuraman have this to say:
Service leaders see service quality as a success key. They see service as integral to the organisation's future, not as a peripheral issue. They believe fundamentally that superior service is a winning strategy, a profit strategy.
Service is improving in so many industries and businesses, and in so many ways, that customers are learning to expect more. Suppliers are making it easier to do business. Toll-free inquiry numbers are now common. Extended hours of service - weekends and late hours - are common everywhere except in government departments. Some businesses are now offering guaranteed service response times, and some suppliers are providing their customers with access to their computer to allow them to punch in their own orders.
I believe that consistency is a crucial factor in service. You can't give good service everywhere except credit, and still convince customers that you are a quality organisation. Customers judge you on their worst experience and your worst service.
Problem #2 - the reliability of the crystal ball
I think there is a world market for about five computers.
The prediction of Thomas J Watson, Chairman of IBM, in 1943
The phonograph is not of any commercial value.The radio craze will die out in time.
Thomas Edison, predicting in 1880 and 1922 respectively
An economist, it has been said, is an expert who will know tomorrow why the things he predicted yesterday did not happen today.
The Economist, 25 February 1995
Predicting who will pay and who will not pay their bills is akin to the job done by weather forecasters or economists - it's not a precise science. I've noted the flawed predictions of Watson and Edison above, which look pretty silly in hindsight. Isaac Asimov, the science and science fiction writer, wrote in Science Digest magazine in 1965 that:
Predicting the future is a hopeless, thankless task, with ridicule to begin with and, all too often, scorn to end with.
Problem #3 - it's especially hard to predict the success of a business
Commercial credit managers, in order to predict whether a business will pay, often have to assess whether the business will be a success, and that's equally difficult to do. The success of a business depends on so many factors. What should we look for to indicate future success or failure? Which factors are the most important? Bear in mind that new businesses often have no past history on which to base an informed decision, and established businesses may refuse to show us the information we would like to see.
Let's pick an expert to pour scorn on. An example I like is the case of the Harvard academic who marked Fred Smith's homework. Fred was doing an MBA (Master of Business Administration degree) at the prestigious Harvard Business School. For his major project he presented a new concept for package distribution. He argued that rather than transporting items directly between each major city, as had traditionally been done, it would be more efficient to have a central "hub". All packages would come into the hub, where they would be sorted and then be sent on to the appropriate destination. So, for example, instead of having planes and packages going direct from New York to, say, 100 other U.S. cities, planes would fly from New York to the hub airport. At the same time, planes and packages would enter the hub from the 100 other cities. They would all swap packages, turn the planes around, and head for home.
Smith scraped through with a "C" for his project - a pass but a bare pass. Undaunted, he took the concept, and in 1973 foundeda package delivery firm called Federal Express.
Federal Express was an overnight success. It was the first company ever to report US$1 billion in revenue within its first 10 years of business. In 1994, it was reported to have 90,000 couriers and customer service agents handling 400 million shipments a year using the largest air cargo fleet in the world. Its hub airport, Memphis International, handled more cargo than any other in the world. I think it's fair to say that the concept was successful. At least the learned academic who marked his paper can be thankful he didn't give it a "D".
Problem #4 - the "no customers means no bad debts" trap
Credit managers often talk about the importance of building the fence of credit approval at the top of the cliff rather than just parking the ambulance of collection at the bottom. However, they need to be aware that the credit approval process can actually do harm by turning good customers away.
Stuart Sutherland, in an excellent book on why people make bad decisions, gives an example which is analogous to the trap which credit professionals can fall into. His example is the use of lie detectors - machines which measure the stress suffered by a person when answering a question such as "are you stealing from us?" Although these machines are known to be imperfect, they are, he says, commonly used by US businesses to detect employees who have stolen from them.
Now suppose its success rate is 90 per cent (it is almost certainly lower), that is, one innocent person in ten gives a positive response to it and one guilty person in ten gives a negative response (in practice the two figures are unlikely to be the same). Any employee found guilty is discharged from the firm. On the face of it, it would appear that nine people are correctly found culpable for every one incorrectly found guilty: to the managers of the firm (though not to many other people) this might be acceptable. But the reasoning is false. There are likely to be many more employees who do not steal than ones who do. Consider a firm with 1000 employees and let us suppose that during a given year 1 per cent of them (ten) steal from the firm and 99 per cent (990) do not. All employees take the test and nine of the ten (90 per cent) who are guilty fail it; however, 990 employees are innocent and 99 (10 per cent) of these will also fail. Hence, for every guilty person caught by the test, nearly ten innocent people stand falsely accused. Once the 'base rate' [the total rate of stealing - 10 people per 1000 staff], is taken into account, it turns out that many more of the innocent suffer than the guilty.
Let's apply this line of thinking to credit approval. Recent research by Dun & Bradstreet showed that only 2.8% of Australian businesses failed in one year. Substitute for the question, "are you stealing from us?" the question, "are you a good risk to whom we should grant credit?" If the credit manager has the same 90% success rate and if as many as 2.8% of credit applicants are bad risks who should be rejected, what would happen over a sample of 1000 credit applicants?
There would be 28 customers who should be rejected, and 25 of them (25.2 to be exact) would be rejected. There would be 972 customers who shouldn't be rejected, and 10% of these - 97 - would be rejected. Out of 1000 applicants the credit manager would turn away 97 good customers who would have paid and only 25 bad customers who wouldn't have paid. Now in a hypothetical example the figures can be juggled to come up with whatever result you want, but the basic argument is sound - it is easy to do more harm than good through the credit approval process.
Problem #5 - how do we measure performance in credit approval?
It's often hard to tell what effect, if any, the credit approval process has. It's usually hard to tell if we're being too tough or too easy. People judge their performance on feedback, but the only failures that credit professionals or senior management are likely to see are those customers who get credit and who then default. If we, as credit professionals make a mistake by refusing credit to a customer who would have paid, neither we nor management are likely to realise it. Moreover, our bosses are likely to judge us on the amount of debt that goes bad, ignoring the fact that, say, a customer who has gone bad owing $30,000, has spent $1,000,000 over the past three years. Management is likely to judge such a case a failure rather than a success.
As you can see, I believe that the credit approval process is fraught with difficulties. It is the most complex area of credit management. For this reason, I devote the next six chapters to discussing this process.