Receivable/Accounts - Information for Credit and Collection Issues

Monday, April 29, 2013

The Lowest Bidder Hurts Us All

I was at a conference last week, and the subject of an RFP recently advertised came up.  Apparently a consumer collection contract was awarded to a collection agency ... for about 13%.  This portfolio, if it compares to others in its industry, has an average balance of $250, and a potential liquidation of 30%.  Clearly the winning bidder and the procurement department that put out this RFP don't realize they have both just hurt our industry and themselves.

In the contingency-fee world, the liquidation of a program and the rate assigned are crucial, key elements in determining the potential revenue for a program.  These revenues are not guaranteed, but with some experience and projection can establish a rough rule of thumb for return on effort.

Now, this isn't the first or last time someone has undercut a contract to the point of non-profitability.  Early on in my career, a couple of decades ago, I was assigned as a collector on a second placement credit card portfolio ... at an 18% commission rate.  This is about half of what this industry would normally award for a program like this on a contingency basis.  The program had been worked heavily by the creditor, and then by the first assignment agency for nine months before it came to our agency, and our team gave 100% effort to liquidate about 4%.  It didn't matter that we collected $100,000 a month in gross dollars, it only resulted in about $18,000 revenue ... for four staff members.  That works out to under $4500 a desk.  In the contingency world, that's not a successful ROI.

Let's Look At the Math

Here's the secret to all collection work plans.  This is the prime magic formula that tells the third party collection vendor the profitability and expected revenue flow of any given program.  I'm going to share it with you.


That's it.  That tells us the manpower needed, the amount of infrastructure and support services we can give to the team working the program.  Simplicity.

So ... taking what we have learned above, let me show you how 13% is a horrible, horrible idea.  Let's assume, for the moment, that 300 files will be assigned per month.  On a manual collection program, that requires roughly 1 FTE (or Full-Time Equivalent person) to work, trace, and manage client support.  So, if we assign a collection staff member to this program, what sort of revenue should it generate on average, after about 60-90 days, each month?

300 (files) x $250 (avg bal) x 30% (liquidation) x 13% (contingency) = $2925

What does this tell us?  It tells us that a collection agency assigning a full time person to this program is going to lose money, with the cost of the staff member, the postage for the initial mailings (even if there was only one letter), the telecommunication costs, and the other overheads needed to maintain a legal collection agency.

So what will the winning bidder do?  They'll have to cut corners, not send out collection notices required by law, fail to attempt to trace the files, not call files under a certain dollar amount, assign the most inexperienced staff member to the program, throw the files in a slush pile with other programs on a predictive dialer, or whatnot.  And because they'll do that, they won't achieve 30% liquidation.  They'll probably liquidate 15-20%.  This destructive cycle isn't just bad management of the assigned portfolio, it directly hurts the client in a real, financial way.

If the agency had received 20% contingency and liquidated 30%, the recoveries would have been $22,500 a month less $4500 fees, for a net back to the client of $18,000.

Instead, the agency will receive 13% contingency and liquidate 20%, for a recovery per month of $15,000, less $1950, for a net back of $13,050.

That's a shortfall of about $5000 per month, or $60,000 a year.  I'm betting that's pretty comparable to the salary of someone in the procurement department.  With one decision, that procurement manager just eliminated a revenue stream that paid for one of their staff.

So Why Is This Bad?

Decisions like this hurt our industry.  They make us look collectively incompetent because we don't liquidate the full potential available to an industry group.  They hurt us because we are inviting creditors to take us for granted.  Once a rate is set, it's very hard to raise it again, and other companies in the same industry vertical will often mimic the existing standard that's been set.

The problem with a competitive market that is solely based on price, is that someone, somewhere is going to set a price that will run at a loss, or a significant degradation of service.  And while the experienced people in our industry might get together at conferences, shake our heads and grumble at each other, no one is proactively talking about it.


The collection industry needs to work together and not devalue their services.  The collection industry needs to maintain professional standards and explain to their clients what they should expect for a net back result with professional representation.  The collection agency needs to offer transparency for our industry, because they should not be held to unrealistic ROI values.  Occasionally agencies overcharge clients, but that is somewhat internally policed by competition -- but when collection vendors undercharge and provide a substandard liquidation it will leave an impression with the client long after they have closed their doors because they were not running a viable business model.  This needs to be fought with proactive discussion and education to the creditors on what is an acceptable ROI model for their vendor, and what is a reasonable expectation for liquidation.

If you are interested in discussing expected return rates for your industry group, and a reasonable range for a contingency rate structures, please feel free to reach out to me.  I can be reached at my office at Kingston Data and Credit at 226-946-1730.

Blair DeMarco-Wettlaufer
Kingston Data and Credit
Cambridge, Ontario