Navigating the debt collection software tipping point

Overdue accounts. Pretty much every business that extends credit to its customers has to contend with them. Some service them in-house. Some outsource to debt collection agencies. And still others cash in their chips and sell bundles of past due accounts to debt buyers. In fact, a single business may do all three.

Understanding the lifecycle of your overdue accounts can help you build a more efficient recovery operation by knowing when to manage collections in-house with debt collection software, and when to partner with a debt collection agency.

In this article, we’ll explore the ways early and late stage accounts differ, your options for handling them, and how tracking your operating expenses relative to debt recoveries can help you determine the appropriate debt collection strategy for your business. Along the way, we will also touch on some additional considerations around debt collection software, partnering with third-party debt collection agencies, and digital debt collection.

The lifecycle of overdue accounts

Every overdue account has a lifecycle. In the broadest sense, that lifecycle begins when an account becomes overdue, and ends when the outstanding balance is either recovered or completely written off as a loss.

Between those two points, an overdue account may pass through several milestones, and be handed off to multiple parties.

Early stage accounts are typically serviced in-house by creditors with tactics like reminder emails and past-due notices. These early stage accounts tend to have higher recovery rates, but with every day that passes, the likelihood of recovery decreases.

After a period of time – typically 90+ days – overdue accounts may be deemed too costly to continue recovery attempts with internal teams and passed off to a debt collection agency. From there, the debt collector will attempt to recover the overdue amount. Collection agencies are typically paid based on a success basis, claiming a percentage of the amount recovered as a fee.

Unrecoverable accounts may pass through multiple collection agencies before they are ultimately written off. These “placements”, as they’re known in the industry, follow each other sequentially:

• Primary placements - These are first-time placements, typically accounts aged between 90 and 180 days past due. Primary placements have the highest recovery rates and the lowest fees.
• Secondary placements - If an account is not recovered in the primary placement, it will be placed a second time. Recovery rates are lower for secondary placements, and fees are higher, reflecting the greater degree of difficulty in recovering the overdue balances.
• Tertiary placements - After 360 days and unsuccessful recovery attempts by primary and secondary debt collectors, an account may receive a tertiary placement. Recovery rates this far out can be pretty low, and as a result, tertiary placements pay the highest fees.

Throughout the lifecycle of an overdue account, time plays a significant role in the likelihood of recovery. A 30+ DPD (days past due) account is far more likely to be successfully collected than a 360+ DPD account. In effect, every day that passes, an account slides further down the path of diminishing returns. And at some point, the cost required to recover an outstanding balance can potentially exceed the value of the balance itself.

Managing collections in-house

As noted, early stage accounts are often serviced in-house. These accounts are the lowest of the low-hanging fruit, and may only require the gentlest of nudges for a successful recovery. Think customers who just forgot to pay, or whose credit card expired but was not updated.

Such accounts may be serviceable with existing accounts receivable software, or with dedicated debt collection software. Debt collection software goes beyond usual accounts receivable software with extra features and tools dedicated to debt collection. What solution works best, ultimately depends on the nature of the business and the nature of your customers.

Keeping these earliest stage accounts in-house makes sense. It allows for fast reconciliation, which can be important for restoring account standing and reactivating accounts. It can also be beneficial in industries where it’s possible to reconcile an overdue account without the customer’s direct involvement. And, of course, it allows you to maintain full control over the customer experience.

It’s important to note, however, that servicing overdue accounts in-house requires resources. Software has to be integrated, monitored, updated, and patched. Users have to be trained and supported, and someone has to take on admin duties. Reminder emails have to be written and approved. Security and compliance have to be maintained. If you are still using telephone outreach or mailing out past due notices, you have to consider further expenses, such as call centre staffing, printing, and postage costs.

As long as your recoveries stay ahead of your operating expenses, you’re generally going to be fine. But recovery percentages slip as overdue accounts age, and at some point, the recovery-to-OPEX ratio will turn negative - meaning that your collections operation will cost more than the money it recovers.

The OPEX tipping point

Businesses typically place overdue accounts with a debt collection agency after an established amount of time, such as 90 days. But that timing doesn’t necessarily match up with the tipping point where operating expenses outpace recoveries. For certain types of accounts, the inflection may come at 45 days, or even earlier.

Wherever that tipping point lands in the lifecycle of an account, one thing is certain. Once you cross it, there is absolutely no reason to continue pursuing an overdue account in-house. Any further spend on debt collection software, on staff time, on postage, will simply not be made up by the amount recovered. At that point, partnering with a debt collection agency is a no-brainer.

Most debt collection agencies operate on a contingency model, also known as a fee-for-success model. In essence, they only collect a fee based on the amount they are able to successfully recover for your business.

Let’s see how that works in practice.

Say you have a portfolio of overdue accounts worth $10,000.

You opt to service them in-house, and your operating expenses (for hardware, software, staff time, etc) total $6,000.

To calculate your net recovery, subtract your operating expenses from your gross recovery.

Gross Recovery - Operating Expenses = Net Recovery

How does that play out across different recovery rates?

If you’re servicing overdue accounts in-house, your operating expenses are more or less fixed. You have to pay for hardware, software, and staff time at a minimum. If your recovery rate slips below a certain threshold, your in-house collections operation can end up losing money. And as accounts age, their recovery rates will slip below that threshold.

Now let’s see how this works if you place $10,000 in overdue accounts with an agency at a 25% fee.

Gross Recovery - Operating Expenses = No Recovery

When you partner with a debt collection agency, you take operating expenses off the board. Yes, there’s still the contingency fee, but that fee is coming out of money that’s already considered uncollectible. Recovering even $5 is better than recovering $0.

Optimising your collections

When does it make sense to bring in a debt collection partner? There’s no hard and fast rule that says you have to wait 90 days, or 180 days, or until you hit that tipping point where operating expenses exceed recoveries.

From a hard numbers perspective, it depends on where a few different variables intersect:

Your internal recovery rate Your operating expenses to recover overdue payments Debt collection agency’s recovery rate Debt collection agency’s fee

For a similar recovery rate, the tipping point comes when your operating expenses are greater, percentage-wise, than the contingency fee. At this point, you stand to recover more, in total, by partnering with a debt collector.

If the recovery rates are mismatched, that can change the equation so that even a higher contingency fee will net your business a larger total recovery.

If you are already servicing some or all of your overdue accounts in-house, it may be worth placing some earlier stage accounts with a debt collection agency as a trial. That way you can get an apples-to-apples comparison of recovery rates and better evaluate where you can optimise your recoveries.

Beyond the hard numbers of operating expenses, contingency fees, and recovery rates, it’s also worth considering the less tangible elements of the collections process. As a business, you have finite resources. Think about the team running collections. From engineers and developers to finance, compliance, customer support, even copywriters and designers. Is servicing overdue accounts the best use of their time? Is maintaining debt collection software worth the effort? Is there something else they could be focused on to grow the business or enhance customer value? Or is having at least one foot in the collections process worth it to maintain the customer experience?

There’s no one answer here. The circumstances vary by industry and by business. But unless collections are a core, vital part of your business, it may be worth evaluating the benefits of bringing in a debt collection partner earlier in the lifecycle of your overdue accounts.

The rise of digital-first debt collection

In the recent past, placing overdue accounts with third-party agencies might have conjured thoughts of throwing your customers to the proverbial wolves. Indeed, protecting valuable customer relationships is a factor many businesses take into account when deciding to service early stage accounts in-house.

But debt collection is changing. The traditional modes of outreach – phone calls and physically mailed notices – are an increasingly inconvenient and ineffective way to reach consumers. Reliance on these “old school” methods has wreaked havoc on polling over the last decade, and the same is true for debt collectors. According to the Pew Research Center, only 19% of US adults answer phone calls from unknown numbers.

On top of shifting consumer behaviour, new regulations such as Reg F in the United States are putting increased restrictions on how, when, and how often customers can be contacted about their overdue accounts.

All of this is creating an environment in which debt collection is shifting and, increasingly, going digital.

Fundamentally, digital-first debt collection involves communicating with customers over channels such as email and SMS, as well as providing them with a convenient way of resolving their debt online.

Beyond these basic characteristics, differences start to appear. Some debt collectors take a “buy” approach, essentially bolting additional debt collection software onto their existing tech stack. Others are taking a “build” approach to create whole debt recovery platforms that are fully integrated across the front end user experience and the operational back end.

A step further is intelligent debt collection. This utilises data science to analyse every transaction and interaction, create personalised collections journeys based on a customer’s preference, and continuously optimise performance. It features a fully integrated back end, with compliance and reconciliation baked into the product, and is fully auditable by code. In intelligent debt collection, manual tasks that are prone to errors and delays are automated and scalable to any number of accounts.

As intelligent debt recovery optimises, it also delivers superior recoveries, which may make a case for bringing it in earlier in the lifecycle of overdue accounts.

Running the numbers

When is the right time to pass your overdue accounts to a debt collection partner? As discussed, that depends on a combination of your operating expenses, your recovery rate, the contingency fee, and the collection agency’s recovery rate. When those numbers intersect and you begin to see greater total recoveries by placing your accounts with an agency than by servicing them yourself, it may be time to give your internal debt collection software a rest.

How InDebted can help

At InDebted, we’ve built an intelligent debt collections product, Collect, to disrupt the broken industry of debt collection. At the forefront of the debt collection industry, Collect creates tailored experiences and delivers personalised communications on the channels customers prefer. Fuelled by machine learning models and a customer-first approach to collections, InDebted has been able to provide a 40% increase in returns for our clients over traditional debt collections agencies.

Let us help you maintain positive relationships with your customers while increasing your success rate on recoveries.