Outsourcing Collection of Delinquent Accounts: Experiences During Recession and Growth

Abstract

Business process outsourcing (BPE) is becoming more and more commonplace in the 21st century. While BPE is seemingly a recent phenomenon, however, companies have been using outsource providers to collect delinquent accounts for many years. A Credit Research Foundation (CRF) study conducted in 1998 examined the benefits of such outsourcing. The findings, which were generated for the period 1995-1997, indicated that outsourcing collections provided benefits that were related to the size of the companies referring the accounts. A limitation of the 1998 survey, however, was that it covered a period in which the economy was healthy and growing. Another question remains: are there as many benefits to outsourcing collection of delinquent accounts in a recession economy? To address this, CRF conducted another survey in 2003, covering collection experiences for the period 2000-2002.

There were a variety of differences in the findings between the two survey periods. The primary differences were observed in the way in which the recession affected the average sales levels of firms in each of the three size categories, and in terms of referrals of delinquent accounts to outside agencies. On average, sales for the smallest companies in the sample steadily grew over the period 2000-2002, while average sales for the largest firms in the sample decreased on average for the year 2002 after having grown in 2001. It was also evident that firms placed a both a greater number of accounts and a greater percentage of their sales for collection by outside agencies during the recession period. It also appears, however, that the collection agencies were just as effective in collecting accounts during the recession period as they were during the growth years. Finally, the distinct size differences that appeared in the 1995-1997 survey failed to appear in the later version.

The Survey

There were a total of 141 responses to the online survey of November 2003. Of those, 46 (33%) of the respondents indicated that their companies did not outsource collections of delinquent accounts to outside agencies. Of the remaining 95 companies, 24 were eliminated from the sample due to incomplete or unusable response data, leaving a sample of 71 companies that do engage in outsourcing collection of delinquent accounts. Characteristics of the sample are discussed further below.

Respondents were asked to provide referral, collection and demographic data for the three years 2000, 2001, and 2002. These data include the number of agencies used, the number and dollar value of accounts referred for collection in each of the three years, annual sales and number of customer accounts. The respondents were also asked to rank the importance of a variety of criteria for selecting collection agencies.

Sample Characteristics

The sample of 71 companies composing the recession survey matched the earlier sample of 45 companies in a variety of ways. As can be seen in Exhibit 1, the average annual sales and number of customer accounts for small, medium and large firms in each of the two time periods are distributed with similar characteristics. The overall averages for the two time periods are different as a result of the fact that there were more smaller sized firms responding to the 2003 survey (28 as opposed to 7). This accounts for most of the differences in structure between the two samples.

Because of the differences in distribution of the samples, the weighted-average sales for the 2000-2002 sample is lower than for the 1995-1997 sample by almost $1.00MMM. This needs to be kept in mind when the aggregated results are compared between the two periods, as it may be the source of a potential size effect in the results.

The Recession of 2000-01

A recession is typically defined as a decrease in some measure of national economic performance, such as GNP or GDP, over at least two consecutive quarters. The recession of 2000-01 is evident in the decline in real GDP experienced in the last quarter of 2000 and the first two of 2001, as can be seen on the chart in Exhibit 2. This is contrasted to the period of steady growth that can be observed for the period 1995-1997. The recession, however, appeared to be minor, with the percentage declines for the three quarters of-0.056%, -0.161% and -0.321% respectively. By the third quarter of 2001, real GDP was again growing by 0.498%, and it has continued to grow as of this writing. The effects of the recession, however, were felt differently in various sectors of the economy, particularly manufacturing.

The recession's impact on manufacturing are evident in a comparison of the index of overall business output the index of manufacturing output and rate of capacity utilization. As can be seen on the chart in Exhibit 3, the overall index of business output increased steadily throughout the 1990's and into the 21st century. Both the index of manufacturing output decreased in the years 2000 and 2001, and capacity utilization fell from 2000-2002. It appears, therefore, that the most negative impact of the recession was felt in the manufacturing sector.

Impact on Credit, Trade Receivables and Inventories

The time period surrounding the recession of 2000-01 was also characterized by declining interest rates and low inflation. As can be seen on the chart in Exhibit 4, both the prime and federal funds rates declined over the period 2000-03, even to the point where the real rate of interest for federal funds was negative. As this took place, consumer credit increased dramatically, as can be seen on the chart in Exhibit 5. While consumer credit was increasing, commercial loans, however, were falling, as can be seen in the same exhibit. Declining commercial loans by banks were offset by increases in federal government debt held by those same banks. The combination of low interest rates and falling commercial loan volume can be interpreted as a sign of diminishing confidence on the part of banks regarding the prospects for domestic business opportunities at the time. This may have been a contributing factor to the recession itself.

The decline in commercial loan volume coincides with a decrease in both trade receivables and inventories over the same period, as can be seen on the chart provided in Exhibit 6. The interactive effects of the recession and declining business credit made it increasingly difficult (or less necessary) for firms to carry investments in working capital.

Impact on Bad Debt Expenses

Recessions do appear to be related to bad debt expenses. The chart in Exhibit 7 displays the CRF measure of bad debt expense as a percentage of sales for the period 1984 to 2003. As can be seen, there are two peaks in the data series. The first corresponds to the recession of the early 1990's. The second corresponds to the recession of 2000-2001. Interestingly, it appears that the increase in bad debt expense actually leads the recession, as in both the early 1990's and the late 1990's, the bad debt expense percentage begins to increase prior to the initiation of the officially defined recession. This corresponds to the survey finding that during a recession, a greater percentage of sales are referred for collection, yet approximately the same overall percentage of outsourced dollars are collected by agencies, to be discussed immediately below.

Survey Results on Account Referral Activity

The recession appears to have a significant impact on both the relative number and value of accounts referred to outside agencies for collection. Referral statistics for both survey sub-periods are provided in Exhibit 8. During the healthy economic period (1995-97), the overall sample firms referred an average of 0.80% of their customer accounts totaling 0.034% of their total sales for collection by outside agencies (refer to "Weighted Averages" in each table). During the recession period (2000-2002), those values increased to 1.09% of the total accounts valued and 0.103% of total sales.

The results are a bit more striking when examining the effects of firm size on the findings. During the healthy economy, the small, medium and large firms referred accounts averaging 0.049%, 0.031% and 0.030% of their sales (respectively) for collection by outside agencies. During the recession, those averages increased to 0.141%, 0.091% and 0.069% respectively. Two things are notable here: first, it appears that smaller firms tend to outsource a larger dollar percentage of their accounts for outside collection than do larger firms; and second, the pattern is similar, if even more pronounced, between the two different economic periods. This may be due to the fact that smaller firms lack a substantial base of internal resources to pursue delinquent accounts, and are therefore more likely to outsource for collection.

Survey Results on Collectibility

Based on the survey results for the aggregated sample, it does not appear that the recession had a significant impact on the collectibility of accounts once they were referred to outside agencies. As can be seen in the "Weighted Averages" presented in Exhibit 9, 36.46% of all dollars referred were actually collected during the healthy economic period. During the recession, that amount fell, but only to 33.55% of all dollars referred.47 The percentage number of referred accounts eventually collected also did not differ substantially between the two economic periods, being 58.74% for the healthy economy and 56.12% for the recession. It therefore appears that once outside agencies received accounts, they were just as effective in making the collection during the recession.

There appeared to be a discernable pattern of collectibility related to size of the referring companies in the 1995-97 sub-period. This can also be viewed in Exhibit 9. For small, medium and large firm size categories in 1995-97, the percentage of referred dollars collected are 28.59%, 31.51% and 40.86% respectively, suggesting that agencies representing larger firms collect a greater value of the referred accounts. This same pattern was reflected in the percentage number of accounts collected as well. The number of accounts collected on behalf of small, medium and large firms is 36.54%, 47.28% and 70.00% of referred accounts respectively for 1995-97. Both of these findings were originally attributed to the fact that the larger firms were more likely to outsource a collection sooner than the smaller firms. Larger firms in the first survey referred accounts after an average of 118 days past due, while the small and medium sized firms waited an average of 150 and 140 days respectively (see Exhibit 8).

During the recession, however, no similar size-related pattern is discernable. For the recession period, the percentage number of accounts collected for small, medium and large firms were 60.51%, 59.45% and 47.86% respectively, reversing the previous pattern. The percentage value of referred dollars collected on behalf of small, medium and large firms is 24.40%, 48.20% and 31.97% respectively. It is notable that the small and medium companies in the recession survey were quicker to refer accounts for collection. Small firms cut that time from 150 down to 131 days, and the medium firms from 140 to 122 days. This may account for the maintenance of overall collectibility, despite the presence of a recession economy.

Results on Referrals and Collectibility by Size and Year: 2000-2002

In order to determine whether or not there were patterns evident in the collection performance data for each different year in the recession period, the samples for each size category were analyzed accordingly. As can be seen in Exhibit 10, the only apparent pattern is evident in the smallest size category, where both the percentage of accounts and the percentage of sales referred for collection steadily decreased from 2000 to 2002. At the same time, there appears to be little difference in the percentage number of referred accounts collected over the three years. The percentage value of referred accounts collected, however, appears to increase over the three year period (i.e., as the economy came out of the recession). Similar patterns for the medium and larger firms do not appear to be evident. Smaller firms, therefore, may have been hit earlier by the recession, but were able to recover more quickly.

This finding is also coincidental to the evidence that the recession had a different impact on the sales of firms of different sizes. Average sales were lowest for the small firms in 2000, and stayed roughly level for 2001, and increased by 7.5% in 2002. The medium sized firms in the sample experienced consistent increases in sales (4.15% and 7.58%) over the three years, in spite of the recession. Average sales for the larger firms increased by over 10% between 2000 and 2001, the actual recession year, but appeared to slow down in 2002.

Referral and Collection Results by Industry Group

Referral and collection results for each industry group are reported by year in Exhibits 11 and 12. Given the small sample sizes of most groups, there are not many statistically meaningful results other than for the Consumer Goods category, where there are 29 observations. For this group, it appears that average sales increased over the period 2000-2002. In addition, while the percentage of customer accounts referred for outside collection appeared to increase, the percentage of sales dollars referred appeared to fall over the three-year period. At the same time, there does not appear to be the same pattern in the collection experiences of Consumer Goods firms. While the percentage number collected increases over the three years, the percentage of dollars collected increases then falls between 2000 and 2002. The remaining results are provided in the exhibit without further comment.

Choosing a Collection Agency

The important factors in choosing an outside collection agency identified by the 2003 survey respondents, presented in Exhibit 13, did not undergo significant change from the earlier study. As can be seen, with the exception of an added factor, the top four most important factors in choosing an agency did not differ between the 1998 and 2003 studies. The two most important, reputation of the agency and its costs and fees, remained in their established positions. Methods of collection, approaches to collection and the presence of an established relationship with the agency rounded out the top five. Of the remaining six factors, there were only minor changes in the order in which they were ranked.

Concluding Remarks

Evidence indicates that the recession has an impact on the outsourcing and collection of accounts receivable. Bad debts expenses appear to rise in the period around a recession. During the recession, firms of all sizes place a larger number and relative value of their accounts for outside collection. In spite of the recession, outside collection agencies appear to perform as well as when the economy is healthy, collecting just about the same relative number and value of outsourced accounts in both sets of circumstances. The size of a firm may play a role in its outsourcing experiences, but the impacts may have changed between the first and second survey periods.

By: Steven C. Isberg, Ph.D.

Dr. Steven Isberg is currently Associate Professor of Finance at the Merrick School of Business, University of Baltimore as well as a Research Fellow at the Credit Research Foundation in Columbia, Maryland. Dr. Isberg's professional activities include teaching and research in the areas of corporate financial analysis, valuation, entrepreneur ship, strategic business development, and risk management. He has published over 20 articles in both of academic and practitioner journals and is frequently quoted in the media regarding issues in corporate finance and business ethics. He also teaches a variety of professional development and staff training courses, and has been engaged as a consultant by a number of Fortune 500 and SME firms.

Copyright Credit Research Foundation Third Quarter 2004
Provided by ProQuest Information and Learning Company. All rights Reserved