Posted: 01/1998
Integrating Risk Management to Achieve Profitable Growth
By David Nestler
You are a CEO or marketing director about to present your growth strategy to your board of directors. Your company is set to invest millions of dollars on new product development and marketing. How can you ensure the money will be invested to achieve the highest return? Successful growth strategies employ risk management techniques to balance profit potential and customer service with the risks involved in extending credit for long-term profitability.
Driving Growth Is Not the Same as Creating Value
The marketing machines of leading telecommunications firms are creating exciting new pricing and service packages to attract customers. MCI One and GTE Long Distance are two examples (See Figure 1). While successful marketing efforts can generate a large revenue stream, will the revenue be good or bad? Effective risk management programs and processes must be put in place to ensure the market growth creates value for the organization and does not produce a drag on earnings over time.
Risk Management Protects the Bottom Line
Accurate projections of risk and growth are critical to success. The bottom line will reflect a poor risk management program.
Consider a long distance company's business plan for entering the personal communications services (PCS) market with a potential value of $1.5 billion over six years. Figure 2 illustrates how variances in estimating net bad debt dramatically affect projected revenues and losses for this new business. As little as a 3 percent net bad debt rate reduces net contribution by $300 million. A 30 percent net bad debt rate yields a $900 million loss. Factors influencing net bad debt rates include price competition and customer satisfaction. Being knowledgeable about net bad debt and credit risk up front can enable a company to make a smarter business investment, ultimately yielding higher profitability.
The Role of the Corporate Risk Officer
Many providers have begun hiring corporate risk officers (CROs) to ensure well-developed risk management plans. CROs are responsible for integrating risk management principles in every department--from marketing and operations to billing and collections--and at every stage of the process as the telecommunications company prepares to offer a new product or service.
Marketing
In the area of marketing, the CRO helps determine:
- Up-front net bad debt targets for each product profile
- Usage and fraud characteristics (which products have high fraud potential)
- The relationship of pricing to net bad debt
- Pricing strategies (gain market share first, then manage the risk)
- Bundling strategies (package together high- and low-risk products)
- Customer segmentation strategies
- Value of a customer to the organization--the difference between expected revenue from the customer and the expected cost of that customer to the organization
Customer valuation and segmentation are key aspects of the CRO's function within marketing, and the real value of the customer to the organization may vary from product to product. For example, a customer may bring in low revenue on long distance but high revenue in PCS.
Operations
In working with the operations department, where service order activation and provisioning are key processes, the CRO focuses on:
- Scoring and ranking new customers based on their ability to pay
- Developing debtor databases--profiles of previous customers and their credit and service histories
- Determining customer eligibility for special offers based on risk profiles
- Implementing mechanisms to screen for subscription fraud
- Developing strategies for managing customer churn
Mechanisms must be put in place so high-value/low-risk customers are offered optimum choices and opportunities to buy when they request service. Low-value/high-risk customers, on the other hand, should be treated with caution. Customer value, churn, risk and fraud models should be integrated into the acquisition and provisioning process and refined to reflect changing objectives.
Billing
Within the billing process, risk management must be an important consideration for:
- Defining up-sell and cross-sell strategies
- Monitoring usage and managing usage thresholds
- Detecting fraud, instituting threshold limits, developing fraud profiles and instituting preventive measures
The CRO constantly must seek to balance risk factors with usage to determine whether customers are crossing over the threshold of manageable risk.
Collections
Uncollectible accounts once were thought to be part of the cost of doing business. Now, with increased competition, companies realize that even a slight percentage increase in receivables collected or a cost reduction in collections will have a positive--and substantial--impact on the bottom line. In the collections area, the CRO concentrates on:
- Standardizing behavior scoring to predict the risk level of a customer
- Driving the collections process
- Performing specialized collections-handling functions
- Tracking down customers for payment
- Managing the cost of collections
Everything in the collections and recovery process should revolve around a cost of collections model. The CRO is responsible for deriving the most cost-effective way to collect outstanding debt. The cost to collect should not exceed the amount collected. At a usage level, there is a fixed cost associated with delivering service and delivering a profit. In the worst case, the cost of collection is equal to or greater than the total outstanding bill. The best-case scenario is that the recovery expense represents only a small percentage of the profit.
With the advent of bundled products and services, a customer's value score may have to be recalculated and a new collection strategy developed. For example, a customer's long distance behavior score may not predict payment patterns for PCS service accurately. A customer who has two products may be delinquent with either or both. Fraud procedures, usage thresholds and skip/trace procedures must be re-evaluated as well.
The Final Analysis: Improved Profitability
The CRO understands and accepts intended risk. At the same time, the CRO's function is to tighten credit policy so the company is seeking good revenue by segmenting customers according to their current and potential value. With an understanding of customer segments and the appropriate risk management tactics, the CRO can help increase revenue from the most valuable customers and reduce the collections actions necessary for potential debtors. This translates into adding value to the company, establishing sound growth targets and delivering business plans.
David Nestler is vice president with the Telecommunications Risk Management Practice at American Management Systems. He can be reached at (312) 474-6090.
