Introduction and Industry Environment
The business of business is about the future and relies on predictions. It’s done every day – predictions about future inventories, revenues and receivables are the basis for today’s decisions. With increased scrutiny on prior results and future predictions, from regulators, shareholders, auditors and analysts, it is essential that predictions and forecasts be as objective as possible.
Deregulation and competition in the telecommunications industry may have benefited the consumer, but, as most recently evidenced, it has certainly resulted in a significant loss of shareholder value. How can electric and gas utilities, as well as telecommunications, enhance that value when a rate of return is no longer assured?
In this environment utilities need to realize that they, regardless of the services or products provided, are credit grantors. The revenues and receivables of most utilities exceed those of many banks. Understanding the true financial risk of doing business with a customer is critical to managing operating costs and earning an acceptable profit. A major challenge facing gas and electric utilities is retaining profitable customers while at the same time reducing Operating and Maintenance (O&M) expenses to support corporate financial objectives.
The Need For A Customer Lifecycle Evaluation Process
Scoring is most useful in an environment where repetitive decisions are made, high volumes corresponding with low dollar exposures and highly automated billing and collection processes. The areas that risk scoring benefits and impacts include:
- Consistent and unbiased treatment of applicants/customers
- Decreased write-offs
- Increased recoveries
- Reduced collection operation expenses
- Ease in adjusting security and/or credit terms in the face of changing economic conditions and/or deregulation
- Enhanced forecasting ability
- Reduced labor costs and expenses
The use of account scoring throughout the customer lifecycle provides a portfolio management tool that identifies those customer segments that will support cost reductions and / or revenue increases resulting in improved margins.
While scoring is becoming more accepted by the utility industry, it is still a greatly misused term. Scoring is a generic term used to describe the process of grading historical actions as a way of predicting future customer behavior.
Scoring v. Grading: Terms and Definitions
- Articulate the differences between judgmental and statistical scoring methodologies
- Address types of scoring and explore their applications during the account lifecycle
- Identify benefits and justifications of scoring
- Include examples of quantified savings and results
- Introduce emerging applications of statistical methods
- Review TSI’s approaches to scoring and implementation
Subjective grading or coding: Many credit grantors have developed grading or coding formulas or processes that track a customer’s past behavior. This grade or code, often called a score internally, is then used to determine how a customer is treated within the company’s delinquency strategies.
Objective, statistically based scores: Experience shows that active customers can usually be grouped into 4 – 8 segments making treatment decisions and analysis more consistent and effective.
External Scores: Several vendors provide “scores” based on their analysis of large amounts of available credit bureau data. Also offered are codes they call utility “scores” based on their analysis of payment behavior amongst large numbers of people. In the absence of internal data for analysis, these codes and scores can be helpful, especially during the application and early customer portions of the account lifecycle.
Internal, behavioral scoring: There is no better source of information about a utility customer’s behavior than its own billing, payment and treatment data. In addition to quantifiable benefits, internal scoring has the added benefit of being completely objective and acceptable, even in tougher regulatory environments, because treatment is based on an individual accounts past actions, not based on the actions of millions of unidentified utility customers nationwide.
Scoring the Account Lifecycle: How and when
The three (3) basic stages in the customer lifecycle are acquisition, existing and former customer. Within each stage there are multiple applications for scoring resulting in cumulative benefits.
Customer Acquisition – Application Scoring
When a customer applies for service, a utility can choose to deploy positive identification (PID) to validate customer identity. Once the customer's identity is verified, in the absence of internal data, an external credit score can be used. From this credit score, a utility can decide if conditions for service (i.e. deposit, prepay, etc.) will be placed on the customer. In cases where a deposit cannot be obtained, the recognition of a "high risk" customer can be used to set a more aggressive collection path.
While a deposit can be an effective tool when collected from the “right” customer, identifying that customer has proven less than an exact science. From a customer perspective, a deposit is an inconvenience and a negative to customer satisfaction. From a provider perspective, a deposit program that doesn’t target the appropriate customer results in nothing more than additional costs associated with processing and increased interest expense.
The application for service is a critical time for the customer relationship. How many bad debt accounts are first bill defaults that you’ve never heard from since application? The sooner a risk is identified and acted upon, the lower the financial impact. Experiences have confirmed that 50% or more of residential write-offs are attributable to customers within the first 12 months of service. Regarding commercial customers, a widely held statistic that 99 out of 100 start-up companies fail is the best rationale for beginning the risk evaluation early in the customer's lifecycle.
Existing Customer – Behavior Scoring
During this portion of the customer lifecycle, the utility needs to continually assess its on-going risk. Utilities have numerous "moments of truth" with customers, such as billing, inbound calls, in-person visits, correspondence and the Internet. At the time of any customer contact, a utility can benefit from knowing the "payment risk" a customer represents in order to either promote value added goods and services or to impose limits to reduce exposure.
Early Behavior Scoring
The behavioral score has a specific crossover point at six (6) months, for most utilities. In the first six (6) months a combination of external score and customer payment behavior can be useful in developing a comprehensive score. This scoring is important so that the utility can quickly address their risk and take the appropriate actions to train customers to pay promptly or to determine when a customer is absolutely unwilling to pay.
Mature Behavior Scoring
After the customer has been with a utility for more than six months, the payment habits have demonstrated higher confidence than external scores in determining the risk of non-payment. The score takes into account the past treatment methods and the resulting customer response. Remember, the minimum treatment required to prompt the desired customer response is the true measure of collection effectiveness.
Behavior scoring, when used to prioritize accounts and drive collection activity, has resulted in excellent operational improvements. Reductions of between 10% and 15% of the active account collection expense are typical. The ability to identify both the customer's propensity to pay and the best technique (e.g. call versus letter) to motivate the customer to pay is critical to minimizing collection expense along with improving cash flow and lowering write-offs.
As an example, one large electric utility conducted a study of customers receiving a reminder document. The evaluation of customer payment behavior revealed that the customers who received the phone call paid more and paid sooner than those who received no treatment. The utility used this information to accelerate the timing of the phone call resulting in a cash flow improvement that paid for the cost of the calling program.
Former Customer – Final Account Scoring
If your company has unlimited resources you can skip this section. Since you are still reading, your organization must be like most, with limited resources and / or a desire to improve final account collections. Experience would suggest that for most companies, their core competency is in managing their active account portfolio. A utility has a great advantage, through the threat of disconnection of service to influence the active customer’s payment habits. Utility call centers and credit departments do not usually possess the tools, or skill sets required, like those in use at outside collection agencies (OCA), to deal with final and, in most cases, skipped customers.
When included with the other customer demographic data, whether used internally or sent to an outside collection agency (OCA), the utility will be able to use the scoring data to track the recovery effectiveness or negotiate tiered pricing. Overall, the use of recovery scoring can result in maximizing the collection of final accounts while minimizing expenses resulting in a reduction in the cost per dollar collected.
After Customer Treatment: What’s Next?
While the use of scoring to drive customer credit decisions is clearly justified by an incredible ROI, additional areas and uses are available to create even larger returns.
Cross/up selling opportunities
Yes, there are good paying customers. A utility needs to ensure that opportunities to build customer loyalty and provide for additional revenue are optimized. No one can argue that payment history shouldn’t play a part in a decision to extend more credit to a customer.
A profitability score can be generated to predict the maximum value that a customer may represent to a utility. Profitability scoring can provide a means to maximize revenues while minimizing risk. By identifying the customer's profitability in a statistically valid method will allow the utility to target those customer segments most likely to choose, and pay for, additional services.
There are also ways of increasing sales in the regulated environment. One utility study revealed that Budget Plan customers paid earlier than those customers not on the Plan resulting in a cash flow improvement and Budget Plan customers used more service than those customers not on the Plan resulting in increased revenue. While most states require that such a program be available to all customers, regulations do not usually prohibit promoting the budget plan to specific customer segments. Scoring could be used to identify the customers likely to contribute the greatest revenue growth with the lowest risk.
Reserve Requirement Forecasting
Modeling historical data, derived from the behavior and recovery scoring efforts, can yield statistically valid charge-off forecasts and an accurate loss reserve. The accurate understanding of payment risk may allow utilities to lower their loss reserve and provide a more accurate reflection of its actual worth to investors, as well as making additional capital available for other projects and investments.
The regulated environment has created and maybe even encouraged utilities to be over-reserved. One of the biggest issues facing a utility wishing to change its reserve calculation methodology is justifying a change to management and the external auditors. FASB, GAAP and the SEC agree that there must be a valid reason for any change. They also agree that any method selected must be consistent, systematic and well documented. Recent experience has proved that, even in the current environment of concern regarding accounting changes, preparation and documentation can make the approval of such a change relatively painless.
Implementation of scoring has yielded tremendous benefits and quantifiable returns on investment. Among the benefits realized by TSI’s most recent clients have been:
Significant reductions in the outstanding delinquencies of as much as 15%
A reduction of 1,200,000+ reminder and disconnect letters over a 12 month period.
A 12% reduction in in-bound credit calls. This represents a 12 - month reduction of 157,000+ calls into the call center.
59+% reduction in field service calls for service disconnection and in actual disconnects
These examples of easily identified benefits yield paybacks that are measured in days – not years. The challenge is to move scoring to a position of high enough visibility and priority to get attention, and more importantly, resources. To that end, it is a pleasure to let you know that one utility attained all of the benefits listed within one year with a project implementation window of less than 90 days.