Integrating Risk Management to AchieveProfitable Growth

Posted: 12/1997

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.