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Collection Agencies: Why are they so sketchy?

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Every small business extending net terms will have to deal with collection agencies at some point during its operations lifecycle. Engaging collection agencies is almost always considered as the last option, a necessary evil that should only be initiated after all other organic collection attempts fail. The reason for the chronic lag between the time an account becomes delinquent and the time the same account gets transferred to collection agencies can be explained in two ways:

DAMAGED CUSTOMER RELATIONSHIP

When a third party agency starts to deal with your customer, you risk losing that customer for good. However, if that third party did everything it could to preserve that relationship, the story could be different. But that is often times not the case, which brings us to the next point:

NEGATIVE INDUSTRY REPUTATION

Most of the time, the collection agencies are extremely opaque; their fee structure is not easily accessible. Moreover, these agencies use very unpleasant methods to collect outstanding payments, which at times, could be intolerable. Most of the time, they end up permanently damaging your relationship with your customer.

The natural question then to ask is:

How do collection agencies stay in business?

After all, according to the Commercial Collection Agency Association (CCAA), commercial accounts placed for collections rose to close to $15 billion. And that was in 2008; that number should now be closer to $20 billion. Another metric: the trade credit space in the US is a $2.1 trillion industry, and close to 20% of it is delinquent.

Let’s take a look at the industry trends. Back in the mid-90′s the largest collection agency accounted for less than 5% of the industry-wide contingency-fee revenue of $5.5 billion in 1996 (according to a report by Dun & Bradstreet). As a group, the top 10 collection agencies accounted for just under 20% of the contingency-fee total. Today, when fees from outsourcing, telemarketing, and other non-traditional lines of business are considered, the top-10′s total market share is certainly larger, but based on the traditional contingency-fee measure, 80% of the business remains in the hands of the other 5,000 – 10,000 commercial and consumer agencies. In short, it is a massive industry, but yet so fragmented, opaque and as some would like to put it, sketchy.

It’s not that there are no laws prohibiting bad behavior of collection agencies. It’s that those laws are simply not enforced. As a result, a high number of  collection agencies just ignore these laws. In fact, there are well over 6,000 collection agencies in the United States and only about 5% of those are properly licensed.

The Fair Debt Collection Practices Act has been around for a long time, but given the stratospheric collection fees these agencies charge (which range from 30-50%), the market has been attractive enough to take the risks associated with unprofessional behavior.

Why are the collection agencies fees so high? Let’s just look at what small business owners currently do to manage their accounts receivable. Every small business owner has a percentage of their customer base that is always delinquent (the national average for 90+ days delinquencies is approximately 5%). They first pull expensive credit reports from the credit bureaus, they then try to get their customers to pay by calling them up (good luck, your customer is probably out to lunch), they then send them one reminder letter after another (definitely not an efficient use of their time), they then engage their lawyers to find a solution (costing hundreds of dollars in legal fees), and the list goes on. What’s worse, they waste precious time during this process and the probability of getting paid gets dramatically reduced as the account becomes more delinquent (this was already outlined in our first blog post).

In today’s world, small businesses lack the technology and effective tools to manage their accounts receivable seamlessly and without hassles. Receivables management is not their core business expertise. So to avoid dealing with late customers, businesses send these accounts to a collections agency. The industry is still dominated by old-fashioned mom and pop agencies operating with little-to-no-innovation over the last decade. The cost of collecting delinquent accounts is therefore still high, allowing collection agencies to justify the ridiculously high fees they charge, while getting away with violating the laws imposed by the Fair Debt Collection Practices Act.

Smaller collection agencies feel the competitive pressure more than the larger shops, which results in less transparency, both at the customer as well as at the debtor level. An increase in technology investment is critical to create more transparency in the receivables management industry.

Just as outlined in our previous blogs, start investing in technology to streamline your accounts receivable management processes. You will find that you actually may not need collections agencies to reduce your Days Sales Outstanding and keep your delinquency rates in check. Believe it or not, most processes can be automated, and through investment in technology you can save significant amounts of time and money, increase your cash flow and stay in control of your customer relationships.

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One Response to Collection Agencies: Why are they so sketchy?

  1. Hello! I just would like to give a huge thumbs up for the great info you have here on this post. I will be coming back to your blog for more soon.

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