Bad Debt Can Be Good For Business
The typical image of the credit manager," explains Lester J. Heath III, president of Albany Ladder Co., in Albany, N.Y., "is the guy who sits in the back room and says no to deals." A guy who, Heath might well have continued explaining, would say no to the 87% of Albany Ladder customers who buy with the help of financing.
"We've changed all that," Heath says. "Jim's job is to make the deal work."
Jim is James K. Ullery, credit manager for the $17-million construction equipment and supply company -- and Ullery has taken Heath's directive very seriously. No mere reviewer of credit histories, he instead sees consumer financing through the eyes of a salesman. "I am part of the marketing department," Ullery says.
Now at first, this sounds absurd. Ever since Peter borrowed to pay Paul, the credit manager's role has been to minimize risk, not maximize sales. Low bad-debt totals meant he was doing a good job. If the number of bounced checks and unpaid bills got too high, there was something wrong. And indeed, bad debt at Albany Ladder is about 1.3% of sales, nearly double the industry average. But is Heath annoyed? Quite to the contrary; he's delighted.
"Are we growing rapidly?" he asks himself for his visitor's benefit. "Well, sales have increased 22% a year for the past five years. Are we expanding market share? Yes. Are we profitable? We are extremely profitable." (He declines to give figures.)
"Sales and market share," Heath would argue, "are the key things you should look at, not bad debt. If your bad debt isn't high enough, you aren't taking enough risk."
Heath, 41, says his approach to credit has grown out of the nature of his industry. In the construction business, the 19-year-old carpenter who one week helps remodel your bathroom could decide the next that he wants to be a general contractor. That means he's going to need supplies and equipment -- far more of both than he has cash to pay for -- and credit, even though he may never have had a checking account or car loan in his life.
"Would we sell to that 19-year-old? Probably," says Ullery. "But we'd make sure we were pretty well protected before we did."
Protection is what enables Albany Ladder to use its astonishingly liberal extension of credit as a marketing device. The trick, say Ullery and Heath, is to shift the risk, whenever possible, to someone else -- whether to a third-party financier or the borrower himself. If you can do that, they say, you'll never be hurt too badly should your customer turn out to be a deadbeat.
The case for getting liberal with credit in the first place is easy to make. "Giving someone credit is a powerful tool. If you extend credit to a person who couldn't get it elsewhere, he'll remember that gesture forever and could be a customer for life," says Ullery, who assists at Dale Carnegie courses on the side and has warmed completely to his job of selling credit. "If you give someone credit, you are saying, 'I have faith in you. I know you will pay me back. I believe in you."
Albany Ladder began putting this powerful tool to use when, five years ago, Heath got tired of watching potential customers walk away empty-handed because they couldn't get loans independently. But the company does more than just OK a higher percentage of credit applications. Ullery and Heath actually seek out likely credit customers and make them an offer that, they hope, can't be refused.
Take the case of the 19-year-old carpenter. While it's possible that this fledgling general contractor just turned up at one of Albany Ladder's four locations, the company probably found him first. Ullery's staff of four is constantly reading the local newspapers, checking with trade associations, and driving about town looking for new customers. When they find one, they send out a letter that welcomes the customer to the area and gives a brief pitch for the company's product line. That letter is soon followed by a second that says, in essence, why don't you apply for credit now, it will save time when you need to buy or rent equipment later.
The letters do two things. They help to create a list of qualified direct-mail customers. "For example," says Heath, "by searching through our sales receipts we found that most electricians buy fiberglass ladders. We then did a mailing to the electricians who hadn't bought one from us." The letters are also designed to ensure Albany Ladder is the first place the carpenter thinks of when he needs supplies.
Suppose that at some point after he hears from Albany Ladder, the 19-year-old comes in and says he needs $20,000 worth of equipment to go into business. He wants to buy $12,400 worth -- about 62% of the company's revenues come from sales -- and rent the rest. At that point, even before he fills out the credit application, he'll meet with Ullery. The purpose of the meeting is twofold. Ullery wants to make sure the company makes the sale. "If we don't, it isn't just one sale we've lost. We may never get him to come back." And he wants to size up the prospect and ask -- subtly -- a few questions. "Does he have ties to the community? People who do are less likely to skip out on their bills," says Ullery. "Has he had credit before? If he has, I can find out if he pays on time."
Being 19, it is unlikely that our carpenter is listed by Dun & Bradstreet. But Ullery is unfazed. He might place a quick call to TRW Credit Data Services or one of the other credit-reporting services to see how the carpenter pays his personal bills.
But let's say that inquiry, too, comes up blank. Ullery still wants to make the sale, so now he begins looking for ways the carpenter can get financing while Albany Ladder remains protected from risk. His first step might be to try to help the carpenter qualify for a bank loan. Ullery was once a lending officer in Albany, which means he has contacts in the local banking community and he knows his way around a credit form. But realistically, the banks might be leery of loaning $20,000 to a teenager who reported 13,000 in income last year. The next step is for Ullery to work out terms himself. It isn't altruism, he says. It's just good business. It's the powerful tool at work, binding loyal customers to Albany Ladder.
Still, though, Ullery wants as much protection as possible. Before the carpenter can get his loan, not only will he have to sign papers that allow Albany Ladder to reclaim the equipment should he default, but he'll also sign over a security interest on his truck or whatever else of value he owns. Odds are Ullery is going to require him to have a cosigner, and in cases of a rental agreement, Ullery may ask that the person who hired the carpenter make out the carpenter's check to two parties -- the carpenter and Albany Ladder.
And, no matter what else is required, it is almost certain that the carpenter will be asked to sign a personal guarantee.
"Even 19-year-olds are going to be smart enough to have gone to a lawyer and set up a corporation," says Ullery. The advantage of that to the carpenter is clear. Should the business fail, the corporation -- not the carpenter -- would be liable for the debts. Having the carpenter sign a personal note gets around that legal fiction.
"Would I sign a personal guarantee?" Heath asks rhetorically. "Never. Do our customers, Jim?"
"Ninety-six percent of the time."
The customer, of course, probably doesn't have much choice. If he could pay cash, he wouldn't have to sign anything. But if he wants the equipment, and he can't get financing anywhere else, the Albany Ladder is the only game in town.
It's a game in which the customer will have to pay for the privilege of playing. He'll have to sign security interests, and he'll have to pay 2% simple interest a month, 24% a year -- about normal for high-risk loans -- should he fall behind in his payments. No wonder Heath is proud of his margins. When you borrow at prime and loan money at 24%, you discover a nice contribution to profits.
But people who can't pay back what they owe usually can't pay what they owe plus interest, and that brings us to the last part of Albany Ladder's credit strategy: aggressive collections.
"Bills are payable within 30 days, and on the 31st day, in theory, you should be getting a phone call from us, asking -- politely -- where the money is," Ullery says. Each day the outstanding bills automatically come up on a computer -- ranked from the largest to the smallest -- and Albany Ladder's four-person credit department starts working the phones. Customers also receive written reminders. They start out cute. A reminder that looks like a greeting card shows a man squinting at an eye chart with the headline "I've strained my eyes . . .," and when you open the card it says, ". . . watching for your check! Can you help me?" But the cute messages quickly progress to being more direct. And should the customer be unable to pay, Albany Ladder will work out a repayment schedule, at very favorable terms -- to Albany Ladder.
These aggressive tactics, of course, can be counterproductive. Deadbeats go out of their way to avoid you, and you might alienate good customers as well. Even your best clients, on occasion, may miss paying their bills on time. The bookkeeper gets sick, the bill gets misplaced, whatever. Sending out a reminder on the 31st day to folks who have been buying from you for years could result in their taking their business elsewhere.
"We make mistakes, no question about it," says Ullery. "I personally apologize, and then a day or so later they get a phone call from Les as well." The aggressive collections policy, he points out, is an evil made necessary only by Albany Ladder's generosity with credit.
"I have been on both sides of collections," adds Ullery. "I used to work as a collection agent. Also, I once had a photography business that failed, and had people dunning me for money. Everything we do is predicated on treating the customer as a human being. I know how I want to be treated, and that is how we treat people."
It's the Golden Rule. But gold, as we know, can be expensive.