Old Paradigms Incompatible With Modern Business

No sexy spreadsheets, B2B credit is about more sales, better cash flow and efficiency

By Abe WalkingBear Sanchez

In his book The Structure of Scientific Revolutions, first published in 1962, Thomas Kuhn defines a paradigm as an accepted set of givens which provide a model problem and a successful solution that works for that time. As things change, the old paradigm becomes incompatible with the new reality. New knowledge in time brings about a shift, a Paradigm Shift.

The Old Credit Paradigm
Many business executives are caught up in thinking about credit in much the same way as their fathers and grandfathers did in the 1950s. Today's world, however, is very different and the old risk management/accounting thinking must give way to a new understanding if modern companies are to utilize their credit area to its fullest profit potential.

The 1950s were very much defined by World War II, which preceded the '50s. It was a time of pent-up and growing demand for goods and services. It was a time of Americans having money in the bank or in war bonds. It was a time of great social change worldwide and a time of limited competition.

In a seller's market, with people standing in line to buy things, credit was seen as a privilege, as a favor to some and not others. In such a business environment, the focus was rightly placed on avoiding the risk of customers failing to pay, of incurring bad debt losses. DSO, average turntime on the A/R and percent bad debt were appropriate performance measurements when the goal was risk management.

Credit in Today's World
The shortages of the '50s are long gone. In today's world of rapid change, mergers, huge international companies and increasing local small businesses, big box stores and cyber-competition, the old risk management paradigm is a handicap. Last year, my colleague Declan Flood, executive director of the Irish Institute for Credit Management, visited America for the first time. Prior to coming to America, I said to him that like Ireland, America is a land filled with mini-storage warehouses, basements, attics, garages and storage sheds crammed full of stuff...only more so. The shortages of the '50s are long gone, along with people having savings. Monkeys? We didn't evolve from monkeys, but from pack rats.

In 2007, things are very different from the way they were in the '50s. In order to compete, modern companies must have quality in their products and services and quality in the way they carry out business functions. A lack of quality in a business will lead to increased cost of doing business for everyone involved in a transaction and, in time, to the failure of a company to survive, much less turn a profit.

While the following explanation of the profit system of B2B credit addresses the purpose and the policies and lightly touches on people requirements and performance measurements of commercial or B2B credit, the same concepts apply to B2C or consumer credit. However, a major difference between extending credit to consumers and to businesses is that there are many more consumers than there are businesses. And while, almost across the board, consumer customer service levels continue to hit all-time lows, companies can and will stop buying from a supplier/vendor who abuses them and who drives up their cost of doing business, as will the next generation of managers. Long after the memory of failure fades, the bitter taste lingers on.

Purpose of Credit — The only reason for a business to incur the additional costs that go with extending credit to their customers is to get a profitable sale that would otherwise be lost. If business customers have the ability and willingness to pay up front, extending credit should not be considered. If they can cut a check with the order, grab it. Credit is a lubricant of commerce and allows for the expanded movement of products and services.

Policies of Credit — Every business function can be broken down into its major components. Understandable and thereby achievable goals can then be established for each of the major components. Policies are goal-driven guidelines.

The major components for the credit function are the following: credit approval, past-due A/R management (not collections) and internal communications.

If credit is extended to get profitable sales that otherwise would be lost, then it follows that the goal of credit approval should be to find a way to say “yes” to profitable sales while still confident of payment.

The vast majority of past due customers are not out to avoid payment. Past due A/R management is not collections or the enforcement of payment. It is the process of completing the sale.

The goal of past-due A/R management is to keep customers current...and buying. The most profitable sales are often repeat sales to the same customers. In the course of approving new credit customers and in resolving the many things that can and do go wrong in B2B commerce, the credit function interfaces with customers, vendors and many different internal departments.

This places the credit function in an ideal position to identify and communicate areas of opportunity for improvement, which leads to constant improvement of how things are done. This leads to controlling cost of doing business for everyone involved.

People Requirements and Performance Measurements
First and foremost, the people carrying out the credit function must be able to communicate. Before you ask for a résumé, ask for a ten-minute telephone interview.

Measure the performance of credit approval based on the percent of applied-for dollars successfully approved or even exceeded.

Measure the performance of past due A/R management based on percent current to 30 days past due. This is a general guideline and there are always possibilities for profitable exceptions. Measure the performance of internal communications based on the number of improvements identified.

Whatever we focus on and give energy to, grows. Business executives who continue to think of their credit function as a negative, as a cost center, as a necessary evil and as the ugly step-child of accounting, do so at their own risk.

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The PEI Journal • Fourth Quarter 2007 • Volume 1, No. 4 • Contents are Copyright © Data Key Communications, Inc.
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