How to Manage The Customer Deduction Challenge

Managing Deductions Effectively
In many companies the credit and collections department is dealing with both collection and a high volume of customer deduction issues. To compete in today's business climate, companies are focused on collections performance, cost savings, efficiency and excellent customer service. To meet all of these objectives it is critical for credit managers to understand how to manage customer disputes. Customer disputes and deductions must be resolved quickly. Understanding root causes also provides the credit manager an opportunity to take the lead in addressing the driving issues.

In short every credit manager needs to understand what is driving deduction issues and have the right tools in place to manage deductions effectively.

Who is Really Driving Deductions?
History tells us that most customers generally pay as agreed. When there are deductions against payment, customers are right more often than they are wrong. The fact is, your company may be its own worst enemy by actually creating deduction problems.

Not all Deductions are Created Equal

Deductions Accurately Taken: In most cases customers will take deductions only when there is a legitimate problem with an invoice. If they do take a deduction in error they are generally willing to pay once the error is proven to them.

Common deductions include such things as pricing errors, quantity errors, delivery problems (too early, too late, to the wrong location, not signed for), concealed shortages, the wrong product shipped, returns for credit, rebates, advertising credits, etc. None of these is initiated by the credit collections department. However that is the area that identifies the issue and is responsible for collecting open balances. If your company is missing the target in any of these areas, it impacts AR turnover, overhead cost and customer service.

Erroneous Deductions: Some customers may take deductions because they simply lack the information needed to process payment. Others may use this as a tactic to slow payment or hope the issue will just end up as a write off by a weary or disorganized seller.

The unfortunate fact is that the time and cost to research and resolve a deduction can be significant. If it is ultimately determined that the deduction was taken in error, the effort, time and expense required to document your position can be significant. If the amount is found to be due and payable, additional effort will still be required to convince the customer to pay the disputed amount.

Always Consider the Business Context

There are several things you'll want to know before a decision to collect or write off a disputed balance is made.

• What is the dollar value of the disputed amount? Will it cost more to document and collect than the profit from the invoiced amount?
• Does the customer have a history of erroneous deductions? Cumulatively, small erroneous deductions, taken over time and then written off by your company, can have a significant negative impact on your bottom line.

If there is a pattern of erroneous deductions it may be worth spending the effort to dig deeper. You may avoid the much bigger and costly problem of voluminous write offs. It could be that the customer is managing their payment cycle through erroneous deductions or even worse, it could be a cover for cash flow or financial issues you should investigate. This could also be a window into your customer's process breakdowns.

If the customer's deductions are generally accurate when taken because of problems at your end, what are the driving issues? Where should you start? Ask these questions:

• Have you set up a matrix of who is responsible in your company to investigate and resolve each type of issue?
• Are you investigating and tracking process or system issues at your end that are causing the problems?
• Are there specific individuals in the responsible department causing the issue? Are they properly trained and competent?
• Is your sales department negotiating terms and pricing leading to administrative delays or errors?
• Are the processes accurate and timely in your shipping and receiving areas?
• Is your freight forwarder following instructions accurately?
• Are pricing changes, discounts, trade credits and rebates clearly understood and accurately managed?

What You Should Do

Determine if there is a return on your time and effort invested (ROI) to pursue a small dollar deduction. A better option may be to just write it off and avoid the overhead expense needed to prove your case and pursue collection.

Remember, not all customers are created equal. If a major customer is continually taking erroneous deductions it may be unrealistic to pursue disputed balances on a one off basis or to aggressively collect disputed balances. In these situations, you should involve the stakeholders in you company who maintain the business relationship with the customer. Engage the sales representative or project or product manager for example. They have a vested interest in a profitable sustaining relationship with the customer just as you do.

If the problem is ongoing and significant, it is a business issue between your company and the customer. Nothing works better than a customer visit with all the documentation needed to back collection or settlement of open issues. Erroneous deductions can impact the profit margin and must be dealt with.

Analyze and document. If you are seeing a trend of multiple erroneous deductions, the key is to prepare a coherent analysis and documentation for presentation to the customer. Make sure your documentation package is complete and easily understood:

• Clearly stated but detailed.
• All the necessary documentation is included and referenced. (Invoices, sales orders, customer purchase orders, shipping or delivery documents, pricing sheets, rebate program details, vendor agreements/contracts etc.)
• The priority is to make it easy for your customer to get approval through their system. If you remove delays and excuses at the outset, the process will move faster. Remember your customers are busy people too.

If the customer is making claims without supporting documentation, then ask them to provide what you need immediately. The longer it takes to start the investigation process the colder the trail gets and the less likely the issue can be resolved simply. Records get lost, people leave the company, purchase orders close, new budget years start, etc.

Focus on reducing the volume and impact of deductions:

• Categorize and track deductions by reason and assign who in the company is responsible to investigate and resolve each type.
• Track how long it takes from the point a deduction is received until it is resolved and the dollar value of deductions by reason. Status open deductions monthly and report results. Hold internal stakeholders responsible.
• Take advantage of the visibility the credit department has of root cause issues driving deductions. Initiate process and system improvements to eliminate the root causes at the source.

Build a minimum dollar threshold into your credit collections policy for collection versus write-off. If the amount is below the threshold it may be more cost effective to write it off. With that said, it is essential to track customer deduction practices and write-offs. Look for trends. You may find the customer understands how to manipulate your policy guidelines and is managing deduction practices to their best advantage. It may become obvious they are deliberately taking erroneous deductions as a payment delaying tactic.

In setting the collect versus write-off threshold consider both the financial consequences and the workload impact. What can your department handle effectively? Consider the size and workload of your collection/dispute management staff. What level of automation is available to handle disputes efficiently and to streamline workflows? How easy is it to access the needed documentation? What is your company's targeted profit margin? The tighter the margins the more critical efficient deduction management becomes.

If you identify broken processes from someplace within your customer's operations, use that knowledge to become a valuable consultant and source of information to the customer.

To charge back or not to charge back. Companies have different practices on how they book deductions. Some leave only undisputed amounts on their open aging and track the rest of the deducted amounts separately. Others immediately credit the disputed amount and charge the customer back, pending a decision to credit the chargeback or pursue collection. Regardless of how your company handles it, in every case, disputed balances should be treated as an open balance by the collector.

Ten Steps For Tackling Deductions

Look at it this way. The collector has two sets of balances to be paid/resolved. One is the open collectable accounts receivable. The focus is external. Contact and follow-up with the customer is needed there. The second is open disputes and deductions where the focus and follow-up is with a second set of contacts, internal stakeholders. These are the individuals who are responsible for the investigation and documentation needed to either issue a credit memo or restart the collection process.

In short, the collection and dispute resolution processes are essentially the same. Identify, follow-up with the right source, track open items and bring the issue to a close in a timely fashion.

Determine how the customer is treating others in the marketplace. Join an industry trade credit group. These groups provide a platform for credit managers to legally share their customer payment experience. You may find that every supplier is having the same issues with a customer. You may find you are having unique issues and need to look internally. Often times others have been down the road before with a given customer and can suggest the right customer contacts.

Have a good system to automate the deduction management process. There are a number of tools available in the marketplace. Commonly used ERP systems can be used or supplemented by third party solutions that add to or enhance ERP capabilities. Automate the workflow process. Initiate corrective action immediately as a dispute or deduction is identified. Track and report the status and results.

Pick your battles. A good rule of thumb is to always look at a deduction through the eyes of a Judge. Let's say you decide to pursue a deduction. Can you prove that the invoice was valid? Is there documentation confirming the customer ordered what your company invoiced? Can you prove your company delivered the right product, in good condition, to the right place at the right price and quantity? Can you prove the customer was wrong to take credit for a discount, rebate or incentive? If you can meet these guideposts and the amount is worth pursuing then go for it. If you can't, a more realistic approach may be to negotiate a settlement or write the balance off.

A lot depends on the size and nature of the business your company is doing with the customer. In some cases the best option may be to hold future orders and shipments as leverage for payment.

Take as an example, where the only outstanding balance is the disputed amount and it is a one time or infrequent customer. It may make business sense to stop shipping and refer the account for third party collection.

In some cases it may be a larger, ongoing customer with significant deducted or disputed amounts. If you have proven your case and the customer refuses to pay, the best option may be to escalate the issue. Involve whoever in your organization has responsibility for the customer relationship. Jointly decide how best to resolve what is due. At that point you can pursue collection by escalating the issue within the customer's organization. Leverage your company's internal relationships to get the customer's attention. The credit manager is often better off using a team approach.

Summary

Deduction management can be a challenge to any credit manager. It is essential to understand if your company is driving customers to deduct disputed amounts. It may be a process or system failure on your company's part. On the other hand, the customer may be attempting to manipulate their payment cycle using erroneous deductions as a delaying tactic or have process issues of their own.

It all starts with an analysis of the real drivers and issues. Once the root causes are identified and tracked, and the individuals responsible are identified the process can be managed. The ultimate objective is to leverage the credit manager's knowledge and relationships to reduce the impact and volume of customer deductions.