Magazine article Business Credit

Credit Department Structure and Policy-Making: Rethinking the Basics for a Competitive World

Magazine article Business Credit

Credit Department Structure and Policy-Making: Rethinking the Basics for a Competitive World

Article excerpt

Rethinking the Basics for a Competitive World

The biggest problem in managing credit, today or in the past, is a basic one: how to structure the credit department and formulate credit policy so that the department operates in the interests of the selling firm. Unfortunately, because of the inefficiencies it introduces, the traditional solution to this problem probably will not be adequate in today's increasingly competitive world.

There are difficulties that occur in structuring the credit department and making its policies. These difficulties revolve around a tradeoff common in structuring organizations: the benefits of specialization versus the dilemmas that specialization introduces. To understand the matter, consider a firm operated by an entrepreneur who makes all the business decisions, including credit decisions. The entrepreneur will consider all the benefits and all the costs of the credit decision: the profits from increased sales, bad debt and accounts receivable carrying costs. To the best of the entrepreneur's ability, the decision made will be the one that has the best benefits relative to its costs.

The great advantage when there is a single decision maker is that of integration: the decision maker can weigh all the advantages and disadvantages of the situation and come to a decision based on all the characteristics of the alternative courses of action. The particular effects of the decision on various parts of the organization play little role since the virtue of the decision is assessed relative to the entire organization. That is, the destructive effects of organizational politics are minimized.

However, there are also grave disadvantages to this situation. The entrepreneur cannot be expert in all aspects of the business and will make some poor decisions as a result. Further, as the firm grows, the entrepreneur will simply not have enough time to make all the necessary decisions; authority must be delegated. Consequently, in larger firms specialized experts are hired to make various types of decisions for the firm.

Once specialists are hired, the structuring problem occurs. The goal of "doing the best for the firm," which is addressed directly by the single decision maker, has to be subdivided. Different specialists are assigned to manage different aspects of the firm's decision making. If these specialists are evaluated based on the performance of the aspects of the business that they control, they will act in the interests of those aspects, to the detriment of the other parts of the business. This results in destructive conflict within the firm. Worse, the resolution of this conflict does not necessarily produce the best policies for the firm as a whole. Specialists who are the best negotiators or who have the most bargaining power within the organization will tend to get their way regardless of the effects on the organization as a whole.

If this line of reasoning sounds a bit esoteric, consider its application to credit management. For the entrepreneur who runs everything, credit decisions may not be easy to make, but how to make them is clear: decisions which increase profits, net of any credit costs, are of advantage to the firm. But once the firm grows large enough to require separate credit and sales specialists, profit maximization usually gets subdivided, with the sales staff responsible for maximizing sales and the credit department responsible for minimizing credit costs. The incentives facing sales personnel are almost entirely to make sales.

The incentives facing credit personnel are largely to restrict sales, particularly to risky customers, even if those sales would be profitable. Decisions about particular accounts will not necessarily depend on what is best for the firm. The integration of the costs and benefits of the decision that occurs when a single individual runs the show is lost. In its place is conflict and second-best decision making. …

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