How Behavioral Economics Can Revolutionize Debt Recovery

Traditional debt segmentation, based solely on criteria like the amount owed and the overdue period, has long been employed by companies to manage delinquency portfolios. However, this approach focuses more on the characteristics of the debt than on the specifics of the client, often resulting in less effective collection strategies. To improve outcomes, it is essential to adopt a client-centered perspective that considers their behaviors, attitudes, and financial situations. Moreover, leveraging behavioral elements like nudges can transform communication methods for different types of clients.

Limitations of Traditional Segmentation

Categorizing debts only by value and overdue period offers a limited perspective of the debtor's reality. This method ignores behavioral and contextual factors that influence the client’s ability and willingness to pay. For instance, two clients with identical debt amounts and overdue periods may have entirely different motivations and obstacles affecting their ability to settle.

Furthermore, this homogeneous segmentation often leads to standardized collection strategies that overlook individual nuances. This not only reduces the effectiveness of recovery efforts but may also damage the client relationship, jeopardizing future business interactions.

We are dealing with people, human beings—Homo economicus. Given this, does it make sense for strategies to focus solely on debt characteristics? Wouldn't it be more productive to consider the individual behind the debt?

The Importance of a Client-Centered Approach

An effective collection strategy must prioritize the client, understanding their needs, behaviors, and unique circumstances. By adopting a client-centered approach, companies can develop personalized solutions that enhance the likelihood of debt recovery while strengthening the consumer relationship.

For example, identifying that a client is facing temporary financial difficulties allows the company to offer installment plans or deadline extensions, demonstrating empathy and flexibility. This personalization not only facilitates debt settlement but also fosters client loyalty to the brand.

Evidence from Recent Studies

Throughout my career, I have always considered two key dimensions: willingness to pay, linked to character, and ability to pay, related to resource availability. However, the study Personalized Communication Strategies: Towards A New Debtor Typology Framework expanded this view by proposing a new framework for debtor typology based on four behavioral dimensions:

• Willingness to pay: Reflects the debtor's intention or willingness to settle their debts.
• Ability to pay: Indicates the financial resources available to make the payment.
• Financial organization: Assesses the debtor's level of control and planning over their personal finances.
• Rational behavior: Measures the debtor's logical and objective approach to financial management.

By combining these dimensions, researchers identified 16 distinct debtor typologies. Each represents a unique combination, enabling a deeper understanding of individual client behaviors and needs.

Distribution of Typologies

The study’s analysis revealed five predominant debtor typologies that account for 63% of cases:

1. DICE (Defiant, Insolvent, Chaotic, Emotional): Resistant to payment solutions, often in severe financial situations.
2. WAOE (Willing, Able, Organized, Emotional): Willing to pay, with greater financial capacity but sometimes erratic communication.
3. WACE (Willing, Able, Chaotic, Emotional): Motivated yet disorganized and inconsistent in honoring agreements.
4. WAOR (Willing, Able, Organized, Rational): Reliable payers who respond well to clear financial incentives.
5. DICR (Defiant, Insolvent, Chaotic, Rational): Resistant, with a history of accumulated debts, prioritizing rational decisions.

Implementing Client-Centered Strategies

To transform the collection approach, companies should:

1. Collect and Analyze Behavioral Data: Use analytical tools to understand client patterns and preferences.
2. Develop Client Profiles: Create segmentations based on behavioral dimensions, moving beyond debt value and overdue period.
3. Personalize Communication: Tailor the content, tone, and timing of messages, employing nudges to enhance relevance.
4. Offer Flexible Solutions: Propose alternatives that address each client’s specific needs.
5. Monitor and Adjust Strategies: Continuously evaluate outcomes and optimize approaches.

Conclusion

Traditional segmentation, by focusing on the debt rather than the client, limits the effectiveness of collection strategies. Incorporating a client-centered approach that considers behavioral and financial dimensions enables companies to develop more effective and empathetic strategies. This not only improves recovery rates but also strengthens long-term client relationships.

The future of collections lies in understanding people—their motivations and behaviors. As the study demonstrates, it is time to rethink traditional strategies and embrace an approach that combines data, empathy, and innovation.

Reference

DOEVENSPECK, M.; VAN DONGEN, E. Personalized Communication Strategies: Towards a New Debtor Typology Framework. arXiv, 2021. Available at: https://arxiv.org/pdf/2106.01952. Accessed on: December 5, 2024.