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What are the Costs involved in providing Credit as a Marketing Tool?
Businesses provide credit to their customer for various reasons. In fact, credit can be used as a marketing tool by companies. In order to do so, a company must look at the maximization of profits via incremental sales. However, it is easier said than done.
This is so because, in order to use credit as a marketing tool, the companies have to bear the following three types of costs −
Production and Sales Costs
Production and selling costs increase with the incremental sales a firm tends to seek.
If sales increase within the already existing production capacity, then only variable production and selling costs will increase. On the other hand, if capacity is increased for production that arises due to loosening credit policy, both variable and fixed costs will increase.
It must be noted that if a company tightens its credit policy to reject some companies from getting the credit, the company losses some opportunities of profitability as some of the companies who have been rejected may have provided the credit money back to the company.
The opportunity of gaining back the lost opportunity starts to grow once the firm loosens its credit policy. Therefore, the firm may reclaim its lost sales and lost contribution if it loosens the credit policy.
Administrative Costs
The companies have to bear two types of administrative costs when it forms a credit policy. These are credit supervision and administration costs and collection cost.
A firm must have good management in order to manage credit supervision and administrative costs if it loosens the credit policy. This is so because the firm will have to offer credit to a large number of companies. So, keeping track of all these customers will increase the admin costs.
With a good administrative cost, the companies offering credit must also increase their efforts to collect the credit money from the financially less-sound customers. The increasing cost of admin will be zero if the current credit department can implement the new credit policy without having to add additional costs.
It is notable that companies must bear the admin and collection costs if they implement a credit policy of any kind. If the credit policy is loosened, the admin cost will increase as more customers’ records and management of accounts have to be done.
However, tightening the credit policy can diminish the admin costs along with the lost opportunities of losing opportunities of profitability.
Bad Debts
Bad debts are the funds that cannot be raised back from the customers who have been granted credit.
In practice, companies with a loose credit policy offer credit to many customers. Some of these customers may delay in paying back the credit amount while some others may not pay any amount. Therefore, the companies offering credit in a lenient fashion can incur losses in terms of bad debts. Companies may avoid bad debts by adopting a very stringent credit policy.
However, too much cut of bad debt losses is not the ultimate aim of the companies. If the ultimate aim of companies were to minimize the bad debts, they would adopt a very tough credit policy and won’t use the credit policy as a marketing tool. This will incur palpable opportunity cost in terms of lost contribution as the expansion of sales gets diminished.
Conclusion
Companies having a credit policy need to bear the three types of costs mentioned above. The costs may be variable depending on the types of credit policy but building a policy that offers the firm the most flexibility along with the minimized amount of losses should be the aim of the firm. There are surely some challenges but when utilized wisely, a good credit policy can offer huge benefits to a firm.
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