20 Destroyers of Business Value: # 3 A Highly Concentrated Customer Base

Posted on July 27, 2012 · Posted in Blog

Customer concentration risk is a very common issue for even the most successful companies.   It is not uncommon for a privately held company to have high levels of revenue from only a few customers. Many times a handful of customers account for over 50% of all revenues and often this number exceeds 70% – 80%.

Over time, many business owners get accustomed to customer concentration and don’t perceive this as a risk.   As long-term, stable relationships develop, both the company and the customer can become dependent upon each other.

This creates a dangerous trap and vicious cycle.  As the relationship develops – and in most cases so do profitability and revenue – more company resources are used and added to serve the customer.   As revenue and profits grow, it becomes easy to add resources to serve these critical customers.

More often than not, this is done at the sacrifice of the only strategy that will help solve the problem – finding new customers!

The situation is akin to a frog boiling to death in water.  While a business owner may not perceive this risk, it will not go unnoticed by any potential investor or buyer of the business.   Overtime, management may become comfortable with the customer concentration, but the real risk of customer concentration can be hard to mitigate.

Even the best customer will be exposed to economic downturns, changes in management, new technology, changing market conditions, an acquisition or any number of factors that could force them to change suppliers or reduce order volumes.

So what can be done to help mitigate the risk of customer concentration?

  1. Continue to put resources into developing new customers and market share.
  2. Build a “Rainy Day” savings account in case the day comes when you receive the phone call or email that your top customer is changing suppliers.
  3. Have your customers enter into Long Term Supply Contracts or Preferred Vendor Agreements like we discussed in our last post.  This makes switching more difficult.
  4. Ensure that all employees who serve the account are under non-compete agreements.
  5. Have a back-up plan:  What will you do if you lose a key account?  What expenses will be eliminated?  What steps will you take?

Ultimately, realize that all valuation models discount for the risk of customer concentration.  If you can’t diversify this risk, then don’t expect to receive a high valuation.   What are you doing to lower the risk of customer concentration?

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