Everyone dreams of the big order, but that big order may come attached with parameters and constraints such as limited visibility, complex supply chain and delivery issues, and a big brother, whether your business is offering a product or service that may squeeze your margins and squeeze out a lot of time you could be searching for other clients. That coupled with sometimes challenging cash conversion implications, makes the concentrated customer something that needs to be handled carefully.
One of the many risks a business faces is customer concentration. In general, if a large customer represents more than 10% of revenues, the business is exposed to customer concentration risk. In order to assess whether or not your business is in a position where you have a customer concentration risk, it is first important to understand what concentration risk is. Essentially, customer concentration is a measure of how total revenue is distributed among your customer base. A company serving a large number of small-volume customers has a lower customer concentration than a firm where a handful of large customers account for the majority of its business.
Next, it is important to understand why concentration risk is an important metric to keep track of. We have detailed below some of the key considerations:
- Losing a customer can have a devastating effect on revenue, profit, and cash flow in situations where high customer concentration exists. While a large new customer may be very appealing at first, there are many uncontrollable factors which can lead to the loss of that client just as quickly as you brought them on. Losing any client is undesirable but losing a client which makes up a considerable portion of a business’s income has the potential to be devastating.
- Large customers often lead to a inordinate amount of attention to be directed towards that customer, ultimately effecting the amount of resources available to address other customers. This can lead to the loss of other customers and an even higher degree of concentration risk.
- Large customers often have the ability to exert pressure on pricing which can lead to significantly lower margins. While a large customer may be good from a top line revenue perspective, they may lead to very slim margins, which in turn may lead to cash flow issues in performing for the rest of your client base as many resources are tied up.
- Lastly, in the event that your business is looking for financing, an investment, or a sale of the business, customer concentration has a very negative connotation associated with it, and it can ultimately lower the perceived value of your business.
High customer concentration is a high-risk situation and should be avoided in most cases if possible. If high customer concentration applies to your company, action should be taken to diversify and spread the risk across more customers and possibly more business segments or industries. It is important to set a plan, as well as to consult with business development professionals who can assist you in navigating which clients will bring you the most value over time. TAP has decades of experience working with small business across many industries and has a proven track record of assisting companies with the diversification of their customer base both in the private as well as the public (government) landscapes. To learn more about how TAP can help you not only assess whether or not customer concentration is a risk your business is facing, but also assist you with your planning and execution of business development efforts, please reach out to us here.