Customer Concentration
August 01, 2022
by a searcher from University of Oxford in Adelaide SA, Australia
Any tips or advice for dealing with customer concentration?
When considering an opportunity with customer concentration, what are the best risk mitigation strategies for addressing customer concentration?
from University of Southern California in North Palm Beach, FL, USA
Do the math. A 10% reduction of the top line (revenue) usually ruins the bottom line (profit).
This is one of the first things business buyers, exit planning advisors and business brokers look for when they evaluate companies. Customer / revenue concentration is rarely a good way to run a business, especially if it exceeds 8%. Every customer whose revenue exceeds 8% is a risk to your business for if you lose one or more of these customers your company can instantly become insolvent. Expect to lose sleep if any customer’s revenue exceeds 10%.
But, like most things pertaining to business buying, there is more to the story. Jeffrey D. Jones, on the topic of business valuation writes: “As an appraiser, the red flag is if any given customer represents 15% of total sales. Even then, it depends. How long have they had the customer? What is the relationship with this customer? Is the company one company or a division of a larger company that also does business with your company? Just a blanket statement not to buy if one customer represents 10% of total sales is too broad. I have actually sold businesses wherein one customer was 70% or more of the business. It does not mean the business is unsalable. It means the price will reflect this risk. Fair Market Value is a range concept. The higher the risk, the lower the price, but there will always be upper and lower limits.”
You can even find Concentration Ratios by industry sectors, from the Economic Censuses. It’s a ratio that indicates the size of firms in relation to their industry as a whole.
Don’t be too dependent.
It is risky to be too dependent on key employee(s).
Similar to customer / revenue concentration, key employee concentration poses business risks. Cross-training of employees is one way to keep the business running smoothly if a key employee quits. Another is to (reasonably) do what it takes so the key employee wants to perform at peak capacity. Establish a succession plan so someone else can step in for absent or departed employees.
It is risky to be too dependent on key supplier(s). Suppliers demanding better terms are not uncommon when a company changes hands. Supplier-competition is the antidote to unreasonable demands from vendors.
from University of Missouri in St. Louis, MO, USA
be mooted either by debt reduction or customer diversification. Essentially it gives you enough time to adjust while the seller takes some risk back on the interim years. You could entice them to do this with an above market interest rate. That way if they are hesitant you have some ability to ask why they are worried. If they feel like the concentration would leave in the first 36 months that is an issue. Also, know they don’t have to leave/get sold/file BK to be an issue. If the concentration customer has an issue in their business (ex. A fire at a plant they own) that could mean their insurance takes care of them but you get put off for a while while they rebuild. At a minimum a bank should look at the DSCR if the concentration exists for some reason right away. That gives you some leverage to discuss with the seller.