Strategies to De-risk, Eliminate, and Avoid Customer Concentration

Happy Sunday everyone!

Last week we had 2 fantastic in-person events in Austin that turned out to be a great success.

We had over 100 people show up to our SMB Mixer in the Hill Country overlooking the Austin Skyline while listening to the Eddie Robbins Band rock out with some grunge country Texas blues, all while eating some great tacos from Tacoman512!

We also hosted our first Manufacturing Meetup at Vista Brewing for close to 120 people, where we shared how small businesses can start to prepare for the future by understanding

• The right partners

• The right investments

• The right strategies

We covered robotics with ABB, digital transformation with WM Synergy, and lowering overhead through the global workforce with CaneKast’s Josh Schultz and Reg Zeller!

Thank you to everyone who came, and let me know if you’d like to be on the list for the next one!

Dangers of Customer Concentration

In the complex world of business, there's a lurking threat that often flies under the radar: customer concentration.

Regardless of whether you're a seasoned entrepreneur with years of experience under your belt or a fresh-faced startup founder, comprehending the perils of relying too heavily on a select few clients is absolutely essential.

We'll delve into why diversifying your customer base isn't just an option; it's a strategic imperative to safeguard your business's future.

The Reality of Customer Concentration

Let's paint a vivid picture of a common scenario in the small business landscape – one customer holding the reins to a substantial portion of your sales, sometimes as much as 50% to 80%.

Now, why is this a red alert situation? Imagine you're running a business with robust 50% gross margins and respectable 20% net margins.

If your top customer happens to account for a whopping 75% of your business, losing them would instantly send your net margins plummeting to an alarming -70%.

This precarious situation not only threatens your financial stability but also coerces you into making rushed and potentially detrimental decisions just to keep that client on board.

The Perils of Customer Concentration

Let's dissect the dangers of customer concentration:

1. Process Design: When a single large customer dominates your sales, it's not uncommon for your entire decision-making process to revolve around meeting their unique needs. This tunnel vision can divert your energy away from developing systems that could deliver higher value to a broader market, stunting your growth potential. You end up building systems and processes around their business operations and needs rather than for the company you’d like to build.

2. Energy Drain: Large clients often demand a significant chunk of your company's time, resources, and attention. They become the driving force behind your day-to-day operations, leaving limited room for innovation and growth in other areas of your business.

3. Direction Control: As your business becomes increasingly dependent on a major client, you inadvertently find yourself hitched to their corporate strategies and initiatives. This occurs through "flow down" requirements and directives, which means you're following their mission and direction rather than charting your own course.

4. Forced Investments: The relentless demands of your major clients can dictate where and how you invest your resources. This constraint can prevent you from pursuing your desired growth strategies or having the financial flexibility to meet your personal aspirations.

5. Problem Magnification: Large clients often grapple with substantial issues of their own, given their high stakes and complex operations. These problems can cascade down to your small business, turning their challenges into your own, adding further stress to your operations.

6. Vulnerability to Economic Fluctuations: Depending heavily on a handful of clients means that your financial fate becomes intricately tied to theirs. If they hit a rough patch, you're likely to suffer the consequences.

7. Limited Growth Potential: Over-reliance on a select few customers can severely restrict your growth opportunities. Expanding into new markets or launching innovative products becomes challenging when you're locked into serving just a small group.

8. Reduced Bargaining Power: Having only a few clients often puts them in the driver's seat during negotiations. You might find yourself agreeing to unfavorable contract terms or facing pricing pressures that erode your profitability.

9. Stagnation and Missed Opportunities: Industries evolve, and customer preferences change. Relying solely on your current clients could mean missing out on emerging trends or lucrative opportunities. Diversifying your customer base allows you to stay agile and adapt to shifting market dynamics.

10. Mental Toll: Dealing with all of the above can be mentally exhausting, leading to burnout and decreased enthusiasm for your business.

In a nutshell, customer concentration is a minefield of risks that you should strive to avoid at all costs.

Mitigating Customer Concentration

If you already have it:

1. Resource Plan (MVC): Begin by crafting a Resource Plan focused on creating a Minimum Viable Company. Determine the absolute essential resources required to keep your business afloat and be prepared to cut back to this level if the need arises. Consider all aspects, including real estate, personnel, software, equipment, partners, and inventory. Building this plan in advance ensures you won't be making crucial decisions under emotional stress.

2. Long-Term Contracts: Engage with your major clients to secure long-term contracts. These agreements typically span 3 to 5 years and can significantly reduce the risk of losing a major client. Such contracts should include stipulations related to volumes and exclusivity. To sweeten the deal, you can often guarantee pricing and lead times.

3. Raise Prices on Non-Concentration Business: One swift method to reduce customer concentration is to increase prices on your other products or services. While this strategy carries some risk, it can often be executed successfully through transparent communication with your customers, ensuring fairness. This strategy becomes especially viable if you haven't adjusted your prices in years.

4. Raise Prices on Concentrated Business: Another approach is to negotiate higher prices with your major client for the most challenging or lowest-margin products or services. This can lead to several favorable outcomes:

• They may choose to source those parts elsewhere, freeing up your capacity and reducing the strain on your company.

• They may agree to the higher prices, providing you with additional cash for the same work, enabling you to invest elsewhere.

• If asked about the price increase, they might reconsider their requirements for that product or service, potentially easing the burden on your company.

If you're about to get it:

1. Turn Business Down: As counterintuitive as it may seem, turning down business in the short term can save you from many of the issues associated with customer concentration. This approach preserves your freedom to continue building your company as you see fit, leading to more significant growth in the long run.

2. Discounts: Surprisingly, offering discounts can be a strategic move to mitigate customer concentration. If you possess pricing elasticity, you can lower prices for other customers where there is potential for more business. Crucially, communicate with each customer, explaining your strategy and asking for their commitment.

3. Sales Plan to Outgrow: Develop a comprehensive sales plan designed to help your business grow around your major client. Consider the following strategies:

- Target your major client's competitors as potential new customers.

- Explore different products or services that leverage your existing expertise, facilitating the acquisition of new business in adjacent markets.

- Capitalize on your existing distribution channels, whether they be retail connections, an online audience, or a mailing list, to identify new product opportunities. Alternatively, you can partner with another business possessing a complementary product and sell it through your distribution channels for a fee.

If you're looking at an acquisition that has it:

1. Customer Agreement on Sale: During the due diligence process, meet with the client and candidly discuss the risk that their concentration poses to the business. Offer a locked-in price in exchange for an agreement from the client to guarantee a minimum volume for 3 to 5 years. This immediate action reduces the concentration risk in the short term, affording you the time and flexibility to implement other strategies.

2. Add Risk Premium to Price: When evaluating the acquisition price, factor in the concentration risk. One approach is to assume that the large customer contributes only 15% of the value and not pay for revenue share exceeding that threshold. While this strategy may not work in highly competitive bids, it has proven effective in large industrial acquisitions.

In summation, customer concentration is a treacherous path that can lead to financial instability and missed growth opportunities. To fortify the future of your business, strategically diversify your customer base. While major clients are undoubtedly valuable, spreading the risk across a diverse clientele is a shrewd maneuver that empowers your business to thrive regardless of the economic climate.

Stay tuned for more insights, tips, and strategies on scaling and operating a successful business.

Until next time, embrace the power of diversification!

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