You may be focusing on the wrong indicators in your company. Your revenue may be growing, your profit margins good, and your net profit plentiful, yet you may be close to impending problems. Customer concentration is one of the biggest risks to your business so you must make it an important part of your key performance indicators. You can measure concentration both in terms of market and customer, and both areas need to be monitored for the reasons in this article.
Why Should You Care About Concentration?
Issues relating to concentration come in many forms. While I want to address both market and customer concentration separately, there are some broad implications you need to consider.
- Market Cycles – Every market has a cycle. If you are overly exposed to a cycle this will cause wild swings in your revenue stream.
- Pricing – In many industries, the larger the order size the more control the customers have over pricing.
- Customer Acquisition – The more happy customers you have, the easier it is to acquire new customers.
- Capital – It is easier to attract and lower your cost of capital when you have less concentration risk.
- Margins – There is a better chance of earning larger profit margins when you lower your concentration risk.
- Operations – Predictable revenue allows you to generate cash and makes it easier to plan and invest properly in your support structure. Thus you can serve your customers in the right way.
- Valuation – Buyers pay more for businesses that have lower concentration risk.
Customer Concentration Is A Sign Of Poor Health!
Customer concentration has caused many companies to stall and many to go out of business. In small businesses this can be a challenging issue because first customers make up sizable portions of total revenue, and many times there is no net profit in the business. It is important to work your way out of this situation as quickly as possible. A critical goal for every business is to have no customer make up more than 10% of revenue or profit. Eventually you want that number to drop to 2%. I cannot tell you how many of my clients with total revenue over $10 million violate the 10% rule when we first meet.
Violating the 10% rule is critical for several reasons, but really there is one issue. This one issue becomes fully apparent when a large customer goes away. Your business model becomes meaningless. In many cases, the operating structure you’ve built up can no longer be supported by the current client base. Firing people leaves the business lacking enough structure to support growth. The company struggles to grow, and net profit margin still appears unacceptable. However, what is now obvious is that your business was struggling to grow to begin with, and the business model was flawed.
If your business does not have a regular flow of new customers coming through the front door while it keeps customers from going out the back door, you have a business model problem.
Market Share Concentration Is An Important Leading Indicator!
Securing a threshold market share is important in order for your company to be recognized as a leader or key participant in any given market. However, having excessive market share can create risk to the company in the event that something happens to adversely affect that market. Being diversified and not overly dominant in a single market is important (with a few notable exceptions: e.g. Google dominates in some markets but is focused on being well-diversified).
As management, it is important for you to decide what is a realistic expectation in terms of how much market share you can reasonably garner for your company. Each incremental share can become expensive to acquire. Many times the only way to gain a larger share is acquisition after you have absorbed a certain amount. When that is done, organic growth becomes difficult without new products and services to bring to that market. Once you have fully served that market, it will become important to find new markets, or continued growth will become elusive or too expensive.
Call Howard Shore for a FREE consultation at (305) 722-7213 to see how an executive business coach can help you run a more effective business or become a more effective leader.