Do you have a large number of customers in one industry? Are over 30% of your revenues with one customer? These are just some of the situations that lenders call a “customer concentration” problem.
Why is Customer Concentration a Problem?
If all your investments are in early-stage technology firms, you might achieve terrific returns during many parts of the business cycle. But if there is political unrest, changes to trade or innovation that renders their advantages obsolete, you could lose everything. Or said another way, putting all your eggs in one basket is a riskier business strategy.
How can concentrations hurt you? Here are just a few ways:
- What affects one of your “eggs” may affect them all.
- Lack of revenue diversification may lead to inconsistent cash flows even for profitable businesses.
- Seasonal or cyclical customer needs may force changes in your business approach and limit how you can operate your company.
- Lenders and other partners may be more cautious about working with your company. If their support of you requires any level of risk, they have to evaluate those concentrations as their own risk.
Planning for Diversification
If concentrations are a concern, you should start planning on diversifying your revenue base. But growing into new customer segments isn’t always easy.
In recent research of over 3,000 business leaders, 67% indicated hesitancy growing into new products, services or customer segments because of the short-term cash impact.
Ramping up in these areas might require capital investment in equipment, technology, people, marketing or facilities. This ramp-up period may take longer than growing revenues in industries or customers of concentration because companies may already have infrastructure in place to meet the unique needs of those areas. New customer segments may require new business processes, methods and time, in addition to the capital implications.
To start reducing concentration risk:
- Identify two to three customer growth segments.
- Align your people.
- Create your value proposition and marketing strategy.
- Build a conservative capital plan and budget that limits disruption to existing financial operations but allows for expansion as new customers come onboard.
- Establish clear and conservative growth goals and ROI requirements. You didn’t build your current success overnight, so you shouldn’t expect to succeed in new segments overnight. Patience, persistence and determination are key.
Once new customers start arriving, you’ll be on your way to growing your revenues while reducing concentration risk. But as more new customers find their way to you, pressures on capital reserves may increase as it takes time for those revenues to arrive. Use your equipment and growth funding relationships proactively to ensure you have a financing structure that allows you to achieve this diversification with minimal impact to your near-term cash position.