Reduce Customer Concentration to Improve the Appeal of Your Business

Our blog last month focused on the importance of leadership succession when positioning your business for continued success after a sale. We hope you have given this matter some thought over the past month, and we invite you to contact us at any time with questions about valuing your business accurately.

As a follow up to last month’s topic, we will focus here on another key element of preparation – reducing customer concentration. By doing so, you will be proving to your interested buyers that your business will continue to function successfully because of its broad customer base.

The Concern of Customer Concentration

Your business is considered to have a high customer concentration when:

  • One customer accounts for more than 10-20 percent of total revenue, or
  • Your five largest customers account for more than 25 percent of total revenue.

When one of these situations occurs and a business is overly-reliant on one client or a small group of clients, its revenue and profits will be highly sensitive.

As an example, let’s imagine a van rental agency that supports a local cleaning service. Van rentals to the cleaning service make up 18 percent of the rental agency’s revenues. What happens if the cleaning service loses its contract with the local hospital and suddenly closes the local branch? The van rental agency takes a tremendous revenue hit, and the lost revenues were completely out of its control.

As we can see, a concentrated customer base increases the risk to owners as well as everyone who relies on that business for revenue: from employees to suppliers. Accordingly, potential purchasers seek to shield themselves from future risk by carefully observing the customer base and possible future cash flow when assessing the value of the business. This assessment will be ultimately reflected in the price they are willing to offer.

This customer concentration is also a risk to the bankers who provide funding to the business. The loss of one to three customers who comprise 10-20 percent of your business negatively impacts your business’s ability to borrow. This, in turn, affects the purchaser’s ability to borrow when anticipating a transaction.

Because a concentrated customer base brings these concerns and possibly a lower offering price, it is important to reduce the risk to future revenues and profits.

Steps to Reduce Customer Concentration

If you find yourself in a situation of customer concentration, or if you are close to this scenario, you will want to mitigate the exposure your business has to the associated risks. A great first step is to understand your customers’ businesses and industries so that you can learn what factors might affect their ability to pay for your product or services and prepare yourself accordingly.

There are several other ways to reduce customer concentration, and we can work with you to identify which of these may be the best solution to your unique position.

  • Increase sales to other existing customers.
  • Expand and diversify your customer base. The more customers you have, the lower the occurrence of customer concentration.
  • Consider new lines of business or enter new markets. Perhaps you can transition your business into untapped customer sources just by thinking differently or with minor adjustments to your business plan.
  • Look at potential acquisitions that will broaden your customer base.
  • Ensure your customer relationships are not tied to just one contact or buyer within your customer’s organization. You want to have multiple advocates working with you on the other side of the table.
  • Attempt to enter extended term service and/or supply agreements with your customers to minimize the risk of a sudden change.

Though not a comprehensive list, these points will provide a starting point for working through the matter of customer concentration. 

Advisors You Can Trust

When it comes to selling a business, you want to have a partner who has experience navigating all the nuanced avenues involved in the process. We at Piedmont M&A have years of practice in mergers and acquisitions, and we eagerly look forward to working with you and your priorities as you consider exiting your business.