Nuances of Customer Concentration
We’ve previously shared what kinds of data you should be tracking if you are looking to sell your business. One of the key data points that buyers will want to understand is your customer concentration, which illustrates your company’s reliance on any single or few customers. Typically, a “high” customer concentration would reflect any one customer accounting for somewhere between 25% to 30% of your total revenue. But why is this important to buyers, and is it always so straightforward?
For our firm, customer concentration is a particularly important metric, as we strive to invest in companies that, in most cases, have existed for decades and will continue to thrive for many years to come. We make a promise to the founders with whom we partner, to protect the legacy they’ve built and to commit to growth. For a company with only a few large customers, our commitment to protecting the founder’s legacy becomes more challenging as losing one of these customers at any point would risk the very foundation of the company we aim to protect. Given the risk of losing significant revenue if just one customer is lost or decreases their spend, this emphasis on customer concentration typically extends to most capital providers, including banks, other lenders, or other financial buyers.
A high customer concentration can also make growth-oriented buyers wary of acquiring the company in the first place. In order to diversify the revenue base, a buyer would want to invest capital in growth initiatives to win new customers. At the same time, the buyer may be cautious about making capital investments in growth because if the growth doesn’t materialize or they lose their top customer before it does, the company will be in an even more precarious position given the capital burden. This circular reasoning may limit the type of buyer interested in the company.
While this risk-averse perspective is common for many buyers, it isn’t always as straightforward as automatically dismissing a company with a 25% or higher customer concentration. We’ve found that there are often nuances when diving into this number, some of which can provide comfort to buyers.
Say your company has a customer concentration of 40%, but you’re the only company that can provide that service or product. Or, your top customer has a 10 -year contract tying them to you. Perhaps the customer has been with you for over 30 years, which can provide more comfort to a buyer than a new customer or a customer that has only been in business for a few years themselves. Are you the sole-source supplier for that service or product, or does the customer have multiple suppliers they can easily switch orders to? In the former case buyers may be able to tolerate a higher concentration.
Another area that is more nuanced is how concentrated the decision-making is within that customer relationship. Say your company earns 70% of its revenue from a national grocery chain. But, within that grocery chain, there are seven different regional buyers that operate independently. Because the decision-making for your product or service isn’t concentrated to one person, there is less risk that all of that revenue will be pulled at once. Similarly, if one customer buys multiple product lines from you or engages your company for multiple different projects that all have their own demand trends, this diversity of products or services may help dilute the overall revenue concentration in a buyer’s mind.
These nuances and how much they dilute risk from a buyer’s perspective will vary according to the buyer. Regardless of some of these scenarios, there is still a higher level of risk associated. In the case of a long-standing relationship, what if that business sells to a new owner, or the decision-maker changes, and they decide to switch suppliers as a result? What if the company with separately-operating buyers goes under or has to slash spending across the board due to their own financial position? It’s not just micro factors in your control like quality of work, pricing, or competitive advantage that affect customer spend; macro factors like these also play a role and must be considered.
As we shared in our blog “How to Make Your Business More Attractive to Buyers,” working to decrease your customer concentration is one long-term step you can take to mitigate potential roadblocks with buyers, investors, or other capital providers. We know that’s not always possible, or perhaps you’re already in the process of starting a sale. In that case, it’s worth understanding how buyers may look at the nuances of customer concentration and how those may apply to your company.