Customer Concentration: The Quiet Price Killer

Buyers call it customer concentration when a small group of customers accounts for a large share of revenue. The pattern matters because the price a buyer will pay falls as one customer's share climbs. One lost account can cut sales fast.

Most owners do not notice it building because the big account is usually the easiest one to serve. It pays on time. The work shows up on a steady schedule. The problem shows up later when a buyer looks at where the money comes from and decides the business is riskier than the profit suggests.

What happens if one customer gets too big?

If one customer makes up a large share of sales, the buyer knows his return depends on keeping that one relationship. He has no control over it. The people who decide whether the work continues sit inside another company and they can change vendors for reasons that have nothing to do with you.

That concern turns into money terms pretty quickly. Most buyers either lower the price or hold part of it back until the big customer renews or stays through a transition period. Some pass altogether and look for a business where the revenue is spread out.

What is the first check a buyer runs?

The first calculation is simple. A buyer takes your largest customer and works out what percentage of total revenue that customer represents. He does the same thing with the five largest customers combined.

You can run the same numbers from your own books. Pull revenue by customer for the past twelve months and divide the largest total by overall revenue. Add the five largest together and divide again to get the second figure.

Take a business with $1,600,000 in annual revenue. One customer accounts for $480,000 of that total and that customer is 30 percent of sales. Any buyer doing diligence will spot that in the first pass through the financials.

When do buyers start to push back?

There is no published cutoff that applies to every deal. Buyers judge it by feel and by experience, and the questions get harder as the share climbs.

• At a small share, buyers note it and move on.
• As the share climbs, buyers start asking how long the contract runs and who actually manages the account day to day.
• At a high share, buyers price the risk into the offer, and they may want part of the price tied to that customer staying after the sale.

A signed contract helps at any level because it gives the buyer time. It helps more when someone other than the owner holds the relationship and talks to the customer every week.

Two firms with the same profit, two different risks

How can you bring your customer concentration down?

There is no quick fix for this. The work is ordinary sales work and it takes time to change the mix.

• Go after midsize accounts that are large enough to move the percentage but not large enough to create the same problem.
• Ask the big customer for a written agreement with a real term and clear renewal language if you do not already have one.
• Keep the big account steady and put your growth effort into the rest of the book so the percentage falls on its own.

Owners who start this work two years before they want to sell usually get a better result than owners who start two months before. The customer list needs time to change and buyers can tell the difference between a recent scramble and a book that has been balanced for a while.

When does it still make sense to sell?

A high percentage does not make a business unsellable. For some owners waiting two or three years to bring the number down is worse than accepting a lower price now.

• The big customer is under contract and the agreement still has meaningful time left on it, which gives the buyer time on the account.
• Other people in the company manage the account and the customer is used to dealing with them.
• You have seen the math at the discounted level and the timing still works for you.

That last point decides a lot of deals. An owner who goes in knowing the discount is coming can judge an offer on its merits. An owner who first hears about it during diligence usually has a harder time trusting anything else the buyer says after that. That is why we walk through the mix early when owners talk with us about selling your business.

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