5 Ways to Cut Customer Risk
Remember winning that first big customer? Exhilarating, right? But if it’s not quickly followed up by several other big wins, or a slew of smaller ones, that one customer can become a liability.
Obviously, for small companies, a relationship with a big customer carries weight beyond the mere financials. A relationship with a well-branded and large customer can help persuade others to come on board. It also creates a very financeable receivable for your business.
But customer concentration – over-reliance on one or a few big customers—has serious drawbacks for small companies.
First, there’s the instability inherent in relying on one big fish. Say the big customer pulls an order: You miss your plan for the year, have to cut expenses and ultimately, lay people off or take less home. Big customers also have a way of using their size to justify slow payments, changes in delivery terms, or renegotiated prices.
But there’s also the effect that a big customer can have on an entrepreneur’s mindset. Some entrepreneurs build their company around keeping that one customer happy. Some focus on landing the next big customer, taking resources and customer service away from sourcing smaller pieces of more diversified revenue. And some start to chase revenue that creates financeable receivables, instead of chasing profitable customers. If that large customer suddenly turns away, it effectively destroys the business’ working capital.
Banks don’t like customer concentration either. Yes, banks look at profitability and cash flow—but often with an eye toward the source of that revenue stream. As an owner, you might feel slighted by your very success—hey, what’s so wrong about selling more to a large customer? But a bank may weigh the industry pressures on your underlying customers as much as the strengths of your own business.
Customer concentration is not an easy problem to solve. And some small companies are only set up to work with big clients, and they have to start somewhere. Still, here’s how you can cut some of the risk that comes with reliance on just a few big players:
- Understand your potential customer base and their industry, and figure out what factors would cause a customer not to pay. If you don’t know if your customers are close to bankruptcy or have other financial trouble, you’ve got a problem.
- Embed your company as something that is needed by your customers, not merely a “nice to have.” Building yourself into the supply chain creates stickiness and makes it harder for customers to ditch you.
- Look hard at your contracts and your length of engagement. Both of these can provide you with good opportunities to mitigate risk. If a customer has contracted with you over a longer time period or has kept buying from you even when the economy turned sideways, you’ve got a bit less -- just a bit – to worry about.
- Diversify within a customer as soon as possible. Don’t tie your relationship to any single contact or buyer. You need multiple champions inside your client company who can be counted on to advocate for you. You might consider selling multiple products and services to different parts of your behemoth customer rather than always selling into the same silo.
- Focus on profitability rather than revenue. Revenue can be all-consuming for a small company, with good reason. But measuring the profitability of a relationship—the real value created for your business— will serve you best in the long run. The risk you take on by catering to a huge primary customer should be rewarded by greater profitability from that account.
Based in New York, ED POWERS is a managing director and head of the Capital Access Funds team at Bank of America Merrill Lynch. Capital Access Funds is an experienced, returns-driven private equity fund-of-funds.
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