If you’re like a lot of businesses, you have a prized customer or two.
Those customers that are highly coveted. The ones that you:
- Depend upon to fund your payroll when their revenue finds its way to your bank account.
- Have a special personal relationship with as the owner of your business.
- Customize your otherwise standard solutions at their every request in order to satisfy them.
- Devote more time and attention to than any other customer you have.
Sound familiar?
Believe it or not, that blue ribbon customer is holding you back!
LET’S TALK BUSINESS VALUE
The simplest definition of fair market value is the price at which your business would change hands between a hypothetical willing buyer and a hypothetical willing seller.
The value of a business isn’t solely based on revenue growth or income. Is strong financial performance important to how valuable your business is? Of course.
But did you know that the type and quality of the revenue your business is generating can carry just as much weight when it comes to the value your business will command when you go to sell?
It can even mean the difference between whether or not you have a transferable business!
If an interested buyer begins due diligence on your company and finds out that your prized customer makes up 50% or 60% of your total revenue, there is a pretty good chance their interest level is going to quickly wane. If they are willing to take on the risk and put forth an offer, you can almost guarantee it will come at a steep discount and with several contingencies.
If your customer concentration is perceived as too significant a risk to solicit any offers, it’s an indication that your business may not have a market value under present conditions. Assuming you hope to harvest any value from your company you must begin to de-risk and make some immediate changes.
WHY EVERYONE DOESN’T APPRECIATE YOUR #1 CUSTOMER
There are three primary reasons why a potential buyer doesn’t quite see things the way you do.
Reason #1. Often time these types of customer relationships are so closely entwined with your organization, that they have a unique and deeply personal relationship with the owner or founder.
While you may take great pride in having developed such a relationship, it can be a red flag to potential buyers.
Why?
If the relationship is owner-dependent, what’s to happen when that individual is no longer a part of the business and someone new is introduced into the equation?
There could be a personality conflict, or the new owner may be less willing to customize processes and solutions to please the customer. This new dynamic may cause the customer to reconsider the relationship.
Reason #2. As top-ranking customers become more valued and the owner more financially dependent upon their revenue, owners have a way of bending over backwards to retain them.
They start taking steps like customizing their service, their invoicing, etc. While it helps retain the customer in the short-term, it creates an operational and management nightmare in the long-term.
Your delivery and support model can become wildly inefficient, which can suck up loads of productivity from your team as well as your own personal time.
Buyers want a turn-key operation. What buyer is going to purchase a complicated and unscalable operation?
Reason #3. External factors becoming an immediate risk for your company.
If your top customer makes up 50% of your revenue and continues to grow, it puts a significant amount of risk on the future viability of the business.
While we like to think we can control everything, things outside of our control inevitably happen.
A single external force: a major economic downturn, a new entrant or disruption in their industry or any number of other factors outside of your control may put your customer out of business.
If and when that happens, it won’t matter how much they love you and your company. Overnight, your revenue and profit could plummet. That’s enough to strike fear in anyone looking at buying a company.
At best, these risks will make a buyer second-guess their interest in extending an offer to buy your company. At worst, it could mean a deeply discounted offer or even no offer at all!
SO NOW WHAT?
I’m not suggesting you fire your top customer. That certainly wouldn’t help your business value.
Instead, it’s time to think diversification. No single customer should make up more than 15 to 20% of your total annual revenue. If you can diversify below that, even better!
How?
The first action you can take to mitigate the risk of high customer concentration is to ensure a contract is in place with all customers. The longer the term of the contract, the less risk there is of your customer leaving for a competitor. While not a perfect solution, it’s an action that can be taken in the short-term while you work on more significant changes.
Next, it’s time to put intentional effort into reducing your customer concentration through one or more of the following:
Divert a little attention away from your top customer and a little more towards the following:
- Ramp up your sales & marketing efforts to recruit new customers. The more new customers you bring on, the less dependent you’ll become on any one customer.
- Grow & cross-sell to your existing customers. The larger your other existing customers become, the less concentrated #1 will become.
- “No” is sometimes your best friend. Believe it or not, saying no to your customers can be a good thing. This will help minimize customizations and keep an efficient and scalable operation in place. If your relationship with your top customer is as good as you think it is, they’ll understand an occasional rejection.
Proactively focus on reducing your customer concentration and you’ll have a business that poses less risk, carries more value and be better prepared when it’s time to sell or transfer.