The Risks of a Narrow Customer Concentration
Starting a company takes a lot of hard work and dedication, and you’ve likely put a lot of time and money into getting where you are today. Landing your first big client is a sign it was all worth it — but do you know the risks of relying on one big customer? When you rely on a big client to fund a significant amount of your profits, your business is at risk for high customer concentration.
Find out more about the dangers of customer concentration and how your business can avoid them.
What Is Customer Concentration Risk?
Customer concentration risk refers to the risks associated with relying on a small number of large clients for a significant percentage of your company’s revenue. A high customer concentration can have multiple meanings, and it will likely vary for each business. Typically, most companies consider it high concentration when their largest customer accounts for about 10% or more of their revenue, or when a quarter or more of their revenue comes from their top few customers.
Customer concentration can also apply to industries or niches. For example, your largest customer may account for 10% of your revenue, but if 75% of your customers fall into a single niche, this creates risk as well. High concentration is generally considered bad because of how quickly you can lose revenue if your big customers leave your business.
What Are the Dangers of Relying on One or Two Large Clients?
So, why is it bad to only have one big client? If your business is just starting out, the prospect of a big paycheck can be tempting. However, depending on one or more large customers can be extremely risky for your business and your employees. There are a number of things that can go wrong and lead to your company having to shut down:
1. Your One Big Customer Stops Paying
A common risk of high customer concentration is if the big client you rely on for the majority of your revenue stops paying. Businesses lose customers all the time for any number of reasons — it’s common and companies are usually able to recover. However, if you lose the one big client you relied on, your business will lose all the revenue associated with that client. If your company loses a significant amount of money, it’s also likely you may lose the ability to keep your business running.
The same can happen if a company’s target niche is too small. For example, if your company specializes in a specific target market, the segment of customers you reach will be limited. This leads to reliance on your customers, and you’ll lose significant amounts of revenue if they suddenly decide to work with a different provider. The biggest danger here is that you won’t be able to pay your employees or maintain the business, resulting in liquidation.
2. Your Plan Can Quickly Become Their Plan
When a client has such a large influence on your revenue, it’s natural to want to do everything in your power to please them. However, this can quickly become a trap. It’s common for big clients to request changes to your product or ask you to customize something for them. While this is fine if that’s what your business does, you can quickly get trapped in a cycle of changing your plans on behalf of your client.
Once you make changes according to a client’s product plan, it’s hard to find your way back to what you originally envisioned. When this happens, creating the independent business you set out to build becomes much harder.
3. They Can Divert Your Resources
Another risk associated with your client taking over your product plan is how you manage your resources as a result of the changes. With larger clients, it’s common to feel like you should cater to their needs, causing you to divert your resources and employees from the main goal to service the goals of your client. If your company has adequate resources to do so, it may not be a problem.
Unfortunately, for companies with fewer resources, diverting your resources takes your attention away from smaller clients. As you focus more on the one big customer, you may lose smaller clients. If you end up losing the big client, you risk being left without any clients.
4. They Hold Negotiating Leverage
Large clients have a certain amount of power over your company due to the amount of money they can either give or take from you. When you give clients this kind of power, they tend to take advantage of it. They may try to pressure your business into lowering prices for them or making other exceptions on their behalf that will ultimately result in a loss of money for your company.
5. Customer Concentration Affects the Value of Your Business
A risk that is often overlooked is how a high customer concentration can affect the value of your business. Potential buyers and investors will view high customer concentration negatively, and a buyer will likely have concerns. They’ll know the risks of high concentration, which will affect how much they’re willing to spend on your business. With a more evenly dispersed customer base, your risks will be lower and your business may be worth more to investors and buyers.
How to Avoid Higher Customer Concentration
Being aware of the risks of high customer concentration is the first step to avoiding it in your company. The best way to avoid customer concentration risks is to vary the size and number of your clients. Having multiple smaller, more diverse customer segments is more beneficial than only having one or two large ones. A few ways to achieve this include:
- Extending yourself out of a highly specialized market.
- Finding new places where your product will be unexpectedly valuable.
- Reducing your reliance on a single customer.
- Targeting different geographic locations, industries and demographics.
Keep in mind it’s best to have a diverse customer base so if you lose a client, the blow to your revenue is lessened because your profits are more evenly spread out among your clients. Big clients are exciting and important for growing businesses, meaning it’s beneficial to strengthen your relationships with large clients so you’re more irreplaceable.
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