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Risks Involved with High Customer Concentration

What is Customer Concentration Risk?

Customer concentration risk is the level of revenue risk your portfolio holds as a result of relying on a small pool of customers. The bigger the client, the greater the risk your revenue holds. Like the saying goes, don’t put all your eggs in one basket. By diversifying your portfolio, you decrease your revenue risk.

Did you know that:

  • Accounts Receivable makes up 40% of your business’ assets – and it’s most likely uninsured.
  • About 67% of businesses survive the first two years in business; 50% will survive five years; and only 33% will survive 10 years.
  • 82% of businesses that fail do so because of cash flow problems. 

 
You’ve fought hard to get to where you are today. It took guts, sacrifice, time, and boldness. You’ve defended your brand against competitors and complacency, pushing for growth at every milestone. But is there a risk you’re overlooking? Something that’s already within your gates that could potentially disrupt your entire organization? If you’re like any growing business, chances are that there is. And it might be this:

Your largest customer is responsible for 20% or more of your total revenue. 

What is Considered High Customer Concentration ?

High customer concentration occurs when any single customer accounts for 20% or more of your revenue. Like anything, there are benefits and risks associated with high customer concentration. 

Benefits
 

  • Develop long-term relationships w/ fewer large customers
  • Less contractual agreements and overhead per dollar
  • Greater focus on customer service & customer needs
  • Work with large customers similarly to partners

Risks
 

  • Loss can devastate revenue, profit & cash flow
  • Holds pricing & negotiating leverage, which can decrease revenue
  • Diverts disproportionate amount of resources away from smaller customers
  • Causes difficulty diversifying over time
  • Can decrease the value of your company

It’s OK to have all your eggs in one basket as long as you control what happens to that basket.”

     –Elon Musk

How to Calculate Customer Concentration

How do you know if your customer concentration is too high? Here’s the formula:

  1. Identify your top customer and the amount of revenue you earned from that customer in the past year.
  2. Divide that amount by your total revenue for the year.
  3. Multiply that number by 100.

For example, if your business earned $2 million in gross revenue last year and your top customer was responsible for $250,000, that customer accounts for 25% of your revenue. Here’s the calculation:

250,000 ÷1,000,000 = .25 x 100 = 25%

What if no single customer accounts for 20% of your revenue? That’s good, but you still may be at risk. Do that same exercise and total the revenue for your top 20% of your customers. If that total is 20% or higher, that could also indicate a high customer concentration.

Guarding Against Revenue Risk

If you find yourself concerned that the majority of your accounts receivable comes from a small number of large customers, then it’s time to ask yourself the big question: what would happen if you lost your biggest client or if your industry got hit with an economic downturn? Understanding your current vulnerabilities will help you manage and mitigate the revenue risks you may face down the line. Do you know how to diversify your customer base and alleviate some of the concerns?

Six Tactics for Concentration Risk Mitigation:
 

  1. Try to reduce your reliance on any one customer so that your largest customer accounts for less than 15% of your revenue.
  2. Specialize your services so you’re selling one or two products to as many customers as possible. Push your account-based sales leads to max out account-based selling over the next year to spread the risk more thinly across your entire customer base.
  3. Sign long-term contracts with your major customers, making it more difficult for them to switch vendors suddenly. Find the right method to do this or pair it with a value add.
  4. Continually build trust with your existing customers and take their changing needs into consideration when developing new services and products.
  5. Allocate more resources to expand your customer base and consider targeting different industries and geographic locations, if possible. Is it time to look sideways?
  6. Invest in trade credit insurance (TCI), which insures your receivables and helps you grow your sales strategy by mitigating the risks presented by a smaller customer base.

Consider Trade Credit Insurance to Alleviate Concentration Risk

How would your company’s growth strategy be different if you knew you’d get paid for every service and/or product you provide? What would you do differently? How would you grow? Allianz Trade helps alleviate these unknowns by providing trade credit insurance plans that heighten your probability of success. If your receivables are insured, then you can safely sell more to your existing customers while also expanding out to reach new customers you may have previously perceived as too risky. If you have a few large customers that provide the foundation of your cash flow then you better be sure that if they go under, you don’t go with them. Trade Credit Insurance is that assurance.

Remember:

  • Some of the biggest brands in the world have gone bankrupt. Most of these usually come as a surprise. Don’t be surprised.
  • Entire industries and sectors can tank overnight. If you’re on that boat, have a lifeboat.
  • Insuring your accounts receivable for your largest customers could be the competitive advantage that allows you to crush your competitors when a dry spell hits. Be ready to win.
  • Don’t risk your business for the sake of comfort. Be bold with your diversification. Be bold with Allianz Trade.

Contact Allianz Trade for more information on how to insure accounts receivables.

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