This week, we decided to focus on customer concentration. This has nothing to do with whether your customers are paying attention and everything to do with how much they are paying. Customer concentration is about understanding where the key dependencies in your business lie. As with anything in life, a dependency is a risk.

What happened to the power of focus?

Achieving proper focus in a business is a powerful thing. It’s perfectly fine to focus on a specific service offering or geography, so don’t get confused here. Customer concentration is a further level of granularity, with analysis of the number of customers and their relative revenue contributions.

Being focused in a business is not the same as having a risky level of customer concentration. You can have a beautifully focused operation that is the industry leader in a specific space, yet have an equally beautiful spread of customers within that industry.

Microsoft may well be the perfect example. They are the leader in enterprise software, yet there is no dependency whatsoever on a single client or even a small group of clients. This is why Microsoft has been one of the most valuable companies in the world throughout the technology boom.

Why is customer concentration a risk for buyers of my business?

Think about your favourite sports team. Now, think about the key players in that team. What would happen to results if those players got injured, or left for another club? Even the best teams in the world have key dependencies.

Coaches strive for depth in a team, like Rassie Erasmus has achieved in the Springboks. In case you’re reading this in a non-rugby playing country, another good example would be the way in which Ryder Cup captains take advantage of the strength of golfers on each continent.

You get the idea.

To maximise the value of your business, you need to reduce risk. There are many ways to do this, with a reduction in customer concentration being one of the most powerful methods. When a buyer goes through a due diligence process with you and realises that all the profits are coming from one customer (i.e. if that revenue fell away entirely, you would be a break-even business), then the valuation is going to reflect that risk. Conversely, if you can demonstrate a spread of revenue sources, it will do wonders for the offer price.

Are there any other benefits?

Even if you have no plans to sell your business at this stage, reducing customer concentration is a highly advisable strategy to follow. A reduction of risk for a potential buyer one day is also a reduction of risk for you.

When that day does arrive for a sale, the valuation isn’t the only place where you’ll see a benefit. The other terms of a deal can make or break its attractiveness. If you have strong reliance on one customer, it’s very likely that the buyer will negotiate for a higher proportion of the purchase price to be spread out over several years and linked to performance, thereby mitigating the risk of that key customer being lost. Even though you would have sold the business, the unlock of value would be dependent on the same risk you faced while owning the business: that same customer sticking around.

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Thinking about selling your business, securing investment, or just curious about its worth? Join Graham Stephen from bizval for a free, comprehensive Business Valuation Masterclass. During this webinar, we’ll explore the critical factors that determine your company’s value, strategies to build for value from day one, and how to calculate your business's worth—especially if you’re running a high-growth company (HGC). Learn the key differences between HGCs and traditional SMBs and discover the drivers and detractors that impact your business’s overall value.

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Most small businesses never sell
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Gain insights on practical steps business owners can take to improve their chances of selling, and understand how advisors can assist in this complex process. Don’t miss this opportunity to learn from seasoned professionals, hear real-life stories, and ask your own questions during the live Q&A.

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