Filed under: Private Business

November 15, 2016

By guest contributor Jon Deex, NextLevel

Over-dependence on one customer, or a small handful of customers, can leave a business vulnerable to sudden downturns, or spikes in revenue and volume, that are difficult to manage. Companies with concentration on a single customer, such as aerospace suppliers to Boeing or consultant/contractors to large software and web enterprises like Microsoft and Amazon, often experience considerable pricing pressure and consequential lower profit margins.

Employees in companies with high customer concentration are often reluctant to challenge the increasing demands of a large customer. As a result, small concessions can be made over time – such as free shipping or services that can erode the profit margins even further. When customers know they are holding your company’s oxygen bottle, they often ask for, and receive, significant price concessions.

Finally, the enterprise value of a firm significantly diminishes when it has too much customer concentration. This is because potential buyers rightfully perceive the business as a riskier choice than a company with good customer diversification.

So what do you do if you have a concentrated customer base and your company relies on one or two customers for a large percentage of your revenue? Here are 10 things you can do to get started on the path towards better customer diversification:

1. Make customer diversification part of your strategic plan.

Go through a strategic planning exercise to identify a handful of key initiatives that, if properly implemented, will diversify the company’s customer base. During this process, identify the products or services that your company will sell to new customers as standardized offerings and build a business plan around those services. This should include an operations plan, a sales/marketing program, and a budget to support the plan.

2. Evaluate, and possibly upgrade, your sales team.

A good sales team, with experienced producers and a qualified manager who knows your industry, is essential to gaining new customers. The sales team will need a specific plan to target new clients and may require training or skill development. You may also need to bring on new personnel to achieve your goals.

3. Look at your sales incentives.

If your current sales team is heavily incentivized based on sales from your existing customer base, you should re-design the sales commission plan. The new plan should encourage and reward team members who gain new business, and de-emphasize managing the existing businesses. This is particularly important for the person who heads up the sales team, as they can often assume the role of key account manager for the largest client. As a result, they can be reluctant to move from that position, unless their incentives encourage them to do so.

4. Invest in marketing.

Many companies with a concentrated customer base have devoted little effort or investment in marketing. A marketing agency or consultant may be helpful for providing specific guidance regarding cost-effective ways to target new clients. A marketing coordinator with good web skills is often a cost effective option, although a good agency can provide a marketing strategy and plan. The company’s website is critical in the marketing effort and should be reviewed and updated as a first step.

5. Develop a plan for new customer on-boarding.

If much of the company’s resources have been devoted to a few existing longtime clients, bringing on new customers may strain existing resources. It is important to have an operational plan that serves and creates a great experience for your new customer, while allowing current operations to continue running as planned.

6. Perform an analysis of your firm’s capacity.

Additional production or service capacity may be required. An analysis of current capabilities and the firm’s ability to increase capacity should be conducted. Can the company add a second shift to boost capacity?  Is a large capital investment required? Are more people needed? These are some of the important questions to have answers for as the sales and marketing effort to gain new business gets underway.

7. Consider an acquisition.

An acquisition can offer a fast path to customer diversification, particularly the acquisition of a direct competitor. Conducting a search for a suitable acquisition candidate, with customer diversification as a key criterion for evaluation, is a valid strategy. This is often a very good way to secure large enterprise customers with complex supplier specification processes, for which the acquired company has already met the requirements.

8. Conduct a pricing study.

Pricing is an area that sometimes does not receive enough attention. Companies with severe customer concentration are sometimes out of touch with market pricing for their products or services. Conduct a detailed pricing study to determine competitive pricing levels and decide if purchasing products or services in bundles makes sense in your market segment. You may be surprised that market prices may be higher than the prices currently offered to the major customer.

9. Measure your efforts and results.

The management team should be accountable for their efforts to diversify the company’s revenue. Tracking progress, celebrating wins, and analyzing losses, should be incorporated into the company’s management discussions and meetings.

10. Do not forget your existing customers!

Finally, executives should keep in mind that tending to the existing customer base still requires considerable attention. Diversification efforts should not be at the expense of current customers. It is critical for your company to continue paying attention to, and growing, the established customer base. This enables you to maintain revenue, profit, and cash flow during the diversification effort.

Customer concentration is a relatively easy trap to fall in to. In fact, some companies actually start out that way. Addressing the issue with a focused strategy while making appropriate investments in marketing programs, sales people, and production capacity, will allow your company to diversifying its customer base and reduce its concentration risk.

© 2016 Clark Nuber PS All Rights Reserved

This article contains general information only and should not be construed as accounting, business, financial, investment, legal, tax, or other professional advice or services. Before making any decision or taking any action, you should engage a qualified professional advisor.