Are you worried about your company’s concentration risk?
You should be. Concentration risk is a serious issue for any business, and it can come from anywhere. It could be the result of an acquisition or merger, or it might just happen naturally as your customers grow in size and volume. Whatever the cause, if you don’t take steps to mitigate this risk now, it will only get worse over time.
Don’t let concentration risk ruin your company! Take these steps to avoid concentration risk today.
A high concentration of sales, such as in the case with highly-specialized businesses or those that depend on a single customer for over 10% of all revenue and net operating income (NOI), can lead to an increased likelihood of catastrophic losses.
High concentrations are considered risky because they put your company at risk if one client decided to cancel their contract: catastrophes like these could leave you without enough business streams left open which would make it difficult for your company’s survivability.
- The best way to protect your business is by diversifying the customer base and ensuring that no one client accounts for more than 10% of total revenue. Losing any customers when you have a high concentration will cause devastating effects on profit, cash flow, and even value in some cases.
- When too many customers comprise a large share of your business, they can exert downward pricing pressure and wield negotiating leverage not possible for smaller customers.
This results in decreased profits and cash flow–or worse yet, an increase in expenses!
When you have more than one customer making up the majority of your revenue stream (say 75%), it’s difficult to avoid giving them concessions that other businesses might turn down because these larger clients give you opportunities for increased volume at lower prices. However this comes with risks: if any single client decides to take their business elsewhere or are unsatisfied by what is being offered by another company who has entered into negotiations with them first, then all bets are off on future income from those sources as well as gains made through past
- Over-dependence on too few customers can lower the value of your company. Who would want to buy your company if you only had five customers? The answer is no one, so it’s important that the solvency of a company does not rely on too few people.
Important note: Other types of concentration risk include when a company may have no clients representing more than ten percent of revenue but still sell to a group of customers in one industry. This could be an issue because the risk is not just for concentration, it’s also about being dependent on any single customer or sector with their own risks that are linked to other factors such as international trade and labor forces.
The concentration risk factor is the most predictive of financial failure. If you identify with one or more, start to take action now so that your business is not at high risk for a disaster in the future.
6 steps to avoid or mitigate concentration risk in your business:
1. It’s crucial to get an agreement in place that will help reduce the risk of a customer switching suppliers without warning. It can be tough knowing if you’re going to stick with your supplier, and it could end up hurting both parties financially. Long term agreements ensure stability for all involved so there are no surprises down the line when one party decides they’ve had enough or wants something different
2. Your company needs to allocate resources in order to grow its customer base. This will require a mix of different industries and customers so that all demographics can be properly catered for.
3. Let’s add new or different products that can attract a different customer base as well, and gain a greater share of wallet with existing customers.
4. Watch customer’s habits around payments. Are they on time or late? Are they getting later? Any changes in the economy could affect delayed or no payment which would put a major crunch on your cash flow.
5. Set fair and reasonable terms for your customers that also favor the business. Offer incentives that reward them when they pay on time so you can reduce the risk of late payments, keeping both parties happy!
6. Thinking of selling? Be sure to position the business to be acquired by one of your largest customers.
Want more strategies on how to protect and grow your business profit? Apply for a strategy session: businessprofitaccelerator.com
To Your Success,