To run a successful business, you must learn how to manage your client concentration — a measure of how total revenue is distributed among your customer base. So, if one out of ten clients brings in 80 percent of the total revenue, then you most definitely have a high client concentration.
You assume a major risk when you rely on only one customer for a large portion of your sales. If that client switches services, your business may take a sudden hit.Now, if each of those ten clients contributed 10 percent of the total revenue, then you would have a low client concentration.
The rule of thumb is that no one client should represent over 15 percent of a business’ annual sales. You can also apply this rule to vendors or staff. If you are dependent on one vendor or two employees, the business is valued at less because of the risk. So, how do you approach a potential M&A if your business has a good deal of client concentrations?
Evaluate the Degree of Client Concentration
You must evaluate the degree of concentration. Look at your client to sales ratio, and apply this analysis to your vendors and employees as well. Balance in all things, as they say.
Imagine that the deal closes. How does that impact these VIP accounts? Will they take their loyalty and money elsewhere? Will they demand price concessions? Imagine how disastrous that would be for the buyer. Always keep a pulse on these accounts, and develop strategies for new client outreach.
Strategizing Growth to Manage Client Concentration
You do not want to end up five days out from closing the deal only to lose it. Imagine putting in several months of work in due diligence only to lose the primary client that brings in the bulk of the revenue. Suddenly, your deal and the business tanks.
It’s important to measure and handle client concentration before the deal is done. Buyers look for stability in mergers and acquisitions. Your odds greatly improve at making a successful deal when you show a buyer that no one client brings in more than10 or 15 percent of the total revenue.
How can you protect the existing revenue a major client brings in while managing client concentration? Strategizing your growth matters to the company’s longevity.
Always exercise caution when taking on a new client who directly influences your company and its strategies because of the money they contribute. Landing a major account or client signals a time for celebration. It also means investment on your part through acquiring more inventory, furniture, office space and employees to handle that account.
If the client leaves, they may also leave you with excess overhead that the core business cannot support. Suddenly, those additional lines of credit and other resources are in jeopardy. You start to realize the value of multi-year contracts, and you wish you inserted a clause about a payout in the event of the client breaking the contract early. Client concentrations can easily kill value.
Investigate Relationships for Quality
Ask questions and investigate relationships to know more about the degree and depth of client concentration. Who are the influencers, key decision makers and points of contact? How are these relationships structured?
What are the criteria for selecting vendors? If one vendor “does it all,” do they do a satisfactory job, or would a vendor who specializes in a particular niche provide better results while diversifying your client concentration? Better service makes for satisfied and loyal customers.
How likely are clients to recommend the company and its services? Has the company kept track of its Net Promoter Score (NPS)? The NPS measures a client’s or customer’s experience and predicts the growth of the business. It matters greatly in business valuation and due diligence. A low NPS is often linked to a decline in performance and revenue while a high NPS benefits cross-selling opportunities.
Conduct a client experience survey to measure attributes on a scale of one to ten. Pay attention to the customers that give high scores and thoughtful feedback. These clients are promoters who are very loyal to the company. Those“passives” who score a little above six will typically consider other service providers, and those who fall below this are called detractors — they are likely to hinder business growth. Find the NPS by taking away the percentage of detractors from the promoters.
Take the recommendations and referrals of the client-promoters to heart.Book new clients with good, old-fashioned word of mouth and networking. The quality of these relationships matter to customer experience but also to the company’s growth and prolonged success.
Contact Sun Acquisitions for a consultation on mitigating client concentrations and preserving the quality relationships while making new ones that work for you — and your M&A.