Media & Tech Tuesday - Client concentration - too much of a good thing?

At what point does your largest client become too large? Your largest client might be your best – the closest relationship, the most loyal. Or it might be your worst – the one which squeezed you most on margins to win such an important sale, contract or project.

Regardless, the implied validation such a large client provides can be very important, confirming to a potential purchaser or investor that what you provide is strategic and highly valuable. And the stability they provide can help ensure you have a real platform for growth.

However, as the proportion of your revenues they contribute increases, this ceases to be a confirmation and start to be a concentration – or worse, a dependency.

Concentration & Dependency

Concentration simply refers to the proportion of your revenues accounted for by your largest client/customer, or the top five, ten, or 20.

Dependency emerges when a single client/customer (or perhaps two or three) accounts for so much of your revenues that, if they were to leave, the business couldn’t survive, at least in its current form.

Risk

Too great a degree of concentration becomes a risk for an acquirer/investor, because the business is potentially exposed to the loss of one or more of these key relationships.

Given the uncertainties associated with any change of ownership, potential acquirers and investors will be very nervous if they perceive that the level of concentration is too high – and this will only be exacerbated if your contracts have change of control provisions.

A typical purchaser/investor response will be to reduce the overall valuation to compensate for this perceived risk. Alternatively they might make some part of the value, or the whole deal, contingent on written commitments from key clients/customers that they’ll continue to work with you.

This is clearly pretty problematic – you don’t want to go cap in hand to your clients/customers asking their permission to do a deal, and to do so can potentially expose you to tricky renegotiations or demands.

Direct vs. Indirect Clients & Customers

In the agency world, or for a tech company distributing through resellers or distributors, the problem can be extended – the issue may not be only the loss of your largest client, but the loss of your entire channel.

If a significant proportion of your work comes through third parties and you’re not contracting directly with the client, you need to be able to demonstrate the stability of these intermediate relationships as well as the ultimate client relationships, and this can be a lot harder.

Many of your potential acquirers are likely to compete with your distributor/reseller/primary agency, and they will expect the majority of this indirect revenue to fall away entirely – and quickly.

This means they’ll only value the business based on your direct revenue – because that’s all that will be left – and this can create a gap that’s impossible to bridge.

This creates a real trade-off because a channel or indirect relationships such as these can dramatically accelerate your growth and expose you to a wider customer/client base much more quickly than you could on your own.

How much is too much?

So how much concentration is too much? As with all such questions, the answer is ‘it depends’ but a rule of thumb might be 25%-30%. At this level or higher the loss of such a customer/client is likely to blow a big hole in your profitability; below this level, it’s a risk which can be addressed or mitigated.

But it creates a real problem – if your largest customer/client wants to do more with you, it can be pretty difficult to turn them down! So how do you stop it scuppering a process?

Addressing concentration

  • Be up-front about the issue with potential acquirers/investors. Highlight the degree of concentration early on, and explain how it’s testimony to the strength of the relationship and not a risk or weakness.
  • Avoid change of control provisions in your contracts wherever possible.
  • Don’t launch a process if a key renewal/tender/pitch is on the horizon; wait until you’ve won it.
  • Demonstrate up-front the strength of the relationship – make sure you can demonstrate the renewals, extensions, or other investments or commitments your customers/clients have made around your service/product, etc.
  • Commission a third-party customer/client satisfaction survey to provide genuine, independent confirmation of the strength of the relationship(s). This clearly imposes an up-front cost but it can be an investment well-made if it reassures acquirers/investors about a risk they would otherwise consider fundamental.

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