Your Best Customer May Be Your Biggest Risk

There’s a particular kind of problem in business that doesn’t look like a problem at first.

In fact, it usually looks like success.

You land a great customer. 

They buy a lot. They pay reasonably well. They like what you do, so they give you more work.

And pretty soon, everybody in the company knows how important that customer is.

You hire people to support them. You may buy equipment for them. You may even make exceptions for them. 

Maybe you even give them better pricing because, after all, look at the volume.

Then one day you look at the numbers and realize something uncomfortable.

They’re not just your best customer anymore.

You may have built part of your company around them.

And those are two very different things.

[INTRO MUSIC]

Welcome to Things Entrepreneurs Should Know — a podcast about the decisions, tradeoffs, and occasional hard lessons that come with building a business of lasting value.

I’m Chip Schweiger. And I’ve spent more than thirty years working with businesses and the people who run them.

One thing I’ve learned is that some of the biggest risks in business have a funny way of disguising themselves as good news.

Customer concentration is one of them.

So today on the show, I want to talk about why your best customer may also be your biggest risk.

Not because having a great customer is bad.

Because sometimes a great customer becomes something else without anybody noticing.

[MUSIC OUT]

Welcome back.

So Here’s how this usually happens.

You win an account that matters.

Maybe they're twice the size of your typical customer. Maybe five times the size.

At first, that's terrific.

Revenue goes up. Utilization improves. People are busy. 

Margins may improve because you've got more volume running through the business.

And naturally, you want to keep that customer happy.

So when they need something a little different, you accommodate them.

When they ask you to accelerate a deadline, you make it happen.

When they want special reporting, somebody builds it.

When they need more capacity, you hire another person.

None of those decisions necessarily looks unreasonable by itself.

That's important.

Businesses rarely become overly dependent on a customer because somebody makes one spectacularly bad decision.

It usually happens through a series of perfectly understandable decisions.

And then one morning, 10 percent of your revenue has become 20.

Twenty becomes 30.

Maybe it's 40 percent or more.

And by then, something has changed.

You don't just have a large customer.

You have a customer whose decisions can materially affect the future of your company.

That's customer concentration in the traditional sense.

But I think there's another kind of concentration that's every bit as important.

Decision concentration.

How many decisions are you making because of that customer?

That's the question I think business owners sometimes miss.

You may look at the income statement and say, "They're 25 percent of our revenue."

Okay.

But are they 40 percent of your accounts receivable?

Did you hire six people primarily because of their account?

Did you buy equipment because they promised more volume?

Are they consuming half of your management team's attention?

Have you passed on other customers because you didn't have the capacity?

And here's an especially interesting one:

Would you make the same decisions you're making today if that customer represented only 5 percent of your business?

If the answer is no, they've probably acquired more influence over your company than their revenue percentage suggests.

And that influence tends to show up in some strange places.

Pricing is one.

Large customers know they're large customers.

And sooner or later, many of them will want to be compensated for it.

A discount.

Longer payment terms.

A rebate.

Free freight.

Special service.

Dedicated personnel.

None of those requests is inherently unreasonable.

But there comes a point where you can have your largest customer and discover they're nowhere near your most profitable customer.

I've seen versions of that more than once.

The revenue number looks wonderful.

The relationship feels important.

Everybody is terrified of losing the account.

And then you actually allocate the labor, overhead, special handling, working capital, and management time required to serve them.

Suddenly that "great customer" looks a little different.

But there's an even bigger issue.

Leverage.

If losing a customer would hurt you badly, and both sides know it, the balance of power in the relationship changes.

Maybe subtly at first.

The customer asks for 60-day terms instead of 30.

What are you going to say?

They want a price concession.

They need you to carry more inventory.

They'd like you to make an investment to support their growth.

Each request may be perfectly rational from their perspective.

The question is whether you still have the freedom to say no.

Because one of the clearest signs of dangerous customer concentration isn't a percentage on a spreadsheet.

It's when the owner feels like he can't afford to upset the customer.

That's when a commercial relationship starts becoming dependency.

Now, the obvious answer is diversification.

And yes, over time, that's part of it.

But telling a business owner with a 40-percent customer to "go diversify" is a little like telling somebody to get healthier.

True.

Not terribly useful.

You can't necessarily replace a major account next Tuesday.

And you probably shouldn't want to.

If it's good business, keep the business.

The goal isn't to get rid of great customers.

The goal is to make sure the company can survive without any particular one of them.

There's a difference.

So I'd start somewhere else.

I'd ask a few uncomfortable questions.

What happens if this customer disappears tomorrow?

Not because you've done anything wrong.

Maybe they get acquired.

Maybe their CEO changes.

Maybe procurement decides to consolidate vendors.

Maybe their industry has a downturn.

Maybe somebody you've never met at corporate headquarters decides your work is going somewhere else.

Good relationships help.

But relationships don't eliminate business risk.

So run the scenario.

What happens to revenue?

What happens to gross profit?

What happens to cash?

Which employees suddenly don't have enough work?

Which expenses can you actually eliminate — and how quickly?

What debt or equipment commitments remain?

Could the company absorb the loss for three months?

Six?

A year?

That's a much more useful exercise than simply deciding that 25 percent customer concentration sounds high and 15 percent sounds safe.

Because businesses are different.

A company with substantial recurring revenue, variable labor, plenty of liquidity, and ten other growing customers may be able to withstand losing a major account surprisingly well.

Another company with fixed overhead, thin cash reserves, and equipment financed specifically for one customer may be in trouble almost immediately.

Same concentration percentage.

Completely different risk.

And there's one more thing I'd watch.

Success with a large customer can make a company lazy about selling.

Not intentionally.

It just happens.

The sales pipeline gets a little thinner because operations are busy.

Business development gets pushed aside because there's plenty of work.

"We don't really need another big account right now."

I've heard some version of that sentence many times.

And it can be perfectly reasonable.

Until the phone rings.

That's when everybody suddenly remembers that a sales pipeline takes time to build.

The best time to reduce customer concentration is usually when you don't feel any urgency to do it.

When the big customer is happy.

When the company is profitable.

When the bank account looks good.

When you've got the luxury of being selective about the next customer you bring in.

That's when you have leverage.

And options.

So if you've got a customer you absolutely love — one that's growing, profitable, pays its bills, and appreciates what you do — by all means, take good care of them.

I'd just keep one eye on what the rest of the company is becoming around them.

Because there's a difference between building a strong relationship with a customer...

and building a business that depends on one.

And sometimes you don't realize you've crossed that line until somebody on the other side of the relationship makes a decision you can't control.

That's something entrepreneurs should know.

[OUTRO MUSIC BEGINS]

Thanks for spending a few minutes with me.

If this episode made you think about your own business a little differently, send it to another owner or business leader who might appreciate it.

You can also find the show notes and more episodes at TESKPod.com.

This is Chip Schweiger, reminding you that if you always do what you've always done, you'll always get what you've always gotten.

I look forward to seeing ya next time.

[MUSIC OUT]