Customer Concentration Risk: Guide to Assessment & Mitigation
- Customer concentration is a metric that measures how spread out a company’s revenue is among its clients.
- High customer concentration can pose significant financial and operational risks to an agency, including revenue volatility and cash flow issues.
- To assess customer concentration and mitigate its associated risks, agencies should analyze their revenue streams regularly.
When agency owners think about what KPIs are, they rarely consider this one: customer concentration. It’s one they should pay a lot of attention to, though, because it can easily make or break their business.
Imagine this: you’re running a successful agency, or so you think, that relies on three big clients. What if one of them leaves, knocking out 30 percent of your revenue? Scary, right?
This is what high customer concentration is all about. The risk of your entire business dangling on a few threads, connecting you to a handful of customers.
What is customer concentration?
Customer concentration is a metric that shows the spread of a company’s revenue among its clients. If a few customers account for a large portion of the revenue, the company has high customer concentration.
Conversely, if revenue is spread more evenly among many customers, the company has low customer concentration. Understanding this metric is crucial for assessing financial stability and planning strategic actions.
Types of customer concentration
Understanding the types of customer concentration is essential for evaluating business risks and opportunities.
High customer concentration
High customer concentration occurs when a few customers make up the bulk of a company’s revenue. This can lead to several risks and benefits:
Risks:
Revenue loss if a top customer leaves.
Downward pricing pressure as major customers demand better terms.
Reduced creditworthiness, making it harder to obtain loans or investment.
Benefits:
Strong relationships with key clients, fostering loyalty and trust.
Potential for long-term partnerships, which can be more predictable and stable.
Focused customer service, leading to higher satisfaction among key clients.
Low customer concentration
Low customer concentration means revenue is spread across many clients. This scenario has its own set of risks and benefits:
Risks:
Managing many smaller clients can be complex and resource-intensive.
Benefits:
Less revenue impact if a client leaves, reducing dependency on a few customers.
Increased market stability as a diversified client base provides a buffer against industry-specific downturns.
Examples of customer concentration
Examples help illustrate what customer concentration looks like in practice.
A link building agency generates 70% of its revenue from just three clients. This is a classic example of high customer concentration. If one of these clients leaves, the company would lose a significant portion of its revenue.
A video editing agency relies on a single customer for 50% of its sales. This is an extreme case of high customer concentration. The risks here are even more pronounced because losing this one client could cut the company’s revenue in half.
Impact of customer concentration
Why do agencies rarely give insights into their revenue stream? For one, they don’t want competitors to know why they are successful. Another reason could be that they rely on a handful of clients driving their success.
In the agency world we talk a lot about churn but a lot less about customer concentration. Even though many have this problem! To me, it seems like a bit of an agency dirty secret. No one wants to admit their eggs are in one or two baskets. But for many this is a grim reality. A super dangerous position to be in, so maybe we need to talk about it more.
So, let’s talk about it. Here’s why customer concentration is so dangerous, and how it can impact your agency.
Financial risks
Customer concentration can significantly affect a company’s financial stability, making it difficult to grow an agency.
Revenue volatility: A critical issue for businesses with high customer concentration. For example, if a company derives 60% of its revenue from two clients, losing one could result in a significant drop in revenue. According to Stephen Schiera, a company’s optimal customer concentration is less than 10% of sales from a single customer and less than 25% from the top five customers.
Cash flow issues: They often accompany revenue volatility. When a key client delays payment or defaults, it can create a ripple effect, making it challenging to meet payroll, pay suppliers, or invest in growth opportunities.
Operational challenges
Beyond financial risks, customer concentration also poses several operational challenges.
Over-dependence on a few clients: The company’s resources, including staff and production capacity, are heavily aligned with the needs of these clients. This alignment can make the business less flexible and slower to adapt to market changes.
Negotiation power imbalance: With high customer concentration, clients gain significant leverage in negotiations. They might push for longer payment terms, bulk discounts, or other concessions that can erode profit margins.
Increased business risk
Customer concentration inherently increases business risk. The loss of a major client can lead to a domino effect, impacting various aspects of the business.
Employee morale: High customer concentration can also affect employee morale. The constant pressure to meet the demands of a few key clients can lead to burnout and job dissatisfaction. This can result in higher turnover rates, which in turn can disrupt operations and increase hiring and training costs.
Cyclical dependency: As businesses become more dependent on a few clients, they may find it increasingly difficult to diversify their client base. This cyclical dependency can trap companies in a high-risk situation, making it challenging to break free from the risks associated with customer concentration.
How to measure customer concentration
To show customer concentration, you’ll need to analyze your revenue in a given period of time. If you want to use the Pareto principle, identify your top 20% of your customers who generate 80% of your revenue. Keep a close eye on them, and make sure your customer success team is aware of these customers. Ideally, generate reports in Looker Studio to be aware of any revenue changes.
Getting access to this type of financial data isn’t easy, and keeping reports updated isn’t either. A better solution is to run your agency operations with Service Provider Pro. You’ll have access to analytics on your dashboard and don’t have to do manual calculations. To check up on your customer concentration, open the revenue per client report.
Take a regular look at this report to identify your best clients, but also check if there’s an imminent customer concentration risk.
Does your agency depend on a handful of clients? If so, you should implement strategies to mitigate the customer concentration risk right away.
Mitigating customer concentration risk in 5 steps
If you’re already at risk of relying on a handful of customers, here’s how you can mitigate the risk:
Diversify customer base: Are you selling to private customers? It’s easier to find B2B clients, so start focusing on B2B transactions.
Upsell existing clients: Existing customers already love you, so why not upsell them on services they might be interested in?
Diversify revenue streams: Content agencies could diversify their revenue streams by offering a new, but relevant services, such as link building.
Use annual contracts: Pivot to recurring services on an annual basis to hook your clients into long term contracts.
Partner with agencies: Tap into the best white label services of other agencies to offer more services to your clients.
Ready to mitigate customer concentration risk?
High customer concentration can lead to revenue volatility and operational challenges. Diversifying your customer base, expanding product offerings, and forming strategic partnerships are crucial strategies.
Assess your current customer concentration levels; identify new market segments and industries to target; and start upselling existing customers.
