Are You Relying Too Heavily on One Customer?

Winning a major customer can transform a business. A large contract can provide regular work, predictable income and the confidence to invest in new staff, equipment or premises.

But there is another side to that success which can be easy to overlook.

This is often referred to as customer concentration risk, and it is something growing businesses should keep an eye on.

What is customer concentration risk?

Customer concentration risk occurs when a significant proportion of a business’s revenue depends on a relatively small number of customers.

There is no single percentage that automatically means a business is too reliant on one customer. The level of risk depends on factors including your margins, cash reserves, fixed costs, industry and how quickly lost income could realistically be replaced.

The simplest place to start is to calculate how much of your turnover comes from your largest customers.

If your biggest customer represents a sizeable share of annual sales, ask yourself what would happen financially if that income disappeared tomorrow.

• Could you still comfortably cover salaries?
• Could you still meet rent and premises costs?
• Would loan repayments remain manageable?
• Could suppliers still be paid on time?
• Would VAT and other tax liabilities still be covered?
• Could you continue paying your regular overheads?

If the answer to several of those questions is no, that customer may represent a more significant financial risk than you realised.

A big customer isn’t necessarily a bad thing.

Having a major customer can be extremely valuable. The issue isn’t necessarily the size of the customer. It is the level of dependency your business has on them.

A long-standing client providing regular, profitable work may be exactly the kind of relationship you want to develop. But even a strong relationship does not remove every risk.

Their circumstances can change. They might:

• change supplier;
• bring work in-house;
• reduce spending;
• negotiate harder on price;
• experience their own financial difficulties;
• merge with or be acquired by another company; or
• simply decide that their business needs have changed.

None of those situations necessarily mean you have done anything wrong. But if one customer’s decision can materially affect the future of your business, it is worth understanding that exposure before something changes.

Don’t just look at turnover.

Turnover alone doesn’t tell the whole story.

Suppose one customer represents a large proportion of your sales. That sounds significant, but you should also consider what that customer contributes to your profit and cash flow.

A large contract could require additional employees, equipment, stock or subcontractors. If the margins are relatively low, the headline revenue figure might make the relationship look more valuable than it actually is.

On the other hand, a smaller customer could generate a disproportionately high amount of profit.

It can be useful to look at customers through several lenses:

Looking at those figures together provides a far more useful picture than turnover alone.

Late payment can magnify the problem.

Customer concentration can become particularly noticeable when a major customer pays late.

A sale appearing in your accounts does not mean the cash is already sitting in your bank. Your own costs may still need paying while you wait for the customer to settle their invoice.

The British Business Bank recommends forecasting cash based on when client invoices are actually expected to be paid, rather than simply when the sale is recorded.

If several smaller customers pay late, the impact may be spread across the business. If your largest customer delays a substantial payment, however, the cash-flow effect can be much more immediate.

What would happen if your biggest customer left tomorrow?

It may sound pessimistic, but it is a useful question.

You don’t need to assume the worst is going to happen. Instead, use the scenario to understand how resilient the business currently is.

Look at your latest figures and ask:

• How much revenue would disappear?
• Which costs would disappear with it, and which costs would remain?
• Could employees currently working on that account be moved elsewhere?
• Would you still have enough cash to meet upcoming liabilities?
• How long could the business operate while replacing the lost work?
• What would happen to your profit forecast for the year?

A cash-flow forecast can help model exactly this kind of scenario. Rather than waiting until circumstances change, you can see the potential pressure points in advance.

How can you reduce customer concentration risk?

The obvious answer is to win more customers, but managing the risk is not always as simple as chasing as many new clients as possible.

The aim should be to build a stronger and more resilient customer base.

1. Know your current exposure

   Start with the numbers. Calculate the percentage of revenue generated by your largest customers and track how that changes over time.

   A growing dependency can otherwise creep up unnoticed, particularly if one customer is expanding rapidly with you.

2. Build your pipeline before you need it

   Business development becomes much harder when you suddenly need to replace a major contract. Continuing to market the business and develop new relationships while things are going well can reduce that pressure.

3. Review the profitability of major accounts

   Large does not always mean profitable. Regularly review whether major contracts are generating the margin you expect after staff time, materials, discounts and other direct costs have been considered.

4. Monitor payment behaviour

   Keep an eye on whether a customer’s payment habits are changing. Increasingly late invoices or requests for extended terms may deserve attention, especially where the customer represents a meaningful part of your cash inflow.

5. Build the risk into your forecasts

   Don’t just forecast what you expect to happen. Consider what could happen.

   Running different scenarios can show whether the business could cope with losing a major customer, a reduction in their spending or a significant delay in payment.

Your accounts should help you spot the risk.

This is where management information becomes more useful than simply knowing whether the business made a profit last year.

Good financial information can help you understand:

• where your revenue actually comes from;
• which customers are generating the strongest margins;
• how quickly customers are paying;
• where cash-flow pressure could emerge; and
• how financially resilient the business would be if circumstances changed.

That gives you the opportunity to act while the business is performing well, rather than discovering the dependency after a major customer has already left.

Final thoughts.

Landing a big customer is something to celebrate.

But as your business grows, it is worth making sure that success with one customer hasn’t quietly created a vulnerability elsewhere.

If you aren’t sure of the answer, it may be worth finding out.