Reducing the risk of customer concentration
Customer concentration is one of the most insidious dangers in the world of business. As a business owner, it doesn’t seem like you’re doing anything that could harm the company. You’re developing a handful of loyal customers that give the company reliable revenue streams, to the point that you can virtually pencil in a customer to spend a given amount with you each month, quarter or year.
“It can be easy to have customer concentration, because you don’t have as many customers to deal with, and the customers you have are loyal,” says Mark Lemke, a consultant with The Shealy Group. “It becomes kind of a comfort zone to operate in.”
Before you know it, 35 or 40 percent of your business is devoted to producing one product for one customer, which is fine — as long as that customer keeps buying from you. But as too many manufacturers discovered during the recession, today’s reliable customer is tomorrow’s bankruptcy case. It can happen to any manufacturer in any industry — just ask the automotive suppliers that fell like dominoes when previously invincible giants GM and Chrysler declared bankruptcy.
“Smaller suppliers got hammered by that,” Lemke says. “If a large customer encounters big problems, it doesn’t take long for those problems to cascade downward.”
With that as a cautionary tale, it’s imperative that manufacturers take steps to avoid the pitfalls of customer concentration. Here are some things to remember.
Be prepared for change
Automotive suppliers were hit hard by the bankruptcies of two of Detroit’s Big Three automakers. But your business could still be exposed to customer concentration risk, even if the situation doesn’t involve a once-in-a-century economic crisis. Customers change leadership. They find new vendors, shift the focus of their businesses, or might simply decide they want to change their pay cycles, meaning you won’t see your invoice payments for an additional two or three months. Any of the above situations could endanger your business if the customer in question makes up a significant part of your company’s income.
“Think about what might happen if your largest customer told you it was going to shift its pay cycles from 45 days to 90,” Lemke says. “Even something procedural like that could endanger your ability to operate or even meet payroll.”
Remember the 20 percent rule
So how do you avoid customer concentration? Remembering the 20 percent rule is a good place to start.
“It’s nothing formal, but if one customer makes up more than 20 percent of your business, you’re toeing the yellow caution area of having too much business wrapped up in one account,” Lemke says.
When you have that much business committed to one account, chances are you have personnel committed to managing the account and producing the product for all 40 hours each week. You might have purchased machinery necessary to manufacture the customer’s product — machinery that can’t be utilized in any other capacity. If that customer abandons its account, there is nothing supporting the employee base and machinery investment associated with that customer. It’s a top-down situation, and it can decline in a hurry.
Divide and conquer
Redundancy is a key factor in avoiding customer concentration, both in the breadth of your customer base and in the touch points you have with each customer’s organization.
“Instead of just having the respective owners as touch points, build contacts between people at different levels of the organizations,” Lemke says. “Increase the number of relationships you have between your company and your customer’s company.”
Additional touch points mean additional people who can see the value your company provides.
Niches are the sweet spots of business. If you can create a need that only your company can serve — or serve effectively — you increase your value to multiple customers. Whether that sweet spot is the product you make, your quality versus the competition, your ability to deliver on demand, or some combination of the above, carving out a niche is an ideal way to increase the value you bring to customers. It will help you keep existing customers and attract new customers, enhancing the diversity of your customer base.
“I call it creating barriers to entry,” Lemke says. “Sometimes they’re difficult to find, but if you can find or create a unique product or service that only your company provides, build on that.”
Hand-in-hand with that, learn as much as you can about your customers. The more you know about what your customers want and need, the more effectively you’ll be able to fashion solutions that meet their needs. Customers love a vendor that listens and that puts their suggestions to work. Use that fact to your advantage.
“Successful companies know a lot about their customers,” Lemke says. “They know what keeps their customers up at night and how to create solutions to address those concerns. Those are the companies that customers want to do business with.”
For more information on avoiding customer concentration and how it affects your manufacturing business, contact Mark Lemke at email@example.com.