Customer Concentration Matters to Everyone
When a business has just a few customers, it usually means that it has great relationships with them. There is usually a strong personal relationship that cements the business dealings, both of which may date back many years, or even decades. As a result, the owners are confident that their customer relationships are durable and will last long into the future.
So What’s the Big Deal?
It is our experience, however, that business owners tend to overestimate the permanence of these relationships and underestimate the risk that their customers could leave them for the competition.
For starters, as business owners age, so too do their counterparts. Few are fully prepared for the day when their contacts and friends start retiring and leaving their responsibilities to a younger generation of employees who may not be such loyal customers.
Fewer still have a contingency plan for the possibility that their primary customer could be acquired by a company that has historically done business with their competitors.
And even fewer have an adequate answer for customers who ask them to share their succession plans. An increasing number of sophisticated businesses include a discussion about succession planning in their periodic account reviews with key entrepreneur-owned suppliers.
For some business owners, this line of questioning may be the first indication that their relationships are more vulnerable than they thought and that customer concentration could be more than a theoretical risk that academics have cooked up.
The Buyer’s Perspective
Other entrepreneurs are not lucky enough to get this kind of wakeup call, and see the ramifications of customer concentration only when they try to sell their businesses. Buyers know that transactions can be disruptive to a business and that a change of ownership alone can be enough to cause customers to evaluate their reliance on a company.
Therefore, when a small number of customers account for large percentage of revenue, buyers lower the price they pay in order to account for the additional risk they are assuming.
The only foolproof remedy is to increase sales to a larger base of customers, but this is often unfeasible or even impossible. In those cases, owners can partially address the issue by utilizing long-term contracts. But this approach is imperfect, because no contract is bulletproof, the cost of enforcement can be prohibitive (in terms of actual cost or reputational damage) and, in order to coerce a customer into entering such a contract, a supplier may have to make material concessions on pricing or other terms.
The principals of Bootstrap Capital understand that, in order to have customer concentration, a company must first deliver value and demonstrate the type of responsiveness upon which great relationships are built.
Consequently, we are willing to structure acquisitions in a way that allows sellers to participate in, and reap the reward from, a well executed post-transaction customer retention plan. The end result can be a fulsome purchase price.
If you have business owning clients who would like to sell, but are concerned about how buyers will react to their reliance on a small number of important customers, please consider introducing them to Bootstrap Capital. We can be constructive and creative in dealing with this common issue.