How customer concentration reduces business value

Risk · 7 minute read

Customer concentration is the single most common reason a good business receives a disappointing offer. It is also one of the few value constraints an owner can materially change without new capital.

How a buyer sees it

Suppose one customer represents 40% of revenue and, because it carries better margins, closer to half of profit. The buyer is not asking whether that customer is happy today. They are asking what happens if it leaves in the eighteen months after completion, when the purchase price has already been paid.

The answer determines the offer. If losing that account would take the business from profitable to loss-making, the buyer is effectively being asked to price an option they do not control.

What buyers do about it

• Reduce the multiple applied to the whole business, not just the concentrated portion
• Move a large part of the consideration into deferred payments or an earn-out tied to that customer
• Require the owner to stay on to protect the relationship
• Ask for specific indemnities or a retention held in escrow
• Withdraw, if the contract is short, informal or up for retender

What matters as much as the percentage

Concentration is not a single number. Two businesses with the same 40% figure can present very differently.

• Contract length and notice. A three-year contract with twelve months' notice is a different risk from a rolling arrangement terminable on thirty days.
• Relationship depth. Multiple contacts across the client's organisation, versus one relationship held by the owner.
• Switching cost. Whether the client would face genuine disruption in moving the work.
• History. Ten years of renewals says something a two-year relationship cannot.
• Client health. Concentration in a growing, financially sound client is not the same as concentration in a struggling one.

What an owner can do, in order

Reducing concentration by winning new customers is the obvious answer and the slowest. Before that, there is work that changes how the risk is perceived within a few months.

1. Get the contract signed, extended or formalised on the best available terms
2. Broaden the relationship so it is not held by one person on either side
3. Document the delivery process so the account does not depend on individual knowledge
4. Evidence the renewal history and satisfaction, in writing
5. Then build the pipeline that dilutes the percentage over the following year

An owner who can show a buyer a signed three-year contract, three named contacts and a documented delivery process has changed the risk. An owner who can only say the client has been with them for years has not.