Customer Concentration

Author: Larry Chester

There’s always comfort in working with people you know. But if those people hold the key to 75% of your sales, you may be at risk of having too many of your eggs in one basket. Even though it’s easier to expand your sales with an existing client, it also may create additional risks that you might not be willing (or financially able) to take.

Bring Value through CFO Insights

Rank your customer base. How many customers account for 80% of your sales? Certainly, having more customers to manage creates more work for the sales team and administration. But it also provides additional security for the company. There are obvious inherent risks in having a large percentage of your sales with one or two customers. There is revenue risk, collection risk, negotiating risk, competitive pressure risk, and certainly borrowing risk.

• Business – Distributor of private-labeled machine tools
• Location – Chicago, Illinois
• Sales – $47,000,000
• Ownership – ESOP

Initial contact –

The president of the company reached out at the bank’s request. Customer concentration had become an ever-bigger problem as borrowing increased. Pricing pressure, inventory requirements, and product development costs had greatly affected profitability. In addition, there was pressure from the ESOP Trustees to improve share price for the employees.

Significant Findings and Recommendations:

Reduce Customer Concentration

The company started 40 years ago with a single big box customer, producing exclusive branded tools. Over the years, the big box continued providing opportunities for the company. They eventually developed a relationship with one other big box customer. True to form, the big gorilla became less of a partner and more of a task master during the coming years. With only two customers accounting for 95% of the company’s business, there was increased risk to the company’s viability with each passing year.

Recommendations

• Identify the company’s core competencies – developing and sourcing industrial items as a high-quality, low-cost producer. Use that expertise to develop new product lines for both B2B and B2C customers.
• Work with existing manufacturers to identify other products that are not imported to the U.S.. Select the best options as potential new products for import.
• Use those sourcing skills to move into new areas where they could develop accessories, or competitively priced alternatives to high-cost domestic items. Market those to new clients.
• Evaluate the product lines of other big box companies, identify product holes in their offerings, enabling an opportunity to propose new items for sale.
• Leverage the company’s logistical skill at importing, warehousing, and large-scale distribution—canvass other big box companies to develop new opportunities to provide logistical support for their operations.

Cash Flow Shortages

The big box forced extended payment terms on the company, in addition to increased marketing support. The increased pricing pressure reduced margins, creating additional cash flow problems. With the bank getting nervous, current liberal advance rates were at risk.

Recommendations

• Discontinue year end bonus program. The company had been paying a generous 30% annual bonus to all employees. This program should be suspended until cash flow and profitability improved.
• Push overseas suppliers for more generous payment terms. Standard payment terms were Letters of Credit (LCs), opened at the time POs were issued. These LCs immediately drew down the available line of credit. Since these relationships were long standing, change the payment terms from LCs to wire transfers at the time of shipment. If those payments were delayed till the time of shipment, it would provide between 3 and 4 weeks of additional availability.
• Reduce staffing. Over the years, the warehouse had become less efficient. Instead of demanding better performance from existing staff, additional staff was hired. Tightening up productivity standards would allow a reduction of staff without affecting company performance.

Chargebacks from the Big Box

One insidious draw on cash was chargebacks from the big box for shipping and paperwork errors. The quantity seemed to grow over time, as the accounting department turned a blind eye. It looked like the big box had found another revenue source, at the company’s expense.

Recommendations

• Improve quality control review. The big box had very specific requirements for positioning of labels and placement of boxes on skids. A fine of $10 per label placement becomes a big expense when there are 48 boxes on a skid, and 5 skids in the shipment.
• Add label placement to the QC check for incoming inventory. Put non-conforming product on hold and charge manufacturers the cost of relabeling cartons.
• Verify accuracy of shipping paperwork placed on skids. Assure the license plate on each skid is properly placed so it can be quickly scanned by the receiving dock.
• Fight big box chargebacks. AR chargebacks were increasing over time. Review showed that there were significant inaccuracies in the chargebacks. Push back to the big box aggressively on each of the chargebacks. In some cases, consider documenting the proper placement of labels or skid pack by using digital photos of each skid that shipped.

Finding new customers is hard. Customers that continually order larger quantities, ask for new products and pay their bills on time are highly sought after. If you find them, there is a strong desire to keep feeding them and building that relationship. But, if you don’t watch carefully, a company can find itself increasingly dependent on a single or a few major clients. That dependence carries a significant risk as you build infrastructure and staff to support that single client. What happens if things change – the purchasing agent you worked with leaves, their product focus shifts, or they find a new “favorite” supplier? Suddenly, there’s a big hole in your ongoing sales that isn’t easy to fill.

Many companies view 20% of your total sales as a limit on customer concentration. The easiest (but painful) question to ask yourself is “how badly would it hurt if Client XYZ stopped buying from us?” The loss of every customer is painful. But, what if you:

• can’t replace that revenue stream in 6 months,
• have to eliminate staff,
• must change your facilities dramatically, or
• find yourself “stuck” with significant inventory that nobody else wants?

If that is the case, then you need to seriously evaluate your current customer concentration. Maybe it’s time to reach out and find a larger customer base.