Having one key customer that brings in a big chunk of your revenue can sound like a tempting option. But when you become too reliant on one or two big customers, you’re actually greatly increasing the inherent risk in your business model.
If you lose that contract, or your customer finds an alternative supplier, you’re suddenly faced with a huge cashflow hole and an unplanned-for scramble to bring in new business.
Amilios Costa, Managing Partner at Haines Watts North London, explains how to minimise this risk and why, in business, you should always expect the unexpected.
Becoming too reliant on one key customer
Having one big customer as your main source of revenue, may look like a sound strategy. But with all your income reliant on another business, you’re actually on potentially shaky ground. Let’s break down why this is…
I have a food manufacturing client that does a lot of work for a big supermarket. They’re a preferred supplier, their margins are healthy and they have a steady revenue stream.
The food company’s problem is that the supermarket wants to increase their order size. And this means the food company now needs to scale up its production capability to satisfy this increased demand. So the owner is going to have to make an investment in the business to expand their premises and equipment.
Knowing what’s around the corner
Our food company has a quandary. To keep their big customer, they need to scale up. But to scale, they need to put more money into the business – and that’s a big commitment.
The owner of the food business imports a significant amount of raw materials and ingredients from abroad. This means they’re worried about the impact of Brexit. If we leave Europe, there’s the possibility of being hit by higher tariffs that will have a negative effect on their margins.
The bigger premises that they have in mind requires a 10-year lease, but the owner doesn’t want to sign on the dotted line due to post-Brexit uncertainty. If they don’t take on the premises, they can’t extend capacity and meet the extra demand from a major client.
Being locked in with one big customer has forced the owner’s hand. But there are ways to make this less of an issue, going forward.
Broadening your appeal in the market
If you’re locked into a contract with one key customer, it’s important to broaden your presence in the market.
One thing we’ve looked at is giving this food company its own brand name, so they’re making their own branded products, not the supermarket’s products. It can be a good strategy, as the supermarket still needs your product, but you’re also creating a back up brand.
You’ve got to think about how the business could grow. If you say no to a major customer, the likelihood is that you’ll lose your contract with them. And when you’re reliant on just one client, that can be an absolute disaster. If you swap to a different customer in the same market, you might not get such good margins – or you might not find that customer at all.
Negotiating the best possible deal
There’s no right answer for how you make your position more stable. You’ve got to fully understand the relationship with your key customer, and how much they want to integrate your small business into their own operations.
I had a client several years ago who used to make £1M every year supplying toothpicks to one of the UK’s biggest supermarkets. For 15 years or so, he had a great business that was bringing in great profits. Then the supermarket reassessed their suppliers, found a cheaper option and dropped him immediately.
Things may be ticking over nicely with one big client, but if you can see the inherent risk, it’s vital to take pre-emptive action.
Finding ways to mitigate your risk
There are tried and tested ways to bring down the risk element, add some stability and make your future more certain.
There are three key things to look at:
- Firstly, look at bringing in different clients, so you end the monopoly and have the security of several customer revenue streams, rather than just one.
- Secondly, look at branding your product in your own right. If your sole customer does ever shut you out, you still have that brand out there to work with.
- Thirdly, look at producing different products and diversifying your whole product range. If one product tanks, you have the backup of that whole range to bring in revenue.
Diversification puts you in a stronger position when it comes to negotiating contracts and prices next time around. Ultimately, you’ll get a better deal.
Getting your numbers in order
To succeed with one big customer, you’ve got to be clever with your business model – and completely understand your numbers and cost base.
You have to be in a position to break down your income, understand your overheads and see how much revenue each customer is bringing in.
Using forecasting to plan your future path
Planning is vital. We using forecasting models with clients to understand the trajectory of where their business will go in the future.
With the food business, we ran an analysis of the leasehold costs for the bigger property, the projected income over the next year and calculated that they can easily survive the additional costs of scaling up.
‘What-if analyses’ are a massive help when you’re trying to work out what your next move should be. Understanding and managing your margins is so key for many smaller businesses. If you lose 5% off your margin, that can really hurt your bottom line.
Helping you reduce your risk
When you’re an owner-manager, you want to be your own boss. But being at the top can be both lonely and stressful – so having an advisor who can share the burden and help you get some answers is a real bonus.
It’s a key part of the role we play to help reduce the risk in your business model, and give you the support and guidance you need.
The steps we take include:
- Reviewing your contract with a key customer – so you understand the terms and conditions, when it’s renewed and how much notice period is given if they opt out.
- Looking at other options for who you sell to – including what products you sell and where you could diversify to mitigate risk.
- Improving payment terms – so you’re not waiting 90 days to get paid and cashflow is more positive and secure.
- Ensuring you have a robust business plan – where you understand your key goal, your financial strategy and how you’re going to make a profit from one customer.
Having one large customer feeding the majority of your revenue isn’t always a disastrous thing. But it does need to be managed correctly.
If you work on the principal of expecting the unexpected, you’ll have a much higher probability of success, even when things don’t go to plan.
Talk to one of our Business Advisors about reducing the risk in your business.
Haines Watts is a firm of chartered accountants in Finchley providing tax, business and financial advice and support.