Most small businesses have a small number of people who account for a majority of their business.
This is a bad situation to be in.
Most smaller businesses, especially B2B companies, have the “big client.” At the early stages of a business, this is often unavoidable. In fact, it is usually that one big account that gets the business off the ground.
But it’s a problem every business owner needs to fix as quickly as they can.
That same big account that has been the foundation of your success could easily become the wrecking ball that destroys your business.
You have a responsibility to yourself, your business, and your employees to make sure that doesn’t happen.
When things are good, the owner usually loves this situation. They enjoy a steady income and only need to maintain the relationship with one (or a small number) of people. They are often blind to the fact they are dancing on the edge of a high cliff.
Why is this such a problem?
Risk.
It is the exact same idea that applies to investing. The more concentrated your investments in any one thing, the greater the risk. This is why people diversify their investment portfolios. It reduces the influence of any one thing on performance.
Let’s look at two companies.
Each has $1 million annual revenue. They both have the same cost structure.
- Cost of goods sold of 40% ($400,000)
- Operating expenses of 50% ($500,000)
- Net income of 10% ($100,000)
The difference is that company A has one big client that pays them $600,000 per year – 60% of their total revenue. Company B’s biggest client accounts for only $200,000 per year.
What happens when those big clients leave? Take a look at the table.
As you can see, when Company A loses its biggest client it has a huge loss to make up.
To absorb that shock to revenue, Company A will need to cut its operating expenses by more than half. At a minimum, that means large-scale layoffs and draconian cutbacks on expenses. Often, cutting back that much just isn’t possible, so the company goes out of business.
Company B also swings from being profitable to a loss. But it is a small loss that can realistically be made up from modest cuts or covered by cash reserves.
The owner of Company B might have a bad year, but will recover. The same can’t be said for the owner of Company A.
To avoid Company A’s fate, use the other 20% rule.
Do not allow any one customer to contribute more than 20% of the business’ total revenue.
“But that won’t happen to me.” is a response I hear way too often from owners.
Here’s just a short list of the ways this will happen to you. Notice that none of them are things you can control.
- Customer cuts back spending
- Customer changes the focus of their business and no longer needs what you do
- Customer changes their business process and eliminates the parts you contributed to
- Your main contact leaves and the replacement wants to do business with “their people”
- Customer changes their terms for doing business to something you can’t accept
- Customer gets acquired by another company
- Customer goes out of business
- Customer moves outside of an area where you can serve them
How to follow the (other) 20% rule
Keep an eye on revenue by customer. Whenever one customer gets over 20%, it should be a big red flag.
Treat this as an urgent call to action.
Dig in and find out why your sales are so concentrated with one customer.
- Are you just getting lazy about business development because there isn’t any urgency?
- Do your salespeople lack the skills to bring in new customers?
- Is your process for lead generation working?
When you find the issue, fix it.
Don’t know where to look for the problem? Can’t find the problem? Don’t know how to fix it?
Great post Ed. That is a very important rule, yet hard to implement in the very beginning of the company