Chirayuthchai TraisaengsatheanStrategic Finance for Property Development

Customer concentration: how badly would the company be hurt if a major customer left?

Measure the risk from a major customer in terms of profit and cash, and how to limit the impact while you diversify your customer base

Key takeaways

  • Customer concentration can be measured by revenue share, but the real risk must be measured as the profit and cash lost when that customer cuts orders, pays late or stops buying.
  • In the example, the major customer accounts for 40% of revenue. If it leaves entirely, EBIT swings from a profit of THB 8 million to a loss of THB 6.4 million.
  • Reducing the share takes a long time. In the example, THB 72 million of new revenue is needed, so impact reduction must run alongside it, covering contracts, credit and cost structure.

Many B2B business owners are proud of their major customers because they order steadily, have a good reputation and keep the factory or team fully occupied. Then one day the customer changes its procurement team, moves its production base or reopens the tender, and most of the revenue disappears within a single contract cycle. The question to be able to answer in advance is: if one of the top 3 customers left, how badly would the company be hurt?

Having a major customer is not wrong. The problem is putting many eggs in one basket without knowing how heavy the basket is, and without ever considering what would be left if it fell.

What to measure beyond revenue share

The starting figures are the revenue share of the largest customer and of the top 3. A company might use 30% of revenue from a single customer as a trigger for review, but this is an internal rule that you set yourself, not an international standard. A contract manufacturer with multi-year contracts and a business that wins one-off projects should use different thresholds.

DimensionQuestionsData you need
RevenueWhat percentage do the top 1 and top 3 represent?Sales by customer for the past 3 years, combining a customer's group companies as a single customer
ProfitWhat is this customer's contribution margin after discounts and cost-to-serve?Net price, variable costs, delivery, rework, dedicated support team
CashHow much does this customer owe, and how much cash would be short if it paid later?Ageing by customer, credit terms
ContractHow quickly can they terminate? Is there a minimum volume?Term, notice period, minimum volume, non-compete clauses restricting sales to competitors
Fixed costsWhat percentage of capacity or staff is set aside for this customer?Dedicated machinery, leases, teams and debt borrowed to support the work

Example: if a major customer leaves

Hypothetical example: annual revenue of THB 120 million, contribution margin of 30%, fixed costs of THB 28 million and EBIT of THB 8 million. Customer A's receivables have an actual credit period of 75 days.

CustomerRevenue (THB million)Proportion
A48.040.0%
B18.015.0%
C12.010.0%
D8.06.7%
Other customers34.028.3%
Total120.0100.0%

The top 3 generate revenue of THB 78 million, or 65%. We then test 3 scenarios for customer A.

SituationContribution lost (THB million)EBIT after impact (THB million)Effect on cash
Volume down 50%7.20.8Receivables fall in line with the work, but profit is almost wiped out
Stops buying entirely14.4(6.4)If the receivables are collected in full, there is a one-off cash inflow before the continuing losses begin
Payment stretched from 75 to 120 days0.08.0Receivables rise from THB 9.86 million to THB 15.78 million, so THB 5.92 million of extra funding is needed

If customer A leaves entirely, the company must find THB 6.4 million to offset the loss and get back to breakeven, or find THB 48 million of new revenue to restore EBIT to its previous level at the same margin.

The third scenario is often overlooked. The customer has not stopped buying and the profit in the financial statements is unchanged, yet almost THB 6 million of cash has gone. A company whose revolving credit line is already tight may be in trouble before the customer actually stops buying. If the customer goes bankrupt, a bad debt loss of THB 9.86 million must be added on top.

Diversifying customers takes longer than you think

Total revenue needed for customer A to be 25% = 48 ÷ 25% = THB 192 million

If revenue from customer A stays constant, the company must increase revenue from other customers by a further THB 72 million, from THB 72 million to THB 144 million. If this group grows 15% a year, it takes about 5 years. A diversification plan is therefore not enough unless the impact is also reduced along the way.

Reduce the share (takes time)

  • Expand into customer segments or areas that use existing capabilities
  • Add products or services for mid-sized customers
  • Increase recurring revenue from maintenance or service contracts
  • Set new-revenue targets separately from the sales team's overall target

Reduce the impact (can be done faster)

  • Extend contracts and ask for a notice period or minimum volume
  • Set credit limits and consider trade credit insurance
  • Do not invest in customer-specific machinery without a supporting contract
  • Use variable labour or production capacity for the uncertain portion of the work

Don't decide on share alone

Some major customers may give a low margin after discounts and cost-to-serve, so losing them hurts less than their sales suggest. Conversely, some customers may account for a small share of revenue but generate a high proportion of excess profit. Look at profit by customer before deciding which customers to retain and which to reprice.

Banks and acquirers look at this too. When applying for a loan or preparing to sell the company, have a customer table, contracts and a contingency plan ready to present. Saying that the customer has been a partner for a long time is not evidence.

Contract renewal negotiations should not begin when the customer is about to open a tender. The period when the company is delivering well and the customer relies on us is when we have more information and more bargaining power.

Next steps

  • Combine sales by actual customer group and prepare a top 10 for the past 3 years
  • Calculate the contribution margin and cost-to-serve of the top 5 customers
  • Test 3 scenarios, 50% lower volume, stopping purchases and paying 45 days later, for their effect on both profit and cash
  • Check the contract term, notice period and minimum volume conditions of the main customers
  • Set a credit ceiling per customer and require owner approval when it is exceeded
  • Set a new-revenue target from customers outside the top 3 and report on it every month
  • Define a fixed-cost reduction plan to be activated immediately if a major customer announces a cut in work