Why You Should Care About Client and Vendor Concentrations

Investors and lenders are interested in the customer and supplier concentrations of companies.  This is an important disclosure in financial statements that can reveal business risks.  Concentration risks are not exclusive to large-publicly traded companies.  As a business owner, you need to try to manage your own risk from concentrations.

Client Concentrations

The Whale

Concentrations can take many forms.  The most obvious is when you have one large client who is providing the majority or even all your revenues.  A so-called “whale” can initially seem like a great client to land, but the danger is that all your efforts and resources are directed at one client.  You stop developing new leads and you become complacent.  Many freelancers end up relying on one whale client, some even working for hourly rates.  The freelancer has the same reliance on the client as an employee has on an employer, but without any of the benefits or protections.  The risk is that your business becomes dependent upon the one client; if it should leave for any reason, then you lose a critical revenue stream. 

An Industry

Businesses with many clients may still have an industry concentration; this is a hazard of specialization.  This risk can result in lost revenues when an entire industry is depressed.  Though less common, you should be prudent and imagine scenarios where this could happen and tactics or options you could employ.  This scenario has played out with the pandemic across many industries in 2020.  For example, the Portland, Maine area is home to many nationally recognized farm-to-table fine dining establishments.  When the pandemic forced restaurants to close, the local farmers supplying those many restaurants lost all their Clients at once.  Farmers had to quickly find other local buyers for their highly perishable crops and livestock.  Managing this sort of industry risk is more difficult, but you should imagine these scenarios and develop responses.  If nothing else, this type of risk should encourage you to build a larger cash buffer for these emergencies.

The Payer

Healthcare providers are not immune to patient concentration risk.  Commercial health insurers plans have been consolidating over the past decade; in many markets, one commercial insurer may cover more than fifty percent of patients.  Concentration of health insurance plans often leads to higher insurance premiums for patients and lower payments for healthcare providers.  As with industry concentrations, payer risk is more difficult to manager, but you need to recognize it and develop strategies.

Vendor Concentrations

In business, vendor loyalty often pays.  If you stick to one supplier, you may often obtain better service and better discounts; retailers and distributors offer reward programs with discount and rebate incentives.  For some goods and services, you must choose one provider for practical reasons.  For example, a healthcare provider will select one electronic health records software platform.  The risk is that if that vendor cannot supply a critical good or service when needed, your business is unable to perform its critical processes and services.  An extreme example of this scenario at the system level played out nationally last spring as the healthcare system struggled to obtain adequate personal protective equipment.  Even more recently a tax software service crashed on the filing deadline for many business income tax returns.  These sorts of service and supply risks are difficult to manage, but they are real and should be part of your risk assessment.

Conclusion

Most people do not enjoy imagining worst case scenarios, but when it comes to identifying and assessing risk, it is necessary.  Review your own revenue stream by appropriate segments, such as client, industry, payer, or even geography.  Identify risks and develop strategies and tactics to mitigate your risks.  If you have risk that cannot be mitigated, look at increasing your cash reserves or insurance coverages as appropriate to help buffer any losses.

Perform similar analyses of your critical goods and services.  Determine methods to reduce any mission critical risk, whether it is retaining relationships with secondary suppliers or developing reasonable inventory.  Have a communication plan for your clients should a supplier issue disrupt your ability to provide timely services; while you’re scrambling to bring your business back on-line, you want to also clearly communicate with your clients to manage their expectations.

Make sure that your periodic risk assessments include reviewing customer and vendor concentrations and developing your responses before a crisis occurs.