Is Key Customer Dependence Dangerous?

Relationships with key customers can be the lifeblood of your business. But what happens when those relationships become strained for one reason or another? For instance, how do you ask a key customer to start paying on time? When will they stop asking for price concessions? What happens if you lose these customers? These are questions that a potential buyer will ask.

Key Customers

So, who is considered a “key” customer? If you have audited financial statements, the footnotes to the financial statements will actually list if you have any customers accounting for 10% or more of your annual revenues or accounts receivable. In fact, measuring each customer’s contribution to profits and cash flow may be more critical than revenue contribution.  And While 10% of annual revenue is often used for defining a key customer, having three customers accounting for 50% of annual revenue or profit is certainly a much higher customer concentration which could likely depress the price multiple when the business is sold. 

Key Customer Dependence

Being dependent upon a few key customers can be lucrative but dangerous, especially if the demands from these customers are growing. And if you are increasing payroll, facilities, or other infrastructure to support a key customer, ask yourself what happens if you lose this customer or this customer has a business downturn.

Since the loss of a key customer can have such an adverse impact on revenues and profits, this uncertainty results in risk. A potential buyer is going to want assurances that the key customer will remain with the business. While a long history with key customers and written customer contracts are a plus, and even those assurances may not minimize the perceived risk to a potential buyer.

Larger businesses are often more diversified with less customer dependence, but this is not a hard and fast rule. Some businesses are so dependent on a few customers that the performance of the business mirrors the performance of the key customers. 

Reducing The Risks

Reducing key customer dependence can reduce risk and may improve the price multiple for your business. But should you actually get rid of your key customers? You’ll take a hit to cash flow unless your key customers aren’t profitable. Your success may have been dependent upon these key customers and of course, you may have loyalty to these customers. 

Instead of dumping key customers, consider growing yourself out of that dependence by adding more customers or consider strategies to grow revenue from the rest of your customer base. In making these decisions, the new customer acquisition cost should be budgeted, since reducing customer dependence is truly an investment.

Customer diversification can enhance the price multiple when selling a business, and the business won’t be susceptible to the performance fluctuations of your key customers. This can increase your bargaining power with customers and one day, even those key customers that became high maintenance can eventually be pruned.

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