How to Manage Customer Concentration Risks in Your Agency
While it's tempting to take on any client that comes your way, not all clients are good clients. Some clients may be too big, demanding too much of your time and resources, while others may be too small, providing insufficient income to justify the effort. Finding the right balance is key to ensuring your agency's long-term success and profitability.
What is Customer Concentration?
Customer concentration refers to the proportion of your agency's total income that comes from a single client or a small group of clients. As a general rule, it's best to avoid having any one client account for more than 25% of your gross income. When a single client dominates your income stream, it can lead to what's known as the "Golden Goose Syndrome"—an over-reliance on one client that leaves your agency vulnerable to significant financial risk if that client decides to leave or reduce their business with you. Diversifying your client base and ensuring that no single client holds too much power over your agency's financial health is essential for long-term stability and growth.
The formula to calculate customer concentration for each client would look like this:
(Gross income from client / Agency Gross Income).
Here's an example. Say one of your clients was responsible for $400K of your $1M business; in that case, the customer concentration for that client would be 40%.
Customer Concentration Risk
Customer concentration risk can manifest in two ways: (1) having one or two "golden geese" that dominate your revenue stream or (2) serving too many low-revenue customers. Both situations can lead to significant problems if not managed properly.
Golden Goose Risks
They tend to be overly demanding. They know they are your biggest client, and this gives them comfort to make last-minute requests that always need to be handled immediately. You are nervous to push back because of how much of your billings they represent.
They exert downward pricing pressure. As much as you want to negotiate, you both know who has the most leverage in negotiations.
When you lose the golden goose, you lose the income before you lose the expenses. All those folks you hired to service the account are now sitting on your bench with no clients to service.
Complacency usually sets in. Because the golden goose is so demanding, you tend to over-invest time with them, leaving little time for business development.
Multiple Small Customer Risks
They tend to get over-serviced just like your larger clients—except the profitability is not built into these smaller contracts to compensate for the additional time you're spending on them.
They create an inherent profitability risk when collectively, they represent a large percentage of revenue and your profitability with each customer is small.
When is a customer too big or too small?
When assessing whether a customer is too big or too small for your agency, you need to consider the potential risks associated with customer concentration. To mitigate these risks, you should strive to maintain a balanced customer portfolio, with no single customer accounting for more than 25% of your gross income. On the other hand, you want to be cautious about taking on customers who represent less than 5% of your revenue, unless you feel there is significant room for growth. At less than 5%, the profitability usually doesn't justify the resources you'll expend. This rule doesn't always apply, so think of it as a potential red flag. A good way to think about this is to establish 4-5% of gross income as your minimum customer size.
For example, if your gross income is $1M, your minimum customer size would be $40K-$50K.
When you have customers at this threshold, you can ask yourself the following strategic questions to determine whether you should consider the work:
Can more money be made from this customer in the future?
Does having this customer on our client list help us land other customers?
Does this work help us learn new skills?
Key Takeaway
When it comes to managing your agency's customer portfolio, it's crucial to find the right balance to avoid high customer concentration. While landing a "golden goose" customer can be a significant boost to your business, relying too heavily on a single customer can put your agency at risk. Similarly, taking on too many small customers can strain your resources and impact profitability.
If you need help assessing your agency's customer concentration and developing strategies to optimize your customer portfolio, consider reaching out about our Agency Ops service. We can work with you to create a customized plan that helps you mitigate customer concentration risks and achieve sustainable growth.