Every business owner knows that having a concentration of customers in a particular area introduces risk. And it’s not hard to find yourself drifting into the danger zone; if a single customer represents more than 10% of your revenue, you’re already there. 

But that 10% rule is only the beginning when it comes to evaluating your risk. In this article, we’ll look at the less visible risk factors that could be silently eroding your company’s stability and the steps you can take to spot them—and fix them—before it’s too late. 

8 hidden customer concentration risks

The simplest way of calculating customer concentration risk is to identify the percentage of total revenue that each customer generates. If one customer generates 10% or more, or if the top five generate 30% or more, it’s considered (by lenders and acquirers, among others) as being unbalanced.

But a nuanced and accurate risk profile is more complex, requiring you to know more about your customers than how much top-line revenue they generate. Here are eight factors to think about. 

1. Corporate relationships. Make sure you know whether your customers are subsidiaries, divisions, or separate legal entities that roll up into the same parent company. In these cases, what looks like a diverse customer base can quickly evaporate if the parent changes course. 
2. Seasonality. A standard revenue metric calculated on trailing twelve-month revenue can hide the outsized impact of a seasonal order. A single, one-time order may represent only 8% of your total annual revenue (still within healthy concentration limits), but if it represents 30+% of revenue for a specific month or quarter, it could have a catastrophic impact if it suddenly disappears.  
3. Customer recency. Revenue generated by new customers should also be weighted differently. Since that revenue won’t show up consistently in historical averages, you’ll want to look at forward-looking metrics that capture their full impact on the future revenue stream.
4. AR concentration. Accounts receivable concentration by customer can look very different from revenue concentration, and credit exposure is an important risk metric to track. Examining AR concentration can reveal a percentage of revenue tied up in invoices that exceeds a healthy proportion of the whole. 
5. Gross-margin concentration. Tracking profitability by customer can uncover vulnerabilities that revenue alone can’t. Two customers might each bring the same percentage of total revenue, but if one is a high-margin relationship and the other is near break-even, losing the high-margin customer will have much bigger consequences. 
6. Pipeline concentration. Don’t treat customer concentration risk as today’s problem. Analyze and prepare for future concentration risks by examining the sales pipeline. A pipeline dominated by a single prospect will go totally unnoticed if you only look at current financials. 
7. Industry concentration. If you serve a large proportion of customers in the same sector, a single event, such as a regulatory change or market downturn, could devastate your revenue. Grouping customer revenue by industry can help you spot the issue.
8. Key-person dependency. Close relationships between your customers and staff can present a type of concentration risk that sits entirely separately from the balance sheet. If customers are likely to follow the salesperson when they leave, it’s important to recognize this risk and identify all the customers they maintain close relationships with. 

How to reduce your true customer concentration risk

Protecting your revenue stability isn’t as simple as following the 10% rule, but it doesn’t need to be complicated, either. Tracking a few additional metrics, improving your customer retention strategies, and smoothing out your cash flow is all it takes to make a big difference.

1. Track these critical concentration metrics

To untangle your true customer concentration risk, track the metrics listed below as well as the top-line revenue per customer.

• Revenue per economic entity, such as parent company or controlling ownership group
• Revenue concentration by industry
• Forward revenue concentration (contracted or pipeline revenue for the next 6–12 months)
• Profitability metrics (gross margins) per customer 
• Credit risk (receivables concentration and days sales outstanding) per customer
• Revenue per key person (amount of revenue that might be lost with the departure of a salesperson or account manager)
• Customer tenure (long-standing customers are at less risk of leaving than new customers) 

2. Improve business development and retention 

Robust business development and retention strategies help you fill the pipeline and replenish lost customers. Prospecting should focus on cultivating a diverse customer base, and prospecting activities need to be maintained even during busy periods. 

Finding ways to incentivize long-term contracts can also help to reduce customer churn and stabilize revenue. Special pricing or access to senior-level expertise, contracts that allow customers to exit or adjust the contract for defined reasons, and well-defined service-level provisions are effective ways to encourage customers to commit to longer terms. 

3. Smooth out your business cash flow

The unexpected loss of a customer who generates significant revenue or profit can place a strain on your company financials. If that revenue is earned seasonally, it can be even more challenging to keep adequate working capital on hand. 

Here are two things you can do to make your cash flow smoother and more predictable.

1. Improve accounts receivable processes. Accounts receivable is more than an administrative function. It’s a way to manage, predict, and optimize your business revenues, profitability, and cash flow. Improving purchase order and invoice documents, establishing proactive follow-up processes, and producing detailed aging reports are just a few of the ways you can see more cash sooner. Get more tips on improving your accounts receivable.
   
2. Improve access to working capital. Building strong cash reserves can save your business from going into the red when customer revenues unexpectedly plummet. But it’s not always realistic for a thriving, fast-moving business to keep a large amount of cash on hand. Invoice factoring can help you access operating cash when you need it without tying up cash needlessly when you don’t. Factoring can be used as a short-term fix or a long-term cash flow strategy, and you can choose the number of invoices you choose to factor. Learn more about factoring, or talk to a factoring specialist in your region.