Customer Concentration in Manufacturing: When Your Best Customer Becomes a Risk
Originally published on October 26, 2026
“Just ’cause you’re busy and just ’cause you’re growing doesn’t mean you’re more profitable.” (Kevin Golden, CPA)
In this episode of Moore on Manufacturing, Mike Sibley, partner and leader of the James Moore manufacturing team, is joined by partner Kevin Golden. They discuss customer concentration in manufacturing, which is what happens when one or two customers make up a big share of a company’s revenue. They also cover how to measure that exposure, how to prepare for pressure from large customers and what concentration can do to the value of your business.
A large anchor customer can bring growth, efficiency and room to invest. As that customer’s share grows, though, so does the exposure. Mike and Kevin explain why lenders and buyers start asking questions at around 10% of revenue and why contribution margin and cash flow by customer matter more than sales volume. They also explain how fast growth from a single account can strain working capital.
The two also walk through practical ways to bring concentration down without turning away good work, from selling more to existing customers to building a stronger sales system. Mike shares a recent example of a potential sale in which customer concentration led every interested buyer to discount the price.
Resources
Transcript
[00:03] Mike Sibley: Hi, I’m Mike Sibley, partner and leader of the manufacturing team here at James Moore and Company. I’m joined by Kevin Golden, my partner and also a member of our manufacturing team. Kevin, welcome back on the show again this month. Today, we are talking about a situation that we see all the time in manufacturing, where we have one or two customers that represent a significant portion of the company’s revenue.
[00:27] Mike Sibley: Of course, having that one big anchor customer or a couple of big anchor customers can be great for the business. It can lead to all sorts of efficiencies, growth, opportunities to invest. But the more important that customer becomes, there can be some risk that gets created with that.
[00:46] Mike Sibley: And so today, we’re gonna be talking about what happens when a great customer becomes a concentration risk, how you should be evaluating that, maybe some things that you can do about it and, of course, as always, what does this mean for the value of our business? But before we get started, I just want to have an ask for our audience.
[01:07] Mike Sibley: If you enjoy this content, we ask that you subscribe to us on YouTube or Spotify so you can get all the latest and greatest and get to hear more of these topics that we talk about. And of course, as always, if you’ve got a topic you want to hear about, drop a comment on there and we’ll take that into consideration and see if we can add that to a future show.
[01:28] Mike Sibley: So again, Kevin, let’s get into it and start with maybe the obvious thing. Is customer concentration a bad thing? A good thing? Is it maybe a bit of both? What’s your take on that?
[01:28] Kevin Golden: I think, like most things, it could probably be a little bit of both, right? First of all, you go out there and you land a great customer, somebody maybe you’ve been targeting and trying to get after. It’s exciting. It’s great, especially when they have a lot of needs for what you supply, what you make. There’s nothing more exciting than that. You land that, so what happens next? Well, now you gotta fulfill, right? And then their needs change, and so what do you do? You try to pivot to them and say, “How can I help you? How can I do better for you? Is there something else you need that I can make? Can I make what I’m doing better?” And so over time, trying to service that client
[02:24] Kevin Golden: the best you can and keep them happy and keep yourself profitable, you continue to pivot. So no, I don’t think that’s a bad thing. Like you said earlier, it can lead to more growth, so more dollars to spend elsewhere, whether it’s on your current operations or maybe you’re trying to grow.
[02:46] Kevin Golden: It obviously creates great relationships when you have a good customer like that. So I don’t think it’s necessarily a bad thing. I think it’s whenever all those little pivots add up together to where now you’re servicing maybe that client and that client only, and now, even if you haven’t noticed it, you’ve kind of become dependent upon them. With most things, I say stay away from the extremes. “Okay, we’re only gonna focus on that client and what they need and servicing them because of their size or because of the nature of the relationship.” Not the way to go. But at the same time, if you ignore them altogether, you’ll lose them, right?
[03:16] Kevin Golden: So I think it’s just being aware of, “Am I becoming dependent upon that customer?” And a great way to look at that, too, is, “What happens if that one leaves? What happens to me? What happens to my organization? What would that mean in terms of our growth goals, our vision, me personally as the owner and what I’m able to do?” So again, it’s not a bad thing, but it’s definitely something to be aware of and to understand what those boundaries are if a good customer or set of customers like that may leave, or maybe their needs just aren’t what they were and now they back off a little bit.
[04:02] Kevin Golden: So no, not a bad thing, but definitely something to not become dependent on and keep an eye on, for sure.
[04:02] Mike Sibley: Yeah, I think as they become a larger percentage of your business… We talk about what percentage becomes risky, and I can tell you from a valuation standpoint, from an external third-party standpoint, maybe a lender or something of that nature, they usually start that risk profile somewhere around 10%, and then going up from there. And I’ve seen manufacturers who have customers who are anywhere from 10% to 75% of the business.
[04:33] Mike Sibley: And so there’s a lot of key factors as you look at that percentage besides revenue. When I talked about 10% of your revenue, what is their contribution margin? There’s a lot of benefits, obviously, as you grow. You get overhead absorption that spreads out a little bit more, so you’re able to take all those fixed costs and spread them out, and that makes your margins a little bit better and your gross profit. But what’s your contribution margin from that? What are the cash flows that they generate?
[05:25] Mike Sibley: And then you gotta look into, as that percentage goes up, what is your relationship? You gotta have a deeper and deeper relationship, because what if they have financial problems? Do you know what their financial situation is? Do you understand their forecasts? What about their technology changes? If they change their product, are you able to actually work with them on what that product need is? And I can guarantee you there are other competitors out there.
[05:49] Mike Sibley: Unless you have a very unique business, there are other competitors out there trying to get that business from you. So you’ve gotta stay up on that. And it’s really important that you look annually on a trailing 12. What does my customer base look like? What do my contribution margin percentages look like? What do my gross profit margins look like? Understand the breakdown of those clients and those customers so you can assess risk.
[06:15] Mike Sibley: Because as the leader in your organization, you deal with risk. We’ve talked about supply chain risk. We’ve talked about people risk. Now we’re talking about customer risk. You gotta spend your time with those customers to really focus. You’re gonna look at those percentages, which ones are growing the fastest, which ones are maybe taking up more market share or more of your production share, and start making sure you understand those relationships, their strength and their financial strength. I would absolutely look at their financial strength and where they’re going. In some cases, if your customer’s a publicly traded company, that’s great. You can get all sorts of information on their financial strategies and things of that nature.
[06:58] Mike Sibley: If they’re not, you may have to ask some questions about their goals, where they’re going and how their financials are. But really try to build that relationship so you can de-risk or at least understand the risk that you’re taking as you continue to grow them as part of your business portfolio.
[06:58] Kevin Golden: Yeah. And I think we’ve said this probably several podcasts ago, but when you mentioned contribution margin, it made me think of it. I think we talked about this when we covered growth.
[07:27] Kevin Golden: You can be very, very busy and have a lot of great growth. In this case, we’re talking about growth in relation to one or two specific customers, but either way, you could be growing a whole lot.
[07:44] Kevin Golden: Just ’cause you’re busy and just ’cause you’re growing doesn’t mean you’re more profitable, right? So I like how we’re tying that into contribution margin, to have a better why and make better decisions. Is all the time and devotion I’m pouring into that client, in both hard and soft costs, really paying off like I think it is? Or is there a better opportunity, or even a different way to service that customer that makes a lot more sense, profitably, operationally and so forth?
[08:17] Kevin Golden: So go back to that adage of, “I’m really busy. This client’s gonna bring a bunch of work, a bunch of sales.” Maybe the numbers look good, but really dig into those. Is it really meeting your strategic vision, your profitability goals and so forth? And if not, how can you pivot from there? Just don’t go off of pure volume or how busy they may keep you. And again, I think this pivot into being dependent upon a client or a set of clients
[08:52] Kevin Golden: isn’t something that’s always obvious. If you’re a startup manufacturing company, of course you’re going to have that, ’cause you’ve gotta start somewhere. But especially as you get more experience and you grow, some of these things usually just happen over time.
[09:09] Kevin Golden: Maybe that client didn’t have a lot of needs at first, but they’re growing as well. Like you said, you’re understanding what their needs are, and it just happens gradually. It’s not always night and day, where all of a sudden they’re ordering 10 times as much as they used to. Just like you are, they’re hopefully growing as well, and they kind of grow into that.
[09:30] Kevin Golden: So again, it’s just taking that step back, looking at those relationships, evaluating those relationships and saying, “Is this really in line? Are we really working together, or is this turning into more of a potential concentration risk?” And I like that you also gave a percentage behind it.
[09:49] Kevin Golden: There is no black or white, but in our experience, that’s where this raises an eyebrow. It causes a concern and maybe poses additional questions that a third party, a buyer, a bank or someone like that may want to look at more, and it could potentially even cause concern.
[09:49] Mike Sibley: Yeah. So let’s talk a little bit about what happens
[10:14] Mike Sibley: if I’m the customer. I’m gonna put my customer hat on for a second. I’m coming to you, Kevin, for a lot of business, and it’s growing. Because I depend on you as a supplier, I probably know quite a bit about you, and so I know I’m becoming a major customer to you.
[10:35] Mike Sibley: So what am I gonna do? I’m looking to improve my margin, so I’m gonna come to you and say, “I need some price downs here. If I’m gonna grow this, I need some discounts, because you should be benefiting from my growth, from overhead absorption and from being able to live off the volume. And oh, by the way, I don’t want 30-day terms. I want 60 or 90-day terms on my payments, because we’re gonna have so much going through there.
[11:02] Mike Sibley: You’ll be fine.” So all of a sudden these pressures start coming. As a supplier, as a manufacturer with a customer that’s becoming really large to the business, this is why you go through a budgeting process. This is why you understand your costing.
[11:21] Mike Sibley: Your material costs, your labor costs, your overhead costs. This is why you understand those things, because you’ve gotta be prepared for that to happen as they grow. Now, if they don’t do it, you push for whatever you can push for. But just know that if you’re pushing for something and they’re not getting some benefit, or you’re not being collaborative with them, they might be out there looking for another supplier.
[11:48] Mike Sibley: So you gotta be careful about just always doing price increases. If you’re looking at it, you gotta be prepared to say, “With this growth…” If their volume is going up like this, we don’t necessarily need their prices to go up like that.
[12:03] Mike Sibley: We can maybe cost those out, ’cause we know we’re getting better overhead absorption, as an example. That’s one way to look at it. We might also be able to leverage that, go to our suppliers and say, “Listen, with this forecast going up, we want a discount off of your materials.” So you’ve gotta manage your cost side of things, knowing that we may have to give them some pricing discounts or some price concessions in order to keep that growth going. So you really have to be thinking about some of those things.
[12:32] Mike Sibley: On the other hand, going back to understanding what their business is doing and their technology changes, there’s your own capacity. What have we got? We gotta do CapEx planning. We gotta do space planning. Is our facility good enough? Do we need to hire? There’s a lot of different pieces as this goes, so you can keep this customer happy and keep filling their demand.
[12:58] Mike Sibley: But you have the other risks that we talked about earlier. If you do all this and their demand starts to slow, now you’ve got all this excess capacity. So is it equipment that can be used in other areas? Can you fill that with other customers? There’s a lot of planning and risk analysis that goes into what this means for our business that you gotta think about.
[13:23] Mike Sibley: And the larger they get, the more you need to think about this.
[13:23] Kevin Golden: Yeah. And those things you talked about… I mean, any prudent business owner is always looking at their costs, right? Always looking at how we can make these margins better and how we can squeeze more out of what we have.
[13:42] Kevin Golden: So the ask that a customer like that has, “I’m buying a lot more from you now. I would like better terms. I’d like better pricing,” whatever that means, is not necessarily a bad ask, right? As a business owner yourself, you’re probably turning around and doing the same thing to some extent. So it’s not necessarily bad, but it’s understanding, “Okay, if we do that, what does this mean? If we give those longer terms, even going from 30 to 45 days, how does that impact our cash flow? Is that gonna put undue stress on us, where we’re making some really hard decisions three months from now? Could we have avoided that altogether had we given concessions somewhere else to make that client happy or negotiated slightly better terms?”
[14:28] Kevin Golden: So again, it’s not that those are bad things. We’re happy clients are happy with our products, happy with what we provide and happy they wanna do more and more business with us. But it’s understanding what that means for me. And that gets into the other end: what happens if they leave? So Mike, beyond the obvious impact of, “Okay, we’re not as profitable for the year,” how do you, as a manufacturer, or how do you tell your manufacturing clients, “Here’s how we’re gonna prepare. This 10%, this 15
[14:57] Kevin Golden: or 20% client that we depend upon, if they leave, what are we going to do?” Are we just in the scenario where we’re trying to think of every which way to replace that as quick as possible, or what does that conversation look like?
[14:57] Mike Sibley: Well, I think there are multiple things that we’ve gotta consider with that. I think that’s a great question.
[15:16] Mike Sibley: So when you get into it, and we mentioned this earlier, understand your profitability by customer, so you understand the impact they’re having on the bottom line. Not only their margins, but also their contribution margins, so we can understand it pre-overhead.
[15:36] Mike Sibley: Contribution margin is really revenue minus your direct costs, typically material and labor. That’s typically how it’s measured. Most companies have a pretty good sense of what that is. Sometimes manufacturers have a little trouble with overhead allocations and things like that. It’s still important, so we need to understand that.
[15:53] Mike Sibley: I also think you put a budget together and you put a forecast together. When you’re putting that together, and we’ve mentioned this plenty of times in the past, you have to count in your baseline, and then where are your opportunities and where are your risks? Your risks are, what happens if a large customer decreases, and maybe you don’t have good insight into what their forecast looks like, so you’re just making some assumptions based on the past?
[16:14] Mike Sibley: What happens if that doesn’t happen? What happens if, rather than 10% growth, they actually have a 5% decline? What does that mean for your business? So I think starting with a plan like that gives you insights into what you need to do. Because when you see those risks, you say, “Okay, what do we do to mitigate these risks? Well, let’s go talk to that customer and find out what’s really going on with them and what we can expect.” The other thing that happens when you have a large customer, or a customer that’s growing
[16:44] Mike Sibley: really fast and all of a sudden one day becomes a large portion, is you can tend to neglect the other customers in your client base. So one of the things that we like to do is analyze the customer levels and trends over time and say, “Hey guys, what’s going on with these customers here? Your margins are slipping on them, or their sales are declining.
[17:08] Mike Sibley: Why are their sales declining? Is it because maybe they found somebody else? Maybe they’re not happy with our pricing? Is their business failing? What’s going on with them?” Maybe we have some lost opportunities with these other customers, and we can get our sales team or somebody working on building those back up and maybe reduce a little bit of the risk that we have with this one customer.
[17:32] Mike Sibley: So there are things that you can do on the planning, the setup, the budgeting and the analytics side of things to make sure you understand what’s going on with your business. And then you take that and build it into a cash flow model. As you just mentioned, what happens if we have to go to 60-day terms? What does that mean for our working capital? What do we need to support? Do we need a line of credit? Do I need to go talk to my bank and say, “I need a million-dollar line of credit, not a $500,000 line of credit, because we’re gonna support this growth. We’ve talked to this customer, and they’re gonna grow and they’re
[17:58] Mike Sibley: gonna support this. So we need you as our lender to be in with us and help give us that working capital.” That’s what planning, budgeting and forecasting can do for you. It gives you the big picture to say, “Okay, if something does go wrong, here’s what this means.”
[18:15] Mike Sibley: Because in that scenario, we could easily just say, “Wipe out this customer as if they didn’t exist. What does that mean for our bottom line?” And then you know what your worst-case scenario is. It allows you to step back and say, “Okay, let’s make some decisions to reduce our risk and maximize our opportunities as we move forward into the next year and the years beyond that.”
[18:38] Kevin Golden: Yeah. Well, take the example you gave there of, “I’ve gotta go to the bank and say I need that.” Planning ahead of time, for one, helps you create that vision. ’Cause guess what? You need to repeat that vision to that bank,
[18:55] Kevin Golden: ’cause they don’t live in your organization. Hopefully, if you’ve got a great long-term relationship with them, that may be an easier conversation. But you’ve gotta get them bought in, ’cause that’s what they’re investing in when they lend that money: you and your vision. When it’s clear, you can say, “Here’s what we’ve looked at, here’s where we’ve budgeted those risks and those opportunities and here’s what that looks like if we can increase this volume or this demand that our customer has.” Great. Now they’ve bought into that vision. They’ve bought into a plan. They’ve bought into an
[19:22] Kevin Golden: idea. A lot of times, though not always, that’s gonna go over a lot better in those conversations and those asks. And it’s proactive and ahead of time, so you’re not scrambling at the last minute and subject to whatever’s available at that time. So again, that builds the relationship with those third parties so they buy into the same vision, ideas and thoughts you’ve had, and it shows them that you’ve thought it out. So what does that do? Decreases
[19:50] Kevin Golden: their risk, right? Then they’re much more willing to extend that line of credit, open that new loan or whatever it may be to help you continue to grow. So I like that a lot, not just for the customer risk, but for building relationships and being able to tell a story to any other third parties that may be looking at you.
[20:14] Mike Sibley: Yeah, and we could do a whole session just on getting ready for third parties, dealing with bankers and lenders and things of that nature. But at the end of the day, third parties are looking to understand the story. Every business, the business itself and the financials, they tell a story.
[20:32] Mike Sibley: Where have we been? And really importantly, where are we going? Obviously, if we’ve been very successful in the past, it makes it a little easier, right? If we’ve had good profitability and a good track record. The ongoing joke with banks is they’re always willing to give you money when you don’t need it, right? Well, let’s get that line of credit while we don’t need it. Hopefully we won’t ever need it, but if we do, we’ve got it there. But they also wanna understand the story going forward.
[21:01] Mike Sibley: So part of this planning process is going back to what our story looks like. Our story in terms of our customer base, our customer concentration, where their growth is going and what we forecast our financial situation to look like,
[21:19] Mike Sibley: and why we need a line of credit. Well, it’s for support. We’ve got this growth. Growth requires working capital. Working capital lags, right? The growth comes first. You gotta spend money first, and then the money gets collected later. And if you’ve got a very large customer that all of a sudden ramps up really, really fast, you’re buying a lot of materials.
[21:37] Mike Sibley: You’ve got a lot of labor. And depending on their terms, you could have anywhere from 30 days to six months before you truly collect all the money that you’ve spent out there. So you’ve gotta be very, very careful with a customer who’s ramping up really fast and becoming a big portion, because it’s going to strain your working capital.
[21:59] Mike Sibley: So you gotta be prepared for that. And oftentimes, if a company does a budget, they’re not connecting that budget with a projected balance sheet and a projected working capital need.
[22:15] Mike Sibley: And that’s really, really important, because that’s gonna show you where you’re running into some issues if you hit that growth.
[22:15] Kevin Golden: Yeah. Mike, let’s take that example. Say you’ve got a customer that’s growing a lot, or a new customer comes to you with a large percentage, and over several years you realize, “Oh my gosh, this is getting to be 25, 30% of what I do.” What do you do there? Do you just say, “I need to keep this in check. Let’s get this down to a more reasonable level”?
[22:45] Kevin Golden: I never like the idea of just stepping away from work, especially if we realize it’s good work, it’s good sales and it’s contributing to the bottom line the way we expect. So how do you scale that, or diversify, I guess, to manage these risks a little
[23:04] Kevin Golden: better, without going to a large, long-term customer and saying, “I’m sorry, we’ve gotta reduce, because we can’t handle that size of a risk”?
[23:04] Mike Sibley: Yeah, I definitely don’t see that as being a practical way of saying, “No, we don’t want your business.”
[23:21] Mike Sibley: Of course you’re going to take it. But you do need to make sure: Are we growing, and are we growing profitably? Is it a good win-win for us and for the customer, so we can keep them happy? And going back to what we talked about earlier, we also wanna make sure we understand where they’re going and how they see this growing over time. Is it going to double, triple, quadruple over time? Is it gonna continue
[23:45] Mike Sibley: to grow? We wanna understand all of those things, because we do have to assess our capacity and our ability to grow with that. We may have facility limitations, equipment limitations, people limitations. So we need to understand those components of what’s happening with them, and I think the larger they become, the more important that is.
[24:06] Mike Sibley: Now, what do we do in terms of getting that percentage down? The reality is we get that percentage down by winning some new logos or some business with existing customers.
[24:21] Mike Sibley: And that’s one of the things we talk about a lot, depending on the customer base: your current customers are often the greatest source of new revenue. It’s cheap. They’ve got relationships with you. You’re perhaps already on their approved vendor list. Are we going in and farming that business? We go in and find out, do they have other pain points? We have a product range. They’re only buying this product, but based on their business, they could be buying these other three
[24:50] Mike Sibley: products. What are we doing to go get that and sell to those current customers? Then, and we’ve had a lot of discussions on sales systems, what is our sales system? How are we bringing in new logos? How are we going after that new business? Do we have a good system for our salespeople? What does our market look like? Who are our target market clients? We set all that up and then go in and try to bring
[25:19] Mike Sibley: in additional business. Meanwhile, we’re gonna continue to ride that customer. We’ve gotta ride it the right way, and we’ve gotta do all these things to try to even that out. At the end of the day, it’s not uncommon to see a customer with 10, 15, 20 or 30% concentration.
[25:37] Mike Sibley: It’s part of doing business and part of understanding the risk of doing business, but you gotta make sure you’re not ignoring other customers or neglecting to grow the other side of things. We put strategies around de-risking ourselves, and if we can get them down to 10% and they’re still growing, great.
[25:56] Mike Sibley: If not, let’s continue to try to grow this other side.
[25:56] Kevin Golden: Yeah. No, I like that. It’s almost like it forces you… It’s not black and white, like we’ve said, where you hit a certain threshold and that’s bad. It’s just forcing you to say, “Okay, let me reevaluate current relationships and new relationships we’re trying to form.
[26:15] Kevin Golden: Are we really producing like we think we are? Or, like we said earlier, are we really relying upon the success of one or two clients to get us through?” So again, it’s like most things we talk about. It’s being aware of these things and looking at, as you mentioned earlier, profits by customer, contribution margin, accounts receivable and those concentrations. Just being aware of that is gonna ultimately help you make better decisions.
[26:45] Kevin Golden: Because again, we’ve talked about it before, there’s a lot that you can look at, right? But it’s what do you look at, and more importantly, what do you do with that? So it’s almost a forced look. You get there and say, “It’s time to reevaluate, if we haven’t already, or with some regularity. What are we doing in our current markets and other markets we’re trying to grow into? What are we doing with our current products? How are we educating our customers about them?” And it’s understanding their needs, too, as you mentioned, their pain points, their needs
[27:13] Kevin Golden: and how those may fit together.
[27:13] Mike Sibley: Yeah. So as we get into that side of things, I think that’s why we go back to the planning process. Manufacturers have all the data in the world. They really do.
[27:33] Mike Sibley: It’s a matter of getting that data in a way that’s easily digestible. In fact, we just did a Moore on Manufacturing on data not too long ago, maybe last month or the month before. So we’ve got some discussions on this. But it’s taking that data, being able to digest it and then using it to set a plan to help de-risk yourself and work on those things.
[27:52] Mike Sibley: When a customer comes to you and says, “We need to negotiate something,” you need to be prepared for that. What can we live with? You also have to understand whether the product you develop is your IP. Is there
[28:09] Mike Sibley: anything else out there like it? Is it totally unique, where you’ve got leverage? I’ve got some clients where nobody else can do what they do. And if somebody else can do it, it’s gonna be years before they can, so they’ve got the leverage back.
[28:24] Mike Sibley: So those things can play into it. If it’s something that’s somewhat commoditized, where they can go to three other places and get it, you’ve gotta really take that into consideration. You have to understand what that means as part of your risk.
[28:40] Mike Sibley: Can you do it better? What other things do you bring to the table? Is your customer service better? Is your process better if there’s a problem? What are your differentiators if you do have competition out there? Manufacturers are gonna have different levels of competitors. Some are gonna have a lot of competitors. Some may not have so many. So you gotta understand what your leverage is and your ability to negotiate back. That said, I had a client
[29:09] Mike Sibley: in the last few years who didn’t think they really had any competitors. My big concern was that if the customer can’t afford your prices, and it’s not something that’s locked in IP because it’s very project-based and based on designs from the customer, they’re gonna go somewhere. Somebody’s going to make it, and it’s gonna be done cheaper.
[29:37] Mike Sibley: Now we’re seeing China get involved and others. They basically created their own competitors by not pricing very competitively for what their customers need. And so now they’re seeing a lot more challenges. Those are the kinds of risks you have to evaluate in these processes, because again, unless it’s some IP that only you have, if somebody else can do it, somebody else will be doing it at some point if they’re not doing it now.
[30:09] Kevin Golden: Yeah. I like those differentiators. Like you said, what really separates us? What keeps somebody else from replicating that, either now or sometime in the future, and then taking those customers
[30:26] Kevin Golden: right from you? What is your strategic advantage? And then lean into that. That was a good example of, “We don’t have a lot of competition, or perceived competition, so we can just do what we want,” to an extent. This also goes back to being in touch with your clients, especially those bigger, more highly concentrated clients, and what their needs are.
[30:51] Kevin Golden: Then when those conversations come up, they’re gonna be a lot more collaborative. It’ll feel a lot less demanding. It won’t be, “Oh my gosh, I’m getting all these demands.” No, they’re just trying to do the same thing you are: make a profit and do well at it, right? So now it’s more collaborative, and you’ve got the data to say, “This is the means by which I can work.
[31:07] Kevin Golden: Here are some concessions I can make,” or, “Here’s what I’m gonna ask in return.” That makes it, maybe not quite a win-win, but at least more collaborative, rather than simply a list of demands that could potentially be met elsewhere.
[31:07] Mike Sibley: And I think the better organized you are in your budgeting, your financial statements, your data and your forecasting, the more informed the decisions you can make on what the impact is. Now let’s switch gears to
[31:36] Mike Sibley: perhaps the final point: what’s the impact on the value of the business? I can tell you firsthand, this just happened in the last three months. I had a client going through a potential sale process, and they’ve got a customer that’s a significant portion of the business. The buyer applied a significant discount to the multiple.
[32:07] Mike Sibley: That deal’s not gonna go through, but the point was that because of the customer concentration, any buyer that was interested discounted the price. It was still a good price, but it was discounted. At the end of the day, a significant one or two customers will scare a buyer.
[32:33] Mike Sibley: If you’re looking to sell the business in the next year, two years, three years, a significant customer concentration will devalue. And let’s talk about why. It’s obvious. If that customer leaves, the EBITDA that gets generated out of that business is at risk. So let’s just say you’re a company that has a million dollars of EBITDA, and you have one customer that produces 300,000 of that EBITDA.
[32:57] Mike Sibley: If they run away, 300,000 of EBITDA would go away. That’s a 30% reduction, and so they’re going to discount that. I’ve seen it happen many, many times. In fact, I’ve seen companies that were unable to sell because their concentrations with customers exceeded 50% with one to two customers. Just too much risk for buyers to wanna deal with.
[33:25] Mike Sibley: Maybe it’s ultimately that significant customer that buys you, but they’re going to discount you too, because they know they’re the big piece of what makes up the business. So it really impacts the valuation, and it impacts the risk. It comes back to planning, and one of the things that we talk about is transition planning.
[33:50] Mike Sibley: When you’re planning, ideally we’re looking three to five years out, and we’re looking at all the risks. What are the value drivers of a business? One of those value drivers is your customer base, the profitability of that customer base and the concentration. And the idea, going back to exactly what we talked about earlier, is how do we get that percentage
[34:10] Mike Sibley: down? We’re not gonna stop them from growing. We’re not gonna stop taking their work. But how do we grow the rest? How do we diversify? How do we expand that out? How do we get more of our products in with other customers that we already have? How do we get new logos? Those are really the big things we need to be talking about.
[34:10] Kevin Golden: Well, and when you’re having those conversations, here’s what you don’t want to have happen.
[34:33] Kevin Golden: “Did you realize X, Y, Z customer was 40% of your business?” “No, I really thought it was 20%.” Okay, that creates doubt and concern. “Have you thought about what happens if that client leaves? What does that do to your business?” “No, I’m not really sure.”
[34:53] Kevin Golden: Well, I’ll tell you what it means, ’cause they’re looking at your numbers just as close or closer than you are. That creates concern and risk. You gotta remember, a buyer has gotta step into your shoes. There are relationships you may have had for 20 years that they’re just now taking on, not to mention internal relationships with staff. They have to try to generate the same profit, then grow it from there, pick up where you left off, so to speak, and make
[35:21] Kevin Golden: it even better. A lot hinges on that. That’s a lot of transition. If there’s any concern at all, whether it’s in the numbers, in the relationships or lack thereof, or in a lack of understanding of the true impact of a certain customer on your company, that’s all gonna create doubt. And then, to your point, Mike, doubt does what? Discounts.
[35:46] Kevin Golden: Discounts, discounts, discounts. And it doesn’t seem like a lot at first until you add those up, and next thing you know, you’re 30% lower than where you thought you’d be. I’ve seen it happen before. “If I had known this, this or this would happen and that I’d sell for 30% lower, I would have never done this deal, but now we’re too far along.”
[36:04] Kevin Golden: It’s almost no turning back. So again, it’s not necessarily that concentrations are bad. It’s more what you’re doing with them and how someone else could pivot with that to continue growing your business. That’s what makes you attractive and makes them want to pay top dollar, especially what you’re asking for that business.
[36:25] Mike Sibley: Yeah, great points. So what should manufacturers do? Obviously, the first thing is to understand your customer list, understand your exposure and understand the contribution margin and gross profit for each of these customers.
[36:43] Mike Sibley: And as we said before, make sure you’re budgeting and forecasting and that you understand your baseline, your risks and maybe what your upside is. And really build out that diversification strategy. It’s great for the value of the business.
[36:59] Mike Sibley: It takes down the risk. Start with your current customers. Analyze your current customers. That’s certainly something we do a lot with clients. We help them understand the current client base and any declines, not only in revenue but also in margins, and where things are happening.
[37:18] Mike Sibley: And as you’re doing these forecasts, make sure you’re doing your CapEx forecasts and your people forecasts. What are your risks if you do buy all this CapEx? Can you use it elsewhere? Do you have a standard product? Do you have a whole bunch of products? Are you a contract manufacturer? Are you a job shop? What is the nature of your business? Make sure you build that into it.
[37:43] Mike Sibley: And I think if you set the time aside and do these things, it’s actually gonna be an opportunity to grow your business in other ways, perhaps with other customers. Oftentimes when we do have that significant customer, we can get really busy, and we can take our eyes off the customer side to keep the operations side going.
[38:01] Mike Sibley: We gotta keep focus on the customer side and make sure we’re building and growing that customer base. We need to make sure we’re working with more customers on building out more opportunities with them so we can keep that risk mitigated.
[38:19] Kevin Golden: Yeah, I like that. It’s not something you turn on and off like a faucet or a light switch, where you say, “I’m gonna work on operations here” and completely neglect sales or customer relations, or vice versa. You always have to keep that going. So I like having regular visibility into these customer lists, these concentrations and these various metrics. Look at them regularly to make sure you keep them in check before something becomes a fire, a problem
[38:47] Kevin Golden: that we’ve all of a sudden gotta solve for. ’Cause usually in those moments you’re not making your finest decisions, right? So be prepared, look at it regularly and definitely have some transparency into what that concentration looks like.
[39:03] Mike Sibley: Absolutely. Great points, and Kevin, as always, I appreciate the insights. Another good conversation today. For our listeners, again, you can hit Subscribe on YouTube or on Spotify. We would very much appreciate that. And of course, we’re always open to ideas on topics we can discuss to help bring more knowledge into your business.
[39:28] Mike Sibley: So once again, we appreciate you listening. We hope you all have a great day, a successful month and a great finish. We’re pushing into the last quarter of the
[39:48] Mike Sibley: year, so hopefully you’ve had a successful year and have a good quarter to come.
[39:48] Narrator: To learn more about James Moore and Company’s manufacturing services, go to jmco.com. And don’t forget to subscribe to our Moore on Manufacturing series to receive updates when new videos and podcasts are released.
[40:08] Narrator: If you’d like to be a guest, or if there’s a topic you’d like to see covered on a future episode, contact us on our website. You can also follow us on social media for more news as the landscape on manufacturing continues to rapidly evolve.
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