Too big to fail #client

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For small businesses starting out, growing client business any way possible, is of the essence. Whether that is small bits of business with many clients or larger deals with few clients. Often, growing business with an existing larger client is a preferred route. Familiarity with the client’s business, network with key influencers, reduced admin effort and growing reputation within the business make this an attractive proposition. New clients mean stepping up a learning curve, dealing with unfamiliar processes and culture, additional admin and more uncertainties.

Sometimes, a small business lands a large corporate client, does a stellar job and the client loves to work with them. Subsequently they are asked to do more and more. We’ve seen very small businesses grow to accommodate one particular client’s demands very quickly. The client is a prestigious brand name in the industry. The small business is attractive to them because unlike larger competitors, its giving them all the attention, is flexible and keen to please its cornerstone client. Personal relationships develop and the dynamic accelerates.

However, as much as this sounds like a symbiosis to strive for, it comes with risks for both parties, but more significantly so for the small business. If a client makes up the lion’s share of your revenue, this should give reason to pause and assess different scenarios, from further growth to losing the total client business. It probably should also trigger efforts to diversify the client base before further growing the one client and having an open discussion with the client how to keep the relationship sustainable for both parties.

Instead of a “hope for the best – head in the sand” approach, the following needs to be assessed and planned for:

Relationship quality

This is not just about how great the working relationship is and how successful you are at meeting the client’s expectations. Given this is the largest client, it’s probably right. But also assess more long-term and strategic relationship qualities, including:

  • Is your business able to learn and evolve its’ offering with this client or do you keep being asked performing the same narrow services only?
  • Does the clients’ culture and ethics align with your values or do you need to bend your principles?
  • Is the client supporting your diversification to other clients and interested in being a healthy share of your overall profit or would they rather be exclusive?
  • Does the client’s own business have a healthy outlook for the future or are they in an industry in decline?

These questions are part and parcel in gaining a realistic and rounded perspective on different dimensions of relationship quality beyond just being comfortable with each other. A regular conversation with the client that doesn’t just serve to discuss business as usual updates, but also those more strategic aspects of the relationship are important.

Risk assessment

Assessing your risk with the client is especially important if they are a large “bulk” risk. As a rule of thumb, as soon as they exceed about 25% of your revenue, assessing that risk should become a high priority, but exact numbers depend on the industry and client characteristics (e.g. in certain industries monopoly client or supplier relationships are more common and demand more stable).

The risk assessment includes:

  • Financial risk: revenue at stake, demand fluctuation, cash flow issues, investment requirements
  • Talent risk: key talent on account and succession/backup plan
  • Technological risk: client technology requirements, risk of maintaining outdated technology for client
  • Legal risk: Liabilities specific to the client and ensuring policy cover, legal action risk, IP issues, etc.
  • Reputational risk: Client related reputational risk either through own failure or client misconduct or failure
  • Termination: effect of a partial or full termination of the engagement

Scenario planning

Building on the risk assessment, scenarios can be planned. These range from preparing for the different risks to occur, up to termination or a major lawsuit to positive scenarios with the need to grow and professionalize quickly. The latter is equally important, so that when the client comes with a much larger project and would like to engage you, you are clear whether this is possible, what you need in terms of financing, talent, infrastructure and other investments and what the revised conditions to the client would be.

Scenarios to plan for might include:

  • Loss of major client business
  • Loss of key talent on client account
  • Spike in demand with ad hoc requirement for more resource
  • Change in client technology platform
  • Demand for quick growth of team/engagement size

Not every hypothetical scenario needs to be planned in detail, but those that could realistically occur for your business and client engagement. This is not just good practise and avoids panic and poor response, investors and lenders will likely want to see this fleshed out in a business plan as well.

Contract negotiation

If your client is a significant bulk risk and especially if you are asked to make investments in staff, capital expenditure, tools and others which are hard to divest or transfer if the client terminates the contract, this should be brought up in the contract negotiation. Clearly explain the risk for your business and suggest contract language and provisions that help mitigate those risks for you.

To consider especially are contract termination periods, post contract obligations especially exclusivity/non-compete provisions, right to use specific client references/case studies and specific tools or capital equipment the client requires (joint investment, buy-back clause, client buy, etc.). These are contract clauses if correctly negotiated, can help mitigate some of the risk if the client terminates the contract or significantly reduces the amount of business they give to you for whatever reason.

Diversification

Talking about “bulk risk” clients, it is logical to also work on reducing that risk by diversifying the client base. Looking to diversify clients should not just put your mind at ease, but also the client’s. Being the sole or by far largest supplier has advantages in terms of flexibility and buying power, but also is a big responsibility and comes with the draw back that the supplier is not learning from a broader set of clients.

Procurement teams frequently look at concentration risk in their supply base and a supplier which had revenue come from very few clients is often a cause for concern. If they are the largest client, the reputational and possibly legal risks of reducing the contract is a concern. If another client is contributing the lion’s share of the revenue, the concern is for the financial stability of the supplier should the other client withdraw business and also being low on priority.

For the small business, new clients constitute an opportunity to gain new insights, work in a different environment and with different demands and gain additional industry references. Suppliers are often brought in for their ability to add a different perspective and without a breadth of client work, they become prey to tunnel vision on how things are done with the major client, at the detriment of innovation and competitiveness in the market. So working on a balanced client portfolio is advantageous in most instances. And having a large anchor client in an industry can provide an excellent reference for sales to other companies in the same or adjacent industries.

Finally, the term “too big to fail”, borrowed from the banking world, should be cause for decisive action along above lines. No business is fool proof and could always fail or chose not to engage with a supplier any longer. Management or strategy change, a move to another location, a merger, project failures and more could give way to a termination or significant reduction of the business awarded. Not to be prepared for that case would be ignoring reality and dangerously reckless. Still, many small companies riding the wave of success with a prestigious client make exactly that mistake.

Further reading: 
If your business relies on a single client, you're one decision away from disaster, Financial Press, 2015
5 Ways to Cut Customer Risk, Inc., 2012