Reduce Market Risk With A Diversified Order Book

Have you ever had a customer acting like they own you? Have you ever had them telling you how to operate your business. Telling you when you’ll get paid, or just generally using their perceived power to throw their weight around, and use bully-boy tactics to abuse you as a supplier.


From our article on the ‘10 things you need to sell your business’, we already know that one of the main reasons a small business won't achieve a sale, is because they’re too reliant on a small number of customers.  If you’re reading this, with no real intention of selling your business, that’s fine.  It’s a strategy that should be used in your business, whether you’re a growing business, a stagnant business, or your business is listed for sale.


Now, our ideal scenario, is that we’ll be balanced across customers, and also across sectors.  In real terms this means not having any customer making up more than 10% of our total sales or gross profit.

Taking that one step further, we’ll do the same for the customer sector too, after all, if we’re focused 100% on the retail sector, as an example providing cleaning services to high street shops, we know that the high street is slowly dying, which means retailers are moving away from high street premises, and more toward the distribution model used by Amazon.  This means, as time goes by, as a business that gets all of its trade from this sector, we’ll see a continual decline in sales, as more shops close down, or relocate.  Essentially you’d have to do more sales activity, just to maintain the same size.  By diversifying sectors, if one sector is impacted for whatever reason, it will have less impact on our business.  So ideally you’d want a sector to make up no more than about 20 - 30% of your sales.


But let's look first at diversifying our customer list.  Below, is an example of a refrigeration business that was listed for sale.  To keep it simple, I’ve rounded the numbers, and collated a lot of the smaller customers, but you can see the basic concept behind the story.  So to keep it clear, I’ve listed the top 10 customers to this business, along with the annual sales, and what those sales mean to the business overall in terms of total sales turnover & demand.  The column on the right indicates whether each customer meets our 10% diversification rule.




Customer

Total Sales

% of total sales

OK?

Customer A

£400,000

24%

No

Customer B

£450,000

27.1%

No

Customer C

£300,000

18%

No

Customer D

£30,000

1.8%

Yes

Customer E

£20,000

1.2%

Yes

Customer F

£70,000

4.2%

Yes

Customer G

£120,000

7.2%

Yes

Customer H

£50,000

3%

Yes

Customer I

£140,000

8.4%

Yes

Customer J

£80,000

4.8%

Yes

Total Sales

£1,660,000

100%




Now we can obviously notice that 3 of our customers make up more than 69% of our total customers.  If something happens to one of these customers, our business will be seriously impacted, and will probably end up closing down, or reduce in size substantially.


Anything can happen.  They might abuse their power and delay payments.  Their sector could face a downturn.  Even if they are financially solid, one of their key customers or sectors, that you don’t see directly, may go out of business.  This could transform what appears to be a successful business, into one that suddenly struggles to pay its creditors when they fall due.


These companies might be major international companies, you might be personal friends with the senior management team, you might even be related to the owners, you might believe that you’re safe.  But imagine if one of their competitors comes in & takes them over.  This will most likely mean they bring in their own suppliers, and although you might get a few months notice, you’re now dealing with a business you don’t know.  They might keep you employed, or they might just drop you for their own preferred suppliers.  I’ve seen & experienced this happen with a lot of companies, both large and small, across many sectors.  Trust me, if you’re doubting it to be real, take the action anyway, the risk is too great for your business to bare.


So how do we get around this?

Well there are a few options.  First of all, are the key customers profitable?  If they aren’t, then make a plan to make them profitable, or just get rid of them.  If the latter is your choice, do this over a period of time to avoid having to make your own staff redundant.  Finding and developing good staff is key to the business success, so the last thing we want is to let 40% of our staff go to our competitors.  Also understand how those unprofitable customers contribute to your overhead.  If the gross profit figure is still positive, but not meeting your desired figure, they’ll still be making some contribution to your overhead, both positively & negatively.  Let me explain.  If you have a large office, every piece of gross profit that comes in, goes toward paying for that office.  If you get rid of that customer, you’ve now got the problem of filling the void to pay that lost contribution toward the building.  Likewise, if the customer also means you need to employ a large portion of staff to manage the process, then getting rid of the customer, also means you’ll remove that portion of overhead too.  Fixed overheads will need to be filled, variable overheads can probably be removed.


Hopefully all of your customers will all be profitable, which leads us to the next option.  We can spend the next 12-24 months adding sales, winning more larger customers to better balance it out.  In this scenario, we’d ideally need about 7 customers spending an average of £350,000 each, or in other words, an additional £2.8m in new customers, assuming the existing customer spend stays the same, or reduces in value.


Now, remember we talked about 70% of your competitors reaching the age of retirement in the next 10-15 years.  Well it's very likely, they’ll be in a very similar position to you and your business.  But let’s not just consider your competitors, just look around, what about all those businesses that provide complimentary services to yours too.


So the next option, would be for your business to come together with a business similar to yours.  How good would your combined balance sheets look, if they were together?  Let’s take a look at that customer list under such a scenario.



Customer

Total Sales

% of total sales

OK?

Customer A1

£400,000

12%

No

Customer B1

£450,000

13.5%

No

Customer C1

£300,000

9%

Yes

Customer D1

£30,000

0.9%

Yes

Customer E1

£20,000

0.6%

Yes

Customer F1

£70,000

2.1%

Yes

Customer G1

£120,000

3.6%

Yes

Customer H1

£50,000

1.5%

Yes

Customer I1

£140,000

4.2%

Yes

Customer J1

£80,000

2.4%

Yes

Customer A2

£400,000

12%

No

Customer B2

£450,000

13.5%

No

Customer C2

£300,000

9%

Yes

Customer D2

£30,000

0.9%

Yes

Customer E2

£20,000

0.6%

Yes

Customer F2

£70,000

2.1%

Yes

Customer G2

£120,000

3.6%

Yes

Customer H2

£50,000

1.5%

Yes

Customer I2

£140,000

4.2%

Yes

Customer J2

£80,000

2.4%

Yes

Total Sales

£3,320,000

100%



Now you’ll notice there are still a few customers that exceed that 10% rule, but it’s much better than what it was.  Over the course of say 6 months, a little extra sales could quite easily balance this out.  


Alternatively, imagine if it wasn’t a competitor that you merged with, but rather a complimentary business.  For example, if your business provides cleaning services, imagine if you teamed up with a security business.  Your cleaning services could be sold to their security customers, and vice versa.  This could potentially double each companies turnover within 6-12 months.  

Taking your £1.6m turnover business to £6.4m turnover.


But that’s not all you achieve from coming together with another business.  What about that extra person that comes from the other business, but means you’ll be able to take more time away.


Now, regardless of your intentions, whether to sell, or to use this strategy to grow the business, you’ve ultimately achieved your intention, whilst also reducing market risk to the business.  The chances are, you’ll have added some great people & resources to your team too.  


In the next post, we’re going to look at the second piece of the jigsaw, you’ll need to sell your business. ‘Management Team - Making your business less reliant on you’  Click here to read it now.


We hope you’ve received some value from this article, and some information that you can use to move forward toward your vision.


If you’re confident that selling your business is the way to go, or perhaps you’re undecided, it’s important to consider the significant amount of effort and resource you’ll need to make it happen.  It’s a full time job. - The time investment alone is enough to put anyone off.  So imagine for just a minute, that you didn’t need to do all of this work.  What if this could be done over the next 3 - 5 years (by someone else).  Everything we’ve listed in this article, is what you’d need to do, if you were selling through a business broker, or direct to a buyer.


Unlike other private equity firms, our focus is on growing businesses at the smaller end of the market.  We’ve worked in, and grown our own businesses in the exact same fields you work today.  We’ve spent years coaching and supporting small businesses just like yours, developing their teams, and helping them to grow, but now, we’d like to help you.  


We have a solution for business owners that need to sell their business immediately, or for those who want to stick around for a few years.

If you’re considering the options to grow or sell over the next five years, read more about how we're helping others just like you. Click here to read about our unique approach to helping you get what you want with the YokeFormula™ for your business.

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