The Dangers of Becoming Too Dependent on a Single Customer
By Graham Kenny
A business is part of a complex ecosystem of dependencies. It depends on its suppliers for good quality inputs, delivered on time at a reasonable price. It depends on its customers to purchase its products at a profitable price. These are just some of the more obvious examples among dozens that involve employees, regulatory bodies, financers, and community groups. Any weak link in the chain represents a business risk.
How do you manage threats in these dependencies? You must recognize that every inter-organizational dependency involves an exchange of power. That’s significant because power shapes what CEOs and executive teams can and can’t decide — in other words, the strategies available to them. Acknowledging and managing dependence is important because if mismanaged, it can have limiting, if not disastrous, business consequences.
Here I look at look at what can go wrong when you’re too dependent on one customer and present three ways you can manage the dependency; the lessons can also apply to any relationship between an organization and its key stakeholders. Let’s begin with the cautionary tale.
When Dependence Goes Horribly Wrong
Alan was the owner and CEO of a major plumbing business. His customers were builders of multi-story buildings. The construction industry at this time was booming. As he explained, “We were hard-pressed to keep up with demand and to hire sufficiently well-trained staff to complete the work.”
Business was truly flourishing, but it was running out of control, too. His office was struggling to issue invoices and chase debts while doing all the other tasks required to keep the business afloat. When Alan looked closely at his figures, it became clear that the business was especially dependent on one large customer — and was owed many thousands of dollars by it. “Tragically that client’s business collapsed,” Alan explained. “And it took us down with it since they couldn’t pay their bills.” Alan not only lost his business but the family home which was mortgaged against the business. His marriage followed soon after.
When I asked him why he let this happen, he replied, “poor strategic choice really. I was so very busy running the business that I had no time to raise my head to consider my choices. So, we went the easy route. It was easy for us to rely on one main source of income.”
But matters don’t have to end this way if relationships are managed strategically. Here are three ways to minimize the unpredictability of your dependencies.
1. Spread your risk and anchor it
Will is the CEO of a cooperative of fruit growers. The organization is surrounded by dependencies. As Will explained, “On one side are the growers who own the co-op. The ownership of the business is widely dispersed. As a co-op, there’s no single grower who dominates.”
The co-op sells fruit in two ways. The first is to large supermarkets mainly the giant retailers Woolworths and Coles. They dominate the retail food industry in Australia with 37 and 28% of the market respectively. The second way is via three large wholesalers located in major markets which then distribute the fruit to retail “greengrocers.”
The danger lies in putting too many eggs in the one basket. “We’ve got to be careful,” says Will, “not to become too dependent on a single customer.” It would certainly have advantages for the supermarket if the co-op supplied exclusively to them and it might even be convenient for the co-op.
“But if we had only one customer,” says Will, “it would put us in a position of dependency. With little room to move strategically we could be squeezed in terms of price, product mix and trading terms.”
The co-op spreads the risk of this, selling approximately a third of its product to each of Woolworths, Coles, and wholesalers. But it goes further by anchoring these arrangements via “vendor contracts.” These guarantee access to these outlets and include payment terms, thus building protection for the co-op.
2. Know your customers’ pressure points
Lindsay heads a business I’ll call Geraldton Engineering that supplies replacement parts for major earthmoving and drilling equipment used by international mining companies in Western Australia. He goes beyond spreading risk and studies the pressure points in his customer relationships. I asked him what his company expected from his customers, the mining companies. He listed five strategic factors.
“Number one,” he said, “is prompt payment with minimal red tape.” He added, “if payment is dragged out, we face cashflow problems.” Then comes “margin,” which he explained, “is the difference between make and sell. We need to make money from the relationship. It’s not all volume, you know.” Next was “lead time” which Lindsay described as “the time to prepare the order before delivery is expected” adding “the longer, the better.” Then he added “clear specifications of what is required. We don’t want confusion, with products going back and forth.” And finally, Lindsay added, “we’d like the opportunity to grow our business through a long-term relationship.”
I asked Lindsay what customers wanted on the other side. “They want the products delivered on time, as delays will cost them money. They want products to meet specifications. They want customer service, as they rely on us at times for technical advice. And they want a good price. If we do well on those things, we’re competitive and we get the work.”
When I asked about Geraldton Engineering’s vulnerability to customers, Lindsay replied, “Sure, we’re vulnerable to customers, but two can play that game. While they might know our pressure points, we know theirs. We’ve got the product; they’ve got the money. And if they’re late in paying, we’re onto it straight away.”
3. Decrease your net dependence
So, organizations can spread their risk among multiple customers, or make it their business to know their customers’ pressure points. But what if your business is predicated on a relationship with just one customer?
Take the example of Julia’s company. It manufactures very specialized brake pads for a well-known car manufacturer. The car company is Julia’s sole customer for these brake pads and is contracted to supply them.
While on the surface this sounds dangerous in terms of strategic choice, Julia explained how her business and her customer “are locked in an embrace in which both could thrive — or die. It’s symbiotic.” What she means is that just as her company is dependent on the car manufacturer, the car maker is dependent on her company — and they both prosper together.
Julia explains, “the brake pads are designed and manufactured to the car company’s specification and we’re the sole supplier. Replacing us with another supplier would be difficult, as it’s not easy for set yourself up to make these.”
“There are two sides to this story, of course,” she continued. “The supplier doesn’t want to be solely dependent on a single customer whose collapse can bring it down. But a customer is also dependent if there’s only one supplier for an input it needs.”
As Julia realized, in these situations, the key to a healthy relationship is to balance power between the two parties so that neither one becomes too powerful relative to the other. Think of it as maintaining the lowest possible “net” dependence — the dependence of one organization on another minus the dependence of the second organization on the first.
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The room for a business to maneuver in designing its strategy is conditioned by the power relationships that exist between it and its significant dependencies. This can be between a supplier and buyer as examined here. It can also be between any organization and other key stakeholders. My suggestion is that in your next strategic review, you set aside a session to realistically examine the power relationships of your organization and ensure that they don’t restrict your ability to make strategic choices. Consider spreading your risk, uncovering your stakeholders’ pressure points, and decreasing your net dependence.