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The risk of reliance on a major customer - a cautionary tale
I was recently appointed administrator of a company which had reliance on one major customer, in this case the customer represented over 95% of the turnover of the company. This brought to mind a previous liquidation where a business in a completely different sector was in the same situation.
In both cases the customer withdrew orders from the company. In the previous case the company had no contract with the customer so they had the right to move elsewhere at will. In the most recent case, there was a contract in place and the company directors believed the customer had no legal right to terminate. What then followed was a legal dispute which remains ongoing.
In both cases, with over 90% of turnover suddenly switched off, the companies had no cashflow to continue to trade, and in the second case, no funds to enter into a legal dispute.
The danger of overdependency
Whilst a loyal customer is always something to strive for, having reliance on one can have catastrophic effects.
- Power imbalance. In these situations the customer will often find themselves in a strong position. They know that their custom is keeping the business viable, and they can therefore hold all the bargaining power.
- Size of the parties and respective fighting funds. In the recent case where the contract was ended, the company directors sought legal advice which suggested the contract had not been properly terminated. The customer took a robust approach, making significant counterclaims against the company. In this case the customer was significantly larger than the company and had much deeper pockets to fund legal action.
- Growing to fit the customer. As customer demand grows, it can be tempting to grow the business to meet their demand. Increasing overheads to meet the new and increased demand of a loyal customer would seem to be a sensible business choice, particularly where a contract is in place for future business, however there will likely be significant cost implications to consider.
- Cashflow risk. An income stream suddenly being switched off will cause difficulties. Where a company has grown to meet the demands of its customers, it cannot simply make cuts. In business it is much easier to grow than it is to reduce in scale. The costs of redundancies, moving to smaller premises and making cuts are expensive and time consuming, especially when the company has had its income source significantly restricted.
- Continuity risk. Customer requirements can change, they can reduce orders or look elsewhere. There is also the risk that the customer finds themselves in difficulty and through no fault of the company the customer is unable to continue to place orders.
What lessons can be learned
In both cases the directors had enjoyed a good relationship with their customer, until the relationship soured. They did not see the issue coming and with hindsight would not have allowed one customer to have become so pivotal. So, what advice can be given to avoid others having the same issues?
- Have strong contracts. Whilst a contract will help, as explained they are not the sole solution. Having a robust contract will at least make the customer think twice before suddenly turning off the tap.
- Keep the customer under review. Where the customer is so key to the future of the company, keeping an eye on their financial position is fundamental. If payments start to fall behind, find out why. It may also be worth investing in a financial monitoring service which can flag early signs of distress.
- Diversify. Consider new products and services which can reduce the dependency on a single client or service. When the company is doing well and making money, that is the time to invest for the future.
- Consider other customers. It may be that the company has exclusivity restrictions preventing other customers being brought on board, if not, attracting new customers will be key to the future success of the company.
- Prepare for the worst. A contingency plan is vital; having a strategy for if the worst should happen, but hopefully never having to use it. This could be how to access new working capital, negotiating with suppliers or accelerating new business.
Conclusion
This is unlikely to be the last time I see a company director in a state of panic due to the loss of their principal customer. Whilst directors cannot control what their customer does, they can put plans in place to mitigate the risk as far as possible.
The key when trouble appears is to take proper advice and remember that whilst early advice is always best, it is never too late to seek professional guidance.
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