Can your customer base impact the value of your business? Absolutely!
Your customer base’s size, loyalty, profitability, growth potential, business risk, and brand image all impact value. The risks associated with customer concentration or high customer churn can decrease its value.
Here we identify several customer-related valuation drivers and provide suggestions to minimize those risks with the goal of maximizing your company’s value.
Identify and Improve the Factors to Increase Your Company’s Value
- Growth Potential. A growing customer base signals you are successfully attracting new customers and expanding your market reach. Increased revenues and profits follow.
- Brand (or Reputation). A reputable brand attracts customers, differentiates the company from its competitors and may allow premium pricing. These are reflected in the company’s stronger financial performance and higher valuation.
- The company brand is what counts, not the reputation of the owners in determining the value of a company.
- Customer Loyalty. A loyal customer base shows low churn (turnover). Loyal customers refer other customers to you. They provide positive reviews and helpful feedback. A loyal customer base creates a more stable and predictable revenue stream. This enhances value.
- Repeat Customers. Selling to customers who have already bought from you is by far simpler and less costly than a cold sale. Focus marketing resources on growing your repeat business and track these metrics! A high rate of repeat business lowers risk and increases company value.
- Recurring Customers. These customers purchase your products or services on a regular schedule. A predictable revenue stream from recurring customers decreases risk in a company’s cash flows. It increases company value.
Ask for reviews and publish them. Ask for referrals. Are incentives for referrals a viable option for your company? If so, implement them. People like to help others.
Understand and Resolve the Customer Risk Factors that Reduce Your Company’s Value
Customer Concentration. You rarely turn away business from a large customer. There are associated potential risks, though, that can lower your company’s market value. Does any single customer account for 10% or more of revenues (or gross profits)? Do your largest 5 customers account for more than 25% of revenues (or gross profits)? These concentrations can be mitigated by contracts, the fact there are no or few quality competitors and by long-term relationships. (These percentages are just examples; your situation may differ).
Two identical companies are up for sale. They report similar revenues and margins. Company One receives 35% of its revenues from one customer. Company Two has no more than 5% of its revenues generated from any one customer. All else equal, the Company One is riskier and less valuable to a buyer.
What’s the impact of these types of risks?
- Cash Flow Risk – If one or just a few key customers reduce their orders or even stop doing business with you altogether, it can be devastating. Replacing that revenues stream may be difficult.
- Accounts Receivable Risk – If a key customer faces financial challenges, it may have a negative impact on your receivables and cash flow.
- Margin Risk – Key customers can (and do) exert downward pricing pressure and wield negotiating leverage that smaller customers cannot.
- Lack of Innovation. Over-reliance on a few customers can result in a narrow focus on meeting their specific needs. This may hinder a business’s ability to develop or improve products and services or to explore new markets.
How to minimize the risk and increase value
Implementing these initiatives will improve your company’s cash flow, making it more consistent (and less risky), driving up your company’s value.
- Can contracts be put in place to minimize risk? Often, contracts have termination clauses that provide some lead time. This gives vendors the time to replace the revenue stream from a departing customer.
- Margin Analysis. Compare the profitability of your current focus on customers, industries, and geographical markets to what you may earn by dedicating resources to win new customers, provide new industry applications, and enter new geographic markets. The rewards of diversification include sales growth, potentially higher margins, and diversification of risk. The risks include the cost of these dedicated resources.
- Diversify sectors in which the company operates or expand your product and service offerings, opening up to new potential customers. Think outside the box. How will my product or service provide value to a different industry or customer base? To be effective, you must be an expert in the market your company is expanding into and provide value to the end customer.