I recently came across a fascinating blog about the epic battle between Palotta Networks and Avon Corporation over breach of contract, which Avon lost. The true winners and losers in the battle can’t really be counted in monetary terms. Around 250 employees of Palotta Networks lost their jobs overnight in 2002 when they lost their one single customer. This leads us to an important question that every entrepreneur needs to ask :

How much business should you be doing with your most important client ?

When a business is getting off the ground, it is very tempting – indeed, compelling – to accept any customer and grow with them. After all, acquiring a customer is hard, and when easy growth presents itself with a single or a small number of customers, it is hard to turn down or even regulate the flow of business. However, if the revenue is concentrated on a small number of clients, you really have to put the client relationships under a magnifying glass and constantly assess the risks associated with the flow of revenue from these clients. In the case of Palotta Networks, their whole business was built around one single client – Avon Corp. When Avon pulled the plug on the relationship without any warning, the company went bust overnight.

The problem is not restricted to start-ups. Big corporations are constantly evaluating their account portfolios and their revenue concentrations from certain clients, segments, or product lines. Banks constantly monitor exposure to certain industries, markets, and types of credit. Bear Sterns, the investment bank that went bust and set off the whole financial crisis in 2008, had a high exposure to sub-prime mortgages that went spectacularly bust, forcing the bank into bankruptcy overnight.

Be aware of the market’s influence on demand, especially government policy

In addition, the quality of revenue is determined by market factors that may be more or less out of your control. In healthcare, the US Federal Government mandated that all participants in electronic claims must adopt the ICD-10 code of classification for medical procedures and claims before Jan 1, 2012. Many healthcare companies and service providers made big investments in getting ready for what was considered a “mini-Y2K”.  However, all of a sudden, the Government announced earlier this year that they were pushing the date back by a year or more, and derailed the entire program. The alternative energy industry relies on critical government subsidies to remain profitable, and these subsidies and concessions are under constant attack in Congress at a time when fiscal tightening requires cut-backs on all manner of expenditures. So, if you’re a solar equipment maker relying on government-funded programs to drive demand, you’re at risk if the subsidies disappear.

Manage revenue concentration actively

I worked for a large, multi-billion dollar consulting firm that once had very high exposure to a single client (around 10% of revenue). The client knew how important they were to the consulting firm, and constantly made aggressive demands for pricing and other concessions, eventually becoming what is often referred to as the “client from hell”. The founder of the firm one day decided that the company needed to cut the client loose, and then proceeded to terminate the relationship. He did the firm a huge favor because he could now focus his key resources on generating: more profitable clients, new opportunities, morale improvement, and finally, profits for the firm.

Startups are especially vulnerable to being held hostage by important clients. Clients will demand free products and services, pay below-market rates, and request extended credit terms. I work with the founder of a successful technology advisory firm that’s doing very well in terms of order bookings and growth; however, he is constantly having to infuse capital into the firm to fund working capital (imagine yourself obliged to make payroll every two weeks, while your client pays you only after 45 or 60 days).

If you’re an entrepreneur with a promising product that’s beginning to gain traction in the marketplace, ask yourself a few simple questions every now and then:

  • How much revenue comes from the top 20% of your clients (if you’re in enterprise sales)?
  • How much revenue comes from your largest customer segment (if you’re in a consumer-facing business)?
  • How profitable are your largest clients/segments ?

Be ready to terminate a relationship that isn’t good for your business

Your most important customers are like your most important employees. They have to be constantly nurtured and monitored. You need to keep them happy as long as they are good for your business. The day that changes, it may be time for a parting of ways.

Of course, parting ways with an employee is not the same as parting ways with a client. There is an art to doing both in a manner that does not damage long-term goodwill between both parties. In the case of the consulting firm I referred to, the client and the firm decided to do business again, after a gap of 10 years. Many employees return to their former companies when circumstances have changed. Quite apart from the goodwill involved, there may be legal ramifications to “firing” a client that needs to be carefully considered.

No one likes to fire a client. So, the first thing to do is to ensure you’re signing up the right clients in the first place. Having said that, here are a few things to do when your business is on a fast growth path:

Never let a single client/segment contribute more than a certain % of your revenues. Pick a number between 10% and 25%, depending on what stage of growth you’re in.

As a founder, manage your most important clients actively and directly. That way, if there’s bad news ahead, you will know it first and can act accordingly.

Have a Plan B in place if you were to lose your most important client overnight. Try to have contractual speed-breakers in place so that the separation is spread out over a few months, which will give you time to redeploy your resources and find new clients.

In the end, client relationships have a life cycle (which will be influenced by changes in the market), the client’s business model, or your own business model. It’s like owning a stock portfolio. Manage it actively. And then, hold on to the diamonds – those are forever.