What is customer concentration? Definition, formula and example

This is for owners getting ready to sell and for buyers reading their first set of books. By the end you will know what customer concentration is, how to work it out, and why it changes the price and terms of a deal.

The definition in plain words

Customer concentration means a large part of a company's sales comes from a few customers. If one client pays half the bills, the business has high customer concentration.

Buyers care because a customer can leave. When the owner sells, the relationship may go too. A firm that loses a client worth half its sales can go from profit to loss in one month.

Public companies have a rule about this. Under the US accounting standard for segment reporting, a public company must disclose any single outside customer that brings in 10 percent or more of its revenue. Deloitte's guide to that rule explains it. It also says a group of companies under common control counts as one customer. Small private businesses do not file these notes, but many buyers use the same 10 percent line as a first test.

The formula

The basic measure is simple:

Top customer share = revenue from the largest customer ÷ total revenue

Buyers also look at the top five or top ten:

Top five share = revenue from the five largest customers ÷ total revenue

Use the same period for both numbers, usually the last twelve months. Count related accounts as one. Three branches of one company are one customer, because one person can cancel all three.

Look at gross profit too. A big customer who gets a deep discount may bring in a large share of revenue but a small share of profit. The real risk is the profit that leaves with them.

Worked example

Here is an illustrative B2B services company with $2,000,000 of revenue. The numbers are made up but add up.

Top customer share = $700,000 ÷ $2,000,000 = 35%. Two customers sit above the 10 percent line, and the top five bring in 65% of sales.

Now say Customer A leaves after the sale. Revenue falls to $1,300,000. Rent, wages and software do not fall as fast, so profit falls by more than a third. That is the loss a buyer is pricing in.

Where it shows up in a deal

Customer concentration comes up early. A buyer sees a customer list in the CIM, then tests it in diligence. A quality of earnings report usually breaks revenue down by customer and shows the trend over two or three years.

High concentration rarely kills a deal on its own. It changes the terms. Common responses are:

1. A lower price. The buyer applies a lower multiple to profit that could walk away.
2. An earn-out. Part of the price is paid only if the big customer stays. Our page on the earn-out shows how that works.
3. A seller note. The seller is paid over time, so they share the risk.
4. A longer handover. The owner stays on to pass the relationship to the new team.
5. A contract review. The buyer checks if the big contracts can be assigned to a new owner, and when they end.

Lenders look at it too. A bank making an acquisition loan will ask what happens to the debt payments if the top customer leaves. Talk to your lender and CPA early if one customer is a large share of sales.

How sellers reduce it before a sale

The best fix is time. Win more mid-sized customers so the big one shrinks as a share of the whole. Even two years of steady new accounts can change how a buyer reads the list.

Other steps help. Put the big customer on a written contract with a longer term. Move the relationship from the owner to a manager. Show a long history with that customer, since a ten-year client is less risky than a new one. Our sell page covers how we help owners prepare for this.

Common mistakes

The first mistake is counting related accounts as separate customers. Buyers will combine them in diligence, and the number will jump.

The second is hiding the issue. A buyer will find it in the bank records. A seller who explains it early, with contracts and history, keeps trust and often keeps a better price.

The third is looking only at revenue. Check profit by customer as well. Sometimes the biggest customer is the least profitable one, and losing it hurts less than it looks.