Should You Have a Few Large Customers or a Large Number of Small Customers?
By Alok R. Saboo, V. Kumar, and Ankit Anand
For many businesses, 20 percent of their customers provide 80 percent of their revenues. Firms spend significant efforts managing relationships with these major customers in hopes of reducing marketing and advertising costs, facilitating information sharing and better inventory management.
However, having customers that account for a large proportion of revenues lowers the bargaining power of the firm relative to the customer. It hurts the ability of the firm to benefit from such customers as they demand more perks, such as extended trade credits, better prices and flexible deliveries.
For instance, although most firms strive to have Walmart as one of their key customers, these same firms complain about Walmart’s relentless pressure to gain profit-killing concessions and its effects on the entire operations from factory to financial statements. Therefore, it is important to understand the consequences of having revenues concentrated among a few large customers.
Our research team at the Center for Excellence in Brand and Customer Management used robust econometric methods to analyze data from about 1,000 firms that went public between 2000 and 2011.
We found that when a firm goes public, initial public offering (IPO) investors reward firms with concentrated revenues by propping up their IPO performance, as relationships with large customers reduce uncertainty about the future prospects of the firm and mitigate the liability of newness.
In contrast, having such concentrated customer relationships hurt the overall profitability of the firm, as reflected in the balance sheets.
Why does this shift in outcomes occur? Although relationships with major customers create value in terms of lower costs and improved efficiency, firms are not able to take advantage of these benefits because of their poor bargaining power compared to their customers. Major customers are aware of their importance for the supplier firm and can demand better terms.
Given that it is difficult for young firms to diversify their customer base in the short run, how can these firms mitigate these losses?
These firms should develop their own capabilities (marketing, operational and technological) and continue their relationships only with quality customers, those who can pay back their debts.
Some customers may also be of better quality in terms of providing more feedback on product development process and more insights on market demand.
Why should these factors be important? Higher marketing capabilities allow firms to anticipate customers’ future requirements, improving relationships and reducing churn.
Higher operational capabilities allow firms to bring flexibility in the production processes and improve production efficiencies and firms can pass on these benefits to their major customers to reduce bargaining power.
Higher technological capabilities help firms to enhance their learning from major customers, using customers’ resources and technological know-how and offering superior products to their customers.
Any negative consequences of relationships with a few large customers can be mitigated through enhancing capabilities and forging relationships with better-quality customers to create a win-win situation.
* The research article is conditionally accepted in the Journal of Marketing, under the citation: Saboo, A. R., V. Kumar, A. Anand (2017). Assessing the Impact of Customer Concentration on IPO and Balance-Sheet Based Outcomes.
Alok R. Saboo is an Assistant Professor of Marketing in the J. Mack Robinson College of Business at Georgia State University. V. Kumar is a Regents Professor of Marketing and director of the Center for Excellence in Brand and Customer Management (CEBCM). Ankit Anand is a doctoral student in Marketing at CEBCM in the Robinson College of Business.
Read more from the CEBCM on Saporta Report Thought Leadership here.