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Tuesday, October 16, 2012

Your best customers sometimes kill your company

Sorry I must say "Good Bye and I Am Leaving"!

The old saying “Don’t Put All Your Eggs in One Basket” relates to your customers as well.  Diversification is a highly important characteristic to develop for many endeavors.  Spreading risk does dilute the potential for reward, but it protects the downside as well.  There are many reasons to adopt this philosophy in your business and this includes your customer base.

Diversifying investments of funds in the stock market provides a means of spreading the risk.  Investing $2,000 in each of 10 companies ($20,000 total) means the most you can lose in any single company is  $2,000.  However, your upside is unlimited for each company.   In 2000 or 2007 when the markets were falling, you may have been down on each of your investments, but if you selected wisely, you are most likely in the profit column on at least 80% of the investments.  You spread the risk of a Lehman Brothers, Wachovia, Enron, or other major loss.   You may have not made as much as if you invested all the funds in Apple, but you protected your downside.

In 2002, a consulting practice on the east coast had developed a significant client providing a 7-figure fee.  The client, a Fortune 100 company, planned to add new projects to the pipeline of the consulting practice.  The revenue stream of the practice had grown significantly over a few years.  Revenues from the big company grew to become more than 80% of the total revenues of the consulting practice.  One day the Fortune 100 company decided to spin-off a part of the business into a new company and completely restructure.  The result left the consulting practice with a significant loss in the revenues and they had to survive on 20% of the projected revenue stream.

In the early 2000s, a pharmaceutical company on the west coast was developing a product for treating patients exposed to radiation.  The US Government was the primary customer and maybe the only customer.  The company spent more than $170 MM of investor’s money to gain approval from the FDA to market the product.  When the company asked for the first order from the federal government, a onetime order of around $100,000 was received.  There were no follow-up orders planned and no other customers to approach.  The company went under shortly after that.

Around 2007, a company selling products to a major retail chain enjoyed significant growth and revenue.  The small business provided excellent products and planned to expand.  Expansion funds allocated to the process were significant in order to cover the new proposed site.  One day, the business received notification the retail chain was cutting back and future orders were terminated.  The company in mid-expansion had to deal with cut backs in revenue and later closed the business.

Diversification is not always possible, but is highly desirable.  The customer base of your business is just one area that diversification is important. Going on a buffalo hunt and landing your biggest target is wonderful until they disappear overnight.  Have a party when you get a huge customer, but attempt to build out your customer base such that the loss of the customer does not cause the demise of your company.