Commercial strategy and concentration risk
When we work with clients on their commercial strategy, a key part involves the identification of different risks to their business. We often find that concentration risk features high up the list of critical risks faced by businesses that do not have a diversified customer base. High concentration risk means a business is dependent on a dangerously small number of customers. In many sectors, this means the entire business can be placed at risk should a customer change supplier or start to spread their expenditure across several suppliers.
This is a common risk that we have frequently seen in SMEs. While this risk is serious when dealing with a private sector customer base, for suppliers that rely on a small number of public sector contracts it is critical. For many, the loss of one public contract would result in catastrophic earnings loss and close the business down. Unlike private sector customers who are not compelled to change suppliers unless they choose to do so, public sector buyers must go back to the market every four years. Suppliers with public sector contracts must diversify their income base to reduce their dependency risks. Failure to do so is akin to playing Russian roulette with their future viability.
We are strong advocates for businesses contesting to public procurement contests. While it takes time and investment to win, they offer a means for suppliers to scale-up their operations as contract sizes can be lucrative. This said, the public sector market has changed in the past three years and suppliers that are solely or substantially dependent on the public sector for their business are now seen as sources of supply chain risk.
Public buyers want to see suppliers reduce their concentration risk and dependency on public contracts because they do not want to be responsible for SMEs going out of business should they change supplier. Suppliers that are heavily dependent on a small number of customers should take the time to think about how they can identify new customers that help them become attractive long-term partners for buyers.
A version of this article appeared in the February 2016 edition of ISME’s Owner-Manager magazine. This publication is distributed to the membership of ISME each month.