Why concentration isn’t always a deal killer

Any decent agency buyer will know that client concentration can be a deal killer. But what does concentration actually mean, why is it a bad thing and what can you do to mitigate it, both as a seller and as a buyer. That’s today’s topic.

What is client concentration?

It comes in two flavours and with two numbers. First, there’s income from your largest customer as a percentage of your total income, then the same from your largest three.

Single customer concentration:

If more than 18-20% of your revenue comes from one customer, your revenues are deemed to be concentrated. Single client concentration simply means that you are too reliant on one customer. The risk is that if you lose that customer, you risk losing the business with it.

Why is 18%-20% the number? Well, sometimes it’s not. Different advisors and different businesses have their own number, some as high as 30%. For me, if you’re over-reliant on one customer for one fifth of your income, you might have an issue. I actually prefer to see a single customer capped at around 15-16%.

Top three concentration:

Another good test is to look at how reliant you are on your top three customers. Looking from the other end of the microscope, you might also look at how many customers make up half of your revenues.

For creative agencies, 40% to 50% of your income from your top three customers is normal, but at the higher end is a little concentrated. Losing one of your top three shouldn’t imperil the business itself, but the lower end is a safer place to live.

Client concentration isn’t unique to creative agencies and media companies. Any small to medium sized business can find that an unhealthy amount of revenue is coming from too few. Concentration is an existential threat, so whether you’re selling or not, you want to address it as a pressing strategic priority.

Why is it a bad thing?

The easiest way to answer that is to tell a short story. This is a true story.

I once looked to buy an amazing agency just outside London. When I received the financials, I discovered their top client delivered 60% of all fees. The client was as blue-chip as they come and had a ten-year tenure. The owner stated with confidence that they were looking forward to the next ten years. He acknowledged that it was an issue, but they kept giving him more and more work so what could he do?

Then one day, while we were still exchanging emails, the client pulled stumps.

He hadn’t failed. He was delivering great work and the client was happy. But somewhere in the labyrinthine corridors inside his client, policy changed. He hadn’t failed, but his business did quite quickly afterwards. It was heartbreaking to see such a talented agency die but die it did.

Client concentration can kill your business. That’s a good reason to take it seriously, but there are other ways it can damage you and the value you’re building. Service creep, non-billable client hours, and Del Monte are symptoms I’ll explain another day. For now… service creep is when your business ends up diversifying for operational not strategic reasons and Del Monte is the company that always says yes.

Don’t ignore concentration. It has a habit of biting you for no good reason.

How do you solve or mitigate concentration as a seller?

Let me start with another story – how not to do it.

Once, not so long ago, I was concerned that one of my businesses had a client concentration of over 40% which was £450k in fees. I spoke to the leader of the unit and gave him a mission to reduce concentration of the top client to under 20% over the next year. 12 months later in our annual review and with some excitement, he told me that he had achieved his objective. The client was now only 19% of revenue. On digging into the numbers, I found that we’d billed the same client approximately £230k that year. We’d solved the concentration by losing almost half of the business. That’s not how to do it.

In my growth system I categorise customers into four buckets; whales (12-18% revenues), dolphins (5% - 12%), rainbowfish (2% - 5%) and shrimps (under 2%). A concentrated client is larger than a whale. To solve the right way, you need to grow the rest of your business or acquire another business.

The easiest way is to buy another agency. My friend Peter Lang likes to remind me that M&A can solve any business problem, and this is a good example. Buying another business should automatically solve your concentration issue. But, you could also consider merging with another business of similar size. If M&A isn’t on your agenda (it should be), then you need to find organic growth.

If your concentrated client is highly profitable, I advise you strongly to take 20-30% of the profit you make on that client to turbocharge sales to new customers, and prioritise organic growth from Dolphins specifically. If your concentrated client is not profitable, I’d start with the Dolphins.

If you can’t solve the problem, you might need to mitigate it. These are things you might consider: reduce FTEs working on the account, embed someone in their team, seek better contract terms.

How do you mitigate concentration as a buyer?

Start with the arithmetic. If the target's whale is 40% of their revenue but would be 8% of the combined business, the acquisition dilutes the problem on day one. This is the first reason the title of this piece is true; a concentrated agency can still be a good buy if your own book is broad enough to absorb it.

You're still paying for revenue that could walk out of the door, so structure the deal accordingly. Deferred consideration and earn outs are the standard tools. If a meaningful slice of the price is paid over two or three years and tied to the retention or replacement of that revenue, the seller carries the risk alongside you, which tends to sharpen their memory about how secure the relationship really is.

Then do your diligence on the relationship itself, not just the numbers. Tenure, contract terms, notice periods, and how many people inside the client actually buy from the agency. A whale on a three-year contract with six stakeholders across two divisions is a different animal from one on ninety days' notice with a single champion who's two years from retirement. Remember my agency owner outside London? He had ten years of tenure and lost everything to one policy change he never saw coming. Tenure on its own tells you less than you'd like.

Why it isn't always a deal killer

Concentration is a risk to be priced, structured and worked down, and up to a point that's exactly what a good deal does. A buyer with a broad client base, a sensible earn out and a clear plan to grow the dolphins can take on a concentrated agency with their eyes open. Somewhere past 40% or so, though, the structuring gets so heavy that the seller ends up with a price and terms they'll hate, which is its own kind of deal killer.

The advice lands in the same place for both sides. If you're selling, start fixing concentration years before you sell, and fix it by growing the rest of the business rather than shrinking the whale. If you're buying, don't walk away at the first sight of a big client; ask instead whether the risk can be diluted, structured or contracted away at a price that still works. Concentration killed that agency outside London, but it needn't kill your deal.