Customer concentration - risk or advantage?

Metric Stack 21: Customer Concentration and more!

How many big fish are in your pond? In other words, what's your customer concentration? At first glance, it may appear risky to source most of your revenue from a small subset of customers, but there are advantages to this approach as well.

Welcome to Metric Stack. I’m Priyaanka Arora, your personal metric assistant and Content Researcher & Writer at Klipfolio. This week, we'll learn all about customer concentration and its implications on your business.

What is Customer Concentration?

Customer concentration is the percentage of your revenue that comes from your highest paying customer or small subset of customers. Here's the formula:

Customer Concentration = Revenue from highest paying customer / Total revenue

It's up to you to decide if you want to calculate this metric with one top paying customer, or by selecting a small group of customers that generate the bulk of your revenue. Either way, your aim with this metric is to analyse the risk of losing certain customers.

What is a good customer concentration benchmark?

The rule of thumb is to have a customer concentration of less than 10%. However, it can vary based on target customer type and customer volume. As Head of Finance at Rewind and MetricHQ guest contributor Alamin Mollick says:

If your customer volume is high and mainly consists of SMB companies with low deal value, a more realistic customer concentration benchmark is 1% or less.

Why does customer concentration matter?

We've looked at benchmarks of what your customer concentration ought to be, but you might wonder why it is so crucial to have a low customer concentration. To answer that question, let's take a closer look at what this metric really measures.

Customer concentration is primarily a measure of risk. It is in your best interest to keep your revenue retention rate high, because the cost of acquiring new customers to fill the gap left by churn is high and increasing at an alarming rate. When a huge chunk of that revenue comes from one customer or from your top 5 customers, for example, the loss of that customer or set of customers would leave your financial health in a bad state with no way to quickly make up the lost revenue. However, this doesn't mean that there are no advantages to high customer concentration, or that a low customer concentration is always appropriate.

What are the advantages of high customer concentration?

Firstly, you should know that higher customer concentration is somewhat common in SaaS companies with an enterprise customer base, as well as early stage companies with a limited number of customers. The high-value deals with such types of target customers makes this inevitable. Yet, the risk is reduced. Why?

Because high ACV tends to signify mission-critical functions served by the business, at least when it comes to an enterprise-level customer base. Take the example of SaaS CRM Veeva, with a famously high customer concentration (36% in 2020).

Veeva has several large clients in the life sciences industry where regulations are strictly implemented. These clients send critical information to healthcare practitioners via emails that must be managed, recorded, and maintained without loss or modification of data. Veeva would in turn need to focus time and resources on a small set of clients to ensure this level of compliance is met.

Additionally, high customer concentration affords you to dedicate your sales budget and time towards a limited set of leads and customers, increasing your sales efficiency. It can even lead to longer and more productive relationships with your clients, establishing you as a trustworthy leader in your niche.

It's pretty well-known that benchmarks are merely meant to act as a guide on what numbers to expect. Context is paramount to setting the appropriate customer concentration target for your business. So, assess your business goals and mode of operation before deciding your threshold of customer concentration.

Tune in to the Metric Stack Podcast!

Did you catch this week’s episode of the Metric Stack podcast? Mike Potter, co-founder and CEO of Rewind, dives into the evolution of the business—how it started and where it’s going—and their explosive growth on the heels of a combined $80M USD in Series A and Series B funding. Listen to the episode on Apple, Spotify, or wherever you get your podcasts.