At first glance, the word “concentration” might seem to describe a positive quality for any business owner. You need to concentrate, right? For your business to be able to reach the next level of success, it requires laser focus on the right strategic goals.

In a business context, however, concentration can refer to various aspects of your organization’s operations. And examining different types of it may help you spot certain dangers.

Evaluate Your Customers

Let’s start with customer concentration, which is the percentage of revenue generated from each customer. Many small to midsize businesses rely on only a few customers to generate most of their revenue. This is a precarious position to be in.

The dilemma is more prevalent in some industries than others. For example, a retail business will likely market itself to a relatively broad market and generally not face too much risk related to customer concentration. A commercial construction business, however, may serve only a limited number of clients that build, renovate, or maintain offices or other facilities.

How do you know whether you’re at risk? One rule of thumb says that if your biggest five customers make up 25% or more of your revenue, your customer concentration is generally high. Another simple measure says that, if any one customer represents 10% or more of revenue, you’re at risk of having elevated customer concentration.

In an increasingly specialized world, many businesses focus solely on specific market segments. If yours is one of them, you may not be able to do much about customer concentration. In fact, the very strength of your business could be its knowledge and attentiveness to a limited number of buyers.

Nonetheless, know your risk and explore strategic planning concepts that may help you mitigate it. If diversifying your customer base isn’t an option, be sure to maintain the highest level of service.

Look At Other Areas

There are other types of concentration. For instance, vendor concentration refers to the number and types of vendors a business uses to support its operations. Relying on too few vendors is risky. If any one of them goes out of business or substantially raises prices, the business could suffer a severe rise in expenses or even find itself unable to operate.

Your business may also be affected by geographic concentration. This is how a physical location affects your operations. For instance, if your customer base is concentrated in one area, a dip in the regional economy or the arrival of a disruptive competitor could negatively impact profitability. Small local businesses are, by definition, subject to geographic concentration. However, they can still monitor the risk and explore ways to mitigate it — such as through online sales in the case of retail businesses.

You can also look at geographic concentration globally. Say your business relies solely or largely on a specific foreign supplier for iron, steel, or other materials. That’s a risk. Tariffs, which have been in the news extensively this year, can significantly impact your costs. Geopolitical and environmental factors might also come into play.

Third, stay cognizant of your investment concentration. This is how you allocate funds toward capital improvements, such as better facilities, machinery, equipment, technology, and talent. The term can also refer to how your business manages its investment portfolio, if it has one. Regularly reevaluate risk tolerance and balance. For instance, are you overinvesting in technology while underinvesting in hiring or training?

Study Your Organization

As you can see, concentration takes many different forms. This may explain why business owners often get caught off guard by the sudden realization that their businesses are over- or under-concentrated in a given area. We can help you perform a comprehensive risk assessment that includes, among other things, developing detailed financial reports highlighting areas of concentration. Contact us.