This post is part of a series, “How to Boost the Value of Your Business.”
In our last post in this series, we talked about the dangers of key person dependence. Key person risk is a subset of a larger issue – concentration. Concentration may have been a fun TV game show, but it is a serious issue in business. Think of it as a double-edged sword, with the potential for great gain and great pain.
- Does your business rely on a single customer for much of its revenue?
- Do you depend on a single supplier for a key component of your product?
- Are you a franchisee?
- Do you sell one type of product or service?
If your answer to any of these questions is yes, you are not alone. Many businesses face these issues. (Including us! We have chosen to focus exclusively on business valuation.) Even employees have a concentration problem; they depend on a single customer, their employer.
The Point Is
One should make the decision to concentrate in full awareness of the risks and rewards. If you choose a high risk, high reward option in one area of your life or business, make offsetting choices in other areas.
For example, if more than half of your business comes from a single customer, do not load up on debt. In my corner of the world, we have many companies that depend on the RV industry. The smart managers stash away cash in the good times, like the ant in the fable of the grasshopper and the ants. The “grasshoppers” are now out of business, given the collapse in industry sales the past two years and inability to manage their debt load. (Not to mention the 1,600+ dealerships that disappeared last year because of their franchise/supplier concentration.)
What Can You Do?
If you want to increase the value of your business, take a hard look at your concentrations. One of the reasons large businesses typically sell for higher multiples than do small businesses, is because they have lowered risk through diversification. This is basic portfolio management theory and has broad application beyond your brokerage account.
Try this simple process and repeat it on a regular basis (perhaps annually or quarterly):
- Ask yourself the question: “What’s the worst conceivable thing that could happen to this company externally?” (Hat tip to Warren Miller, who thinks this is one critical question to ask management in the risk assessment process.)
- Make a list of the potential fallout if this worst conceivable event were to happen and jot down ideas about how you would deal with it.
- Pick the best ideas from the list and start working on them as if your business life depends on it, because it probably does!
You may still decide the risk/reward trade-off of a particular concentration is worth it. At least you will be moving forward with your eyes wide open.
If Brian Sittley keeps this up, I’m just going to have to start republishing his feed here… Congratulations to the PSSI blog for being featured on the front page of WordPress.com! I’m privileged to participate in a business improvement group forum with Brian (great name too), and appreciate his insights on business and life. Don’t let the business acumen and ERP talk fool you, Brian also was an English major! He makes blogging and writing look incredibly easy with his talents and experience.