Concentration Risk

What is Concentration Risk?

Concentration risk occurs when a business depends too heavily on a single factor:

• One major customer
• One key supplier
• One revenue stream
• One geographic location
• One product line

Imagine putting all your eggs in one basket – that’s concentration risk in its simplest form. Let’s explore how this risk affects businesses and how to manage it.

Common Types of Concentration Risk

1. Customer Concentration

High Risk Example:
One customer represents 60% of revenue. Loss of this customer threatens business survival.

Healthy Example:
Largest customer is 15% of revenue. Top 10 customers represent 45% of revenue.

2. Supplier Concentration

High Risk Scenario:
Single supplier for critical components. No backup suppliers available. Long lead time to find alternatives.

Better Scenario:
Multiple suppliers for key materials. Regular supplier audits. Backup suppliers identified.

3. Geographic Concentration

Risk Examples:
All stores in one city. All customers in one country. All operations in one region.

Impact Scenarios:
Natural disasters, regional economic downturns, political changes, local regulation changes.

4. Product Concentration

High Risk:
Single product generates 90% of revenue. No product diversification. High market dependency.

Lower Risk:
Diverse product portfolio. Multiple revenue streams. Cross-selling opportunities.

Warning Signs

• Revenue Patterns:
  • Single source >30% of revenue
  • Top 3 customers >50% of revenue
  • One product >70% of sales
• Operational Indicators:
  • Single supplier for key components
  • One distribution channel
  • Limited geographic presence
• Market Dependencies:
  • One technology platform
  • Single marketing channel
  • One regulatory environment

Risk Management Strategies

1. Customer Diversification

• Set maximum customer percentage
• Target new markets
• Develop new customer segments
• Build broader customer base

2. Supplier Management

• Multiple supplier relationships
• Regular supplier audits
• Backup supplier plans
• Inventory management

3. Geographic Expansion

• Enter new markets
• Diversify locations
• Spread operational risk
• Build regional presence

4. Product Development

• Expand product lines
• Develop new services
• Create complementary offerings
• Innovation focus

Measuring Concentration Risk

1. Customer Concentration

Customer Concentration = (Revenue from Largest Customer ÷ Total Revenue) × 100

Example:
Largest customer revenue: $500,000
Total revenue: $2,000,000
Concentration = 25%

2. Product Concentration

Product Concentration = (Revenue from Top Product ÷ Total Revenue) × 100

Example:
Top product revenue: $800,000
Total revenue: $1,000,000
Concentration = 80%

Industry-Specific Considerations

1. SaaS Companies

Risks:
Platform dependency, API dependencies, technical debt, customer churn impact.

Solutions:
Multi-platform support, API diversification, technical modernization, customer retention focus.

2. Manufacturing

Risks:
Raw material sources, supply chain disruption, production facility concentration, market demand changes.

Solutions:
Multiple suppliers, distributed production, inventory management, market diversification.

Creating a Risk Management Plan

1. Assessment

• Identify concentration areas
• Measure risk levels
• Evaluate impact potential
• Review regularly

2. Strategy Development

• Set diversification goals
• Create action plans
• Allocate resources
• Monitor progress

3. Implementation

• Execute plans
• Track progress
• Adjust strategies
• Regular reviews

Remember: While some concentration is normal in business, excessive concentration creates vulnerability. The key is finding the right balance between efficiency and risk management.