This past week saw the termination of a 16-year relationship between American Express Co., AmEx, and Costco Wholesale Corp. In the partnership, Costco accepted only AmEx credit cards in its more than 670 locations. Effective early next year those cards will terminate.
What can private business owners learn from this? Let’s first define a term that may be new to many. The term “Concentration of Risk” typically means that a disproportionate portion of sales or receivables are from a small number of customers.
Situations vary but if your sales to any one customer are more than 15 percent of annual sales, your banker will want to know more before approving or renewing a line of credit. Credit concentration is similar to sales concentration. If any one customer makes up more than 10 percent to 15 percent of your total outstanding accounts receivable, your loan becomes less desirable. You may still obtain or retain your loan if your customers’ credit rating is good, but you may receive a lower loan amount or pay a higher interest rate.
According to American Express CFO Jeffrey Campbell, Costco made up roughly 10 percent of AmEx cards and 20 percent of AmEx loans worldwide. The upcoming loss resulted in its share price dropping 6.4 percent the day of the announcement. You may not care about risk concentration. However, your banker will.
Actually, you should care for the same reasons your banker is concerned. It’s not good business to rely on a customer you can ill afford to lose. If that customer goes elsewhere or goes out of business, your revenue and profit will go down and your business is at risk of closing. An especially dangerous sign is when one customer represents an accounts receivable ratio that is even higher than their sales ratio. For example, if a single customer contributes 15 percent of your sales but represents 20 percent of your accounts receivable, you are even more at risk because they are paying slower than they are buying. Every time they buy, your working capital and cash flow go down. You will eventually be in a position where your customer “owns you.” This means you can’t afford to keep them as a customer and you can’t afford to lose them. You can only hope they will survive and pay you someday.
Another area to check is your supplier list. Are you at risk if a supplier goes out of business or declines to sell to you in the future?
Finally, when it is time for you to exit, your potential buyers will reduce the price they will pay if they find concentration of risk. It takes little time to calculate your receivable, sales, or supplier concentration on a quarterly basis. You should consider any concentration approaching the 10 percent level as a red flag to broaden your customer or supplier list. You and your banker will be glad you did.
Bowser@BusinessValueInsights.com. Dan Bowser is president of Value Insights, Inc. of Durango, Chandler, Arizona, and Summerville, Pennsylvania.