One big customer: the supplier-to-OEM trap

Many Indian factories grow by doing excellent work for one big customer, often an OEM: the company that owns the brand and sells the finished product. Orders come steadily, there is no need for a sales team, and the customer may even help with drawings, tooling or quality systems. It feels safe.

Norm Brodsky and Bo Burlingham’s Street Smarts warns that it isn’t. The book advises a start-up to build on smaller customers at good margins, partly because losing one won’t sink you. Years later, in an Inc. column on what he called a dangerous but common sales mistake, Brodsky described a firm that had grown by selling mostly to one large company and was planning to grow by selling to more of that same company’s divisions. His point: when most of your customers share one thing, such as the same owner or the same industry, you can lose a huge amount of business at once, and your company is worth less when you want to sell. He had seen it in his own business, where most customers came from one industry. (See idea 9 on our Street Smarts page.)

This article applies that warning to the manufacturer rungs of the ladder. The numbers are hypothetical.

Who falls into this trap

• Job workers (3.1) process material the customer owns. A few customers often fill the whole factory.
• Contract manufacturers (3.2) make whole products for brands. One brand can be most of the order book.
• Component suppliers (3.3), Tier 2 and Tier 1, make parts to one OEM’s drawings, sometimes on tooling that fits only that OEM’s product.

All three are good businesses. The risk is not the customer; it is how much of your business one customer is.

How dependent are you?

What one customer can do to you

Ask for a lower price. A customer that is 70% of your sales has strong bargaining power. A price cut goes straight off your gross profit, because your material, labour and overheads don’t fall with it. (See price-down in plain words and OEM pricing.)

Move orders elsewhere. The OEM may add a second supplier, bring a part in-house, change the design or simply sell fewer vehicles. Your overheads stay.

Pay later. Big customers can stretch payment terms. When one customer is most of your dues, its payment days become your cash cycle (see Cash before profit).

Lower what your business is worth. Brodsky’s column makes this point directly: dependence on one customer or one industry can reduce what a buyer will pay. A buyer, investor or bank sees the same risks you do (see Build a business someone would buy).

Getting out of the trap, without losing the customer

Brodsky’s advice in that column is not to drop the big customer. Keep serving it well, and put salespeople on winning business elsewhere, in other industries. For an Indian component maker, that might mean:

1. Sell the same skill to a different industry. A firm that machines two-wheeler parts can often machine parts for pumps, tractors, textile machines or electrical equipment.
2. Sell to the OEM’s competitors where contracts allow. Check your agreements and any tooling ownership first.
3. Look at the replacement market, where you can sell parts through distributors under your own brand. This is a step towards own brand (3.5).
4. Give someone the job of new sales. Without a person whose job is new customers, the easy orders from the big customer always win.

It is slow work, which is why it should start while the big customer is still happy, not after it has asked for a price cut.

A note on rules of thumb

Some summaries of Street Smarts report specific percentage limits for how much of your sales one customer, or your few biggest customers together, should make up. We could not confirm the exact figures in Brodsky’s own columns, so we don’t repeat them as his rule. The principle is clear without them: the more of your business one customer is, the more that customer controls your prices, your cash and your future.

In short

• Work out what share of sales your biggest customer, and your biggest three, make up.
• Work out what a 5% price cut or the loss of half their orders would do to your profit.
• Keep serving the big customer, and give someone the job of finding customers elsewhere.
• Start before you need to.

Related: OEM vs commodity, operating leverage (why a fall in sales hits profit harder) and the manufacturer sub-levels.

The ideas are Norm Brodsky and Bo Burlingham's, from Street Smarts and Brodsky's Inc. column on one-customer companies (October 2016). The explanation and the examples are ours.