How dangerous is an “all-eggs-in-one-basket” strategy? The effect of customer dependence on young firm survival and growth
Attracting customers is one of the hardest challenges and most important milestones for entrepreneurial firms. But the challenge doesn’t end there: once your venture has customers, how should you manage them? Is it good to have a large customer portfolio with each individual customer accounting for a small percentage of sales? Or is it better to have a few key customers that generate a significant chunk of your firm’s revenues, but that your firm is thus more dependent on? How dangerous is such an “all-eggs-in-one-basket” strategy?
A recent study published in the Journal of Business Venturing by professors Helena Yli-Renko (University of Southern California), Lien Denoo (Tilburg University) and Ramkumar Janakiraman (University of South Carolina) provides an answer to these questions. Based on data from 180 young technology-based business-to-business firms in the UK, their study gives insight into how dependence on key customers matters for the survival and growth of young technology ventures, and on how entrepreneurs can manage this dependence and improve their ventures’ outcomes.
The study’s results show that the more dependent a young technology firm is on its key customers, the higher the venture’s failure odds are. This reflects the risks associated with being highly dependent on a key customer: a young firm may become a “captive partner” of its customer. In being obliged to satisfy its key customer, the young firm may have to sacrifice short-term profits to maintain the relation with the key customer and may miss out on opportunities to attract new customers or develop new products. Being dependent on a key customer may also make a young technology firm highly vulnerable to any shocks or changes in the relation. The customer itself may suffer from slow markets, experience cash flow problems, get acquired, go bankrupt, or vertically integrate by acquiring one of the young firm's competitors—any of these could effectively wipe out the key customer's portion of the young firm's revenues.
The study’s results also show upsides to dependence, however. If a young firm manages to survive, the effect of key customer dependence on the growth of the firm’s customer portfolio becomes positive. Dependent relationships are typically more long-term and have a greater scope, which may lead to knowledge spill-overs. Economies of scale in relationship marketing, design, delivery and service may lead to lower sales and fulfillment costs, and also reputationwise, being closely associated with dominant customers – often large established firms – can bring benefits to young firms in terms of credibility and quality. Being dependent on key customers thus also brings some benefits to technology firms.
While dependence on a key customer may nonetheless seem like a risky “all-eggs-in-one-basket” strategy, it may, in fact, be possible for young firms to leverage a key customer relationship for future growth. In addition to uncovering the positive and negative effects of dependence on survival and growth, the authors also showed that firm age, top management team experience, and relationship quality are contingency factors that influence whether and when dependence will harm or help young firms. Key customer dependence can thus be seen as a high risk – high reward strategy for young firms. Below are four key advices for technology entrepreneurs on how to manage customer dependence and use it to the young venture’s benefit.
1. Look beyond revenues: diagnose dependence
2. Avoid or reduce dependence early on
3. Leverage dependence for growth by utilizing industry experience later on
4. Don’t overinvest in developing relationship quality with key customers 4. Don’t overinvest in developing relationship quality with key customers
Overall, the study shows the difficult balance that young technology ventures should find in managing dependence on key customers and the many contingency factors such as firm age, top management team experience and relationship quality that influence the effects of dependence on firm survival and growth. If firms manage to survive the downsides of being dependent on a key customer, however, dependence has a positive effect on the growth of the young venture’s customer portfolio, giving credence to the old adage of “what doesn’t kill you makes you stronger.”
Yli-Renko, H., Denoo, L., & Janakiraman, R. (2020). A knowledge-based view of managing dependence on a key customer: Survival and growth outcomes for young firms. Journal of Business Venturing, 35(6), .