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
Key customer dependence is clearly a critical factor with important consequences for a young firm’s survival and growth. As such, it should explicitly be incorporated into the strategic management of a firm’s customer portfolio. Entrepreneurs and managers should carefully evaluate their firm's level of dependence on each of their most important customers. What is the proportion of revenues coming from the customer? What would be the effect on the firm if the customer relationship were to be abruptly terminated? Has the customer behaved coercively in the past, drained firm resources, or constrained the firm's development? Or has the relationship created value and opened up new growth opportunities? In conducting this systematic assessment, it is important to take a longer-term perspective and resist the tendency to focus just on the next sale.
2. Avoid or reduce dependence early on
Key customer dependence is particularly hazardous for the youngest of firms. Given that survival is a necessary condition for positive outcomes such as growth and profitability to follow, it is of utmost importance to reduce over-dependence on a key customer. Managers in early-stage firms should therefore be especially wary of relying too heavily on revenues from a key customer and should strive to build a more balanced customer portfolio.
3. Leverage dependence for growth by utilizing industry experience later on
Once a firm becomes more established and it treads past the uncertainty of early survival, managers can increasingly leverage key customers to achieve greater overall customer portfolio growth. The reputation effect of the key customer can help the young firm gain legitimacy in the marketplace, and new products developed for the key customer can be sold to other customers. The study shows that the industry experience of the top management team is of importance: ventures with more experienced top management teams are able to extract more value out of the dependence on a key customer resulting in greater customer portfolio growth than in ventures with less experienced top management teams. Young firms would thus be wise to involve some “gray hair” on their top management teams to bring in prior industry experience.
4. Don’t overinvest in developing relationship quality with key customers 4. Don’t overinvest in developing relationship quality with key customers
While it could be expected that the quality of the relationship with the key customer would protect the young firm from the downsides of dependence on the key customer, the study showed that this is not the case. The effects of dependence on survival do not depend on relationship quality, and with regard to customer portfolio growth, the study showed that it was actually better for highly dependent firms to have a relatively lower level of relationship quality with the key customer. This suggests that entrepreneurs should be careful not to overinvest in the development of reciprocity and trust with the key customer, especially if it comes at the expense of neglecting other customers or potential new 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), .