There are a variety of factors that affect the value of a molding business and influence its ultimate selling price. One of the most significant is customer concentration; specifically, having one customer account for more than 30% of revenue. In general, having one client dominate the majority of any business presents increased risks and will lower the enterprise value. As an example, if Acme Plastics Corp. has a value of six times EBITDA, that same company with a customer concentration might sell for five times EBITDA or even less.
Customer concentration reflects the old adage “all your eggs in one basket” and is viewed as a risk. A molding company with one large customer is tied to the success or failure of that one customer (and possibly that one industry). If that large customer has a reduction in business, or were to file for bankruptcy, the plastics supplier is immediately and significantly affected and could quickly become financially troubled themselves. Additionally, If the large customer realizes how important they are to the supplier, leverage can also become a problem, and result in unfavorable pricing, payment terms or other one-sided business arrangements.
There are some instances when customer concentration may not be a major concern for a buyer. If the buyer is a very large plastics company with a diversified customer base, acquiring a smaller company with one large customer may in effect, resolve the issue. The once dominant customer may now represent only a small percentage of overall revenue in the new company. In most cases, however, particularly with financial buyers, customer concentration is a red flag and will both decrease the level of interest in the acquisition and result in fewer potential buyers at the table.
So how does customer concentration happen? Why don’t business owners and managers just easily maintain a diversified customer portfolio? For a small business (less than $50M in annual revenue) the main challenge is simply the size. A few projects with one customer can quickly become a large part of the sales in a small operation. Ironically, customer concentration usually develops when the supplier is doing a great job, delivering high quality and offering value to their customer. Great performance naturally causes the customer to increase its level of business with the supplier and so the unintended path to trouble is laid.
How can a small plastics company maintain a diversified customer base?
It starts with developing a business sales strategy. This is often a challenge for smaller businesses that have little to no internal resources allocated to sales and marketing. A business of any size, however, that does not have a defined direction for their sales efforts, is subject to the whims of their customers and industries and leaves their long-term success to chance. Too often the sales approach is defined solely by the internal capabilities of the company. A saying comes to mind: if you don’t know what you want, you are very likely to get it.
A good sales strategy should be as specific as possible and consider all variables. The capabilities of the company are an important factor, but they are only a starting point. Where to leverage those capabilities is the next question. Which industry and, more specifically, which segment and applications could most use a company’s expertise? If for example, your company has had success molding clear lens components for a customer, and has developed some expertise in the process, a good sales strategy would be to research where else those same types of clear lens components are used. Who are that customer’s competitors? What is the market share of each one? Where are they located in relation to your company’s facilities? How much does each spend on purchasing lens components in a year? What are those customers’ business strategies and which ones are most profitable and experiencing the most growth? For public companies, much of this information can be found on their website. Quarterly and annual reports not only show financial performance, but will often spell out strategy and define in which business segments they will invest and focus on in the coming years. From that research, a list of target customers and products can be developed. Now your sales team has a focus: not just to sell know-how with respect to clear lens products, but to sell to specific customers that have a need for your particular expertise. This sales force is armed with knowledge about their target business and they have a meaningful value proposition to offer.
Developing a sales plan is hard work. Much of the work is in research and planning rather than in actually making sales calls. But it is extremely important for a manufacturer’s future. A solid sales plan will allow a company to be in control of its own destiny, influence what types of customers it works with, and shape what its business is about.
MBS offers business planning consulting for plastics companies. We have both the experience in owning and managing molding companies AND the understanding of what drives value. Whether you are considering the sale of your company in the upcoming years or just want to make your business as robust as possible, we can help you get there.
By Jonathan Soucy