The effect of customer concentration on firm risk, growth and corporate diversification

Despite many empirical studies, research on the relationship between customer concentration and firm performance has not yet reached a definitive consensus on whether companies are better off remaining diverse or concentrated in terms of customers. The research findings on the effect of customer concentration on firm risk and growth provide an idea of risk-growth trade-off. Customer concentration brings benefits on the one hand and costs to the firm on the other hand. Optimal customer concentration will vary from firm to firm.

The risk-growth trade off states that potential growth increases with an increase in risk. As managers and board of directors are likely to be well aware of the risk of dealing with major customers, they will most likely opt for following an unrelated diversification path than a related diversification path. This is often less risky for a company with high customer concentration to tackle an unrelated industry. The potential benefits are also significant for businesses that have successful growth strategies. The stand-alone company does not guarantee the firm an advantage. The supply chain integration required to exploit economies of scale and scope is not without cost. Integration along the supply chain is fraught with contracting problems between customers and suppliers. Critical factors in determining success can be good corporate governance practices and a good level of management expertise.