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What are the Benefits of a Diversified Revenue Stream?

by Michael Iverson, Principal of Trillium Financial

When you think about the way America’s small businesses get started, it should come as no surprise that a relative few have revenue streams that could be considered diversified. A great many startups are the result of the entrepreneurial recognition of a market need.  In many instances, the market need is that of a single, sizeable customer.

For instance, I once made the acquaintance of a woman who helped manage the investments of a state pension fund.  One of the challenges of her position was keeping abreast of corporate governance matters for a universe of nearly 2,000 stocks owned by the pension fund.  Her team had a fiduciary duty to vote the shares in the best interests of the pensioners.  Yet, keeping tabs on executive compensation plans, auditor changes and corporate acquisition proposals for 2,000 different stocks was nearly impossible, given the small staff of the pension fund.  Why wasn’t there a service that could provide advisories on the stocks owned by her fund and other pension funds?

To make a long story short, she left the pension fund to become an entrepreneur and start the business that would address the very need she had identified.  She started a fiduciary advisory service to track corporate governance issues of stocks held by pension funds.  Her former employer became her first customer.

Starting Out

In the early years of a startup, it’s not uncommon for a business to be strongly dependent on its first customer. For some startups, it is 100 percent of first-year revenues and more than 50 percent of second-year revenues.

No matter how solid that first customer may be, it is prudent to become less dependent on the customer by diversifying the revenue stream.  Keep the original customer happy by providing outstanding service, but develop new customers as quickly as you can.

Diversification of revenues provides financial stability for your company, reduces business risk and makes your business infinitely more marketable when it comes time to sell.   Diversification can be number of customers, geography of customers, and product offering.  One of the metaphors that I have heard over the years is a three-legged stool offers more stability then a two-legged stool.

Shoot for 15%

As a goal, try to diversify your business to the point that no single customer is responsible for more than 15 percent of revenues.  Until you achieve that goal, the possible loss of your largest customer (due to reasons as varied as a change of ownership or a sudden downturn in the customer’s industry) carries significant financial risk to your business.

I have met any number of business owners who have lost a customer responsible for 30 percent or more of their revenues.  The results can be devastating.  Imagine having taken on debt to expand the business, only to lose a customer of that size.  Some businesses can’t survive that kind of a hit; others survive, but with great difficulty and sacrifice in the way of layoffs and contract renegotiations.

As many of my clients know, it’s not easy to achieve the 15 percent target. It’s not uncommon for talented service providers to be approached by a large customer who wants more of their time, not less. I advise clients to be disciplined and politely dismiss opportunities that would make them more reliant on a large customer.

Even though the initial financial rewards may be tempting, there is an important trade-off in terms of autonomy.  A business owner who hitches his wagon to a single customer often feels more like an employee than a business owner.

Is your business in need of a more diverse base of revenues?  We have ideas about acquiring new revenue streams. Give Trillium a call at (404) 353-2148 or send us an email.