What 80/20 really means: One big failed customer will kill you

Comment Once again small and medium-sized enterprises (SMEs) are being held up as the saviour of the economy in general and the IT industry in particular. But once again, I expect our industry to ignore what's staring them in the face.

Why is it that vendors, big business, governments and Uncle Tom Cobley are talking about the value of SMEs and how important they are for current and future growth? What has spurred this sudden blinding inspiration? This is a market, let’s face it, which they’ve largely ignored for some 14 years or so.

Let’s hark back to 1999 for some answers, a time when many of our industry’s great and good were tapping through some serious miscalculations as to what the year 2000 would yield.

As early as the third quarter of 1999, it became evident that we were heading for a period of turbulence and uncertainty. In the UK, large sector players, fattened and overweight through historical annual growth rates of 25 per cent plus and with less than a keen eye on costs, were smacking their lips in anticipation of hugely increased business activity arising out of the much-publicised “millennium” liability. Many moved to add further considerable overheads in anticipation of another spike in spending.

Sadly, this never happened in the fourth quarter of 1999. More damagingly, neither did it appear in the first quarter of 2000. Many nonetheless steadfastly refused to acknowledge something was drastically wrong and held back, hoping the position would improve in Q2. Well, it didn’t.

Those that did react in cutting overhead costs rationally, and quickly changed direction, swam reasonably well against the tide while the ones who didn’t filed a series of poor results. Their reaction was slow and as a consequence, their curve to recovery would be far more prolonged and painful.

In the meanwhile, big money was being thrown at anything with a dot com suffix...before 2001-2002, when the "dot com bubble burst" led to a prolonged period of recession similar to one back in 1992.

Some well-known names crashed spectacularly or had to work extremely hard to move on. Enron, Marconi, NTL, Energis and Worldcom all spring to mind as does the failed InterX, original owner of the distribution business of Ideal Hardware Plc that was sold to Bell Microproducts in the US. Within 24 months of receiving funds from this sale and attracting further significant investment via a rights issue, InterX was obliged to delist in August 2002, changing its name to Danogue Plc before moving to liquidation in May 2003.

So how does all this history affect the SME business?

Because at the same time as all this was happening, we witnessed the onset and potential of "e-commerce", a way of doing business online and cutting out cost. People of all ages and qualification levels were running around talking about return on investment and reducing the “cost of a sale”. Many had no idea what this meant, or worse, what impact it would have.

The IT sector is prone to mimicry and all it takes is one person to come out with a buzzword or idea that sounds plausible and the rest will copy it. E-Commerce and B2B activity was on the rise but the harsh reality was that despite substantial investment in front end web design and E-Commerce enabling tools, clients would still use sites as a means of determining availability and pricing, preferring to make a telephone call to close the deal. This has not materially changed today, hence the proliferation of price comparison sites and businesses.

Large organisations, in common with others, took a view that pushing low-end business online allowed them to concentrate effort and attention (misguidedly) to where resources were (at least in their view) really needed: those big fat juicy accounts yielding the most sales revenue. And here is how the rot set in.

Doing too much business with too few players can be a killer

The Pareto principle or the 80/20 rule, states that 80 per cent of the effects come from 20 per cent of the causes... This is as true in business as anywhere else: in most cases, 20 per cent of your accounts will yield 80 per cent of business. Previously, as a strategy, greater emphasis was placed on growing the business done with the vital 20 per cent, pushing the other 80 per cent, which yielded 20 per cent of sales revenue, into less focused and more tranquil sales pastures.

SMEs and their lower spend therefore almost became irrelevant, with many losing their dedicated account management. The result was gradual further erosion, with the ratio heading to almost 90/10 – a very dangerous game to play. It stands to reason however. Increase someone’s target and they’ll go to those accounts that already trade heavily rather than those that do not.

If the top 10 accounts with whom you trade make up 60 per cent or more of total business or one client approaches 10 per cent of your business, your business risk is enormously heightened and pressure on margin is inevitable.

Objectively, bigger clients place greater demand on a supplier. This may take the form of price protection, stock rotation, rebate, special reporting, funded heads, monthly reports, special logistics and stock holding requirements and the inevitable cost burden of sales back office support personnel in order to manage the relationship.

To make matters worse, big clients will squeeze the life out of pricing, reduce overall margin and add cost with often disputed debt and extended credit terms. Some may even have the audacity to "tender" their business annually.

From a risk perspective, too, it is precisely these clients that cause greater pain should their results weaken, reducing the availability of credit insurance cover and negatively impacting on a supplier’s analysis of business risk across the accounts receivable ledger. Dealing with a £5m exposure when your own risk judgment suggests it should be lower and you no longer have cover presents obvious problems.

What many missed throughout all this turmoil and change is that the SME sector that was forcefully pushed into the wilderness between 2002 and 2007 through pressure to buy online was actually far more resilient.

Sales structures changed too; fewer people were actively engaged in selling, back office sales support numbers rose to meet the demand of trading with fewer and bigger clients and vast swathes of SME businesses was buried into mass reactive sales driven areas that simply took incoming calls. Sadly, this still prevails today, even after the financial meltdown witnessed at the beginning of 2008.

Learning from past mistakes

Many large businesses carry too much of their volume with too few clients and fail to recognise the value of lost client accounts or more balanced receivables. Continuous penetration and review of unused credit, diminishing or lost sales and evaluation of client profitability are crucial activities no matter what size of business you are.

One must remember that small guys today might well be big in five years time. SMEs pushed out, not with malice but in a somewhat slanted and irrational drive to follow the lead of others, are not going to sit and wait for you to recognise the value they offer.

Many years ago, I met with the finance director of a large business based in the City. Their concentration of resource went exactly the same way, towards the bigger players, and their experience mirrored many others. Those big clients crushed margin, placed greater demand on resources and then suddenly reined in spend. The Company’s revenue declined from £37m to £24m and they only broke even in one month, making losses in all others. Headcount was heavily reduced, the previous finance director was pushed out and it took almost four years to move back into profit.

In most market economies, SME business accounts for more than 70 per cent of total workforce and business volumes are equally high. Dependence upon fewer and much bigger clients is guaranteed to stifle growth, diminish profitability and increase risk substantially.

In truth, even SMEs themselves are careless in their approach to sales-volume spread, hankering for those big "blue-chip" or public accounts, just to show how "successful" they are. An entirely misplaced notion given the havoc big clients can wreak with their demands or lack of loyalty.

I met an SME business owner many years ago in a medium-sized industrial park who had recently moved into the premises. He lamented the low success rate in targeting SME end user clients. Looking out of the window, I asked him if he had made an effort to review or at least contact the two engineering companies across the road or those 20 or so around him in the same industrial park. His answer, remarkably, was negative.

From a risk and business sense perspective which would you rather have: 100 accounts each on 30-day terms with a fully utilised credit line of £10,000 generating a gross margin of 8.9 per cent, or 10 accounts on 60-day terms with fully utilised credit lines of £100,000 generating a gross margin of 3 per cent?

A client won should never be lost. The cost of winning new clients is infinitely greater than retaining them and "big boys" are not necessarily "manna from heaven". ®