We protect ourselves by building safeguards into any buying or selling relationship that is significant enough to hurt us badly if the other party has problems. Obviously, you can’t always dictate all the rules, much less protect yourself from all of the risk that is inherent in business. But you can find ways to stack the deck in your favor -- here's how:
Watch where you put your eggs: It’s a basic rule of business to avoid having any one customer – or relatively small number of customers – represent a large enough share of your business to pose a threat to your security. Depending on circumstances, rules of thumb consider it “unhealthy” to have anywhere from 10 to 30 percent or more of your business dependent on any single customer.
When my family bought its first business in 1976, the already 30-year-old company had effectively one customer, an exclusive distributor. Had there been a problem with that relationship, we would have been out of business overnight. The distribution model was quickly changed, and by the time we sold the company in 1998 we had over 1,000 wholesale customers, some very large, but no single one on which our survival depended.
Many small business owners don’t have much control over this, either because of the nature of their product or service, the number of years they’ve been in business (young, small companies often don’t have a large customer base), or the manner or breadth of their distribution. My current business still has one or two customers we really can’t afford to lose, and it is an ongoing priority to reduce that risk while continuing to enjoy the rapid growth of these major accounts.
No one wants to give up business, and clearly few owners would purposely do less business with a good customer just to keep its “dependence percentage” in check. So the keys are to carefully manage your biggest relationships to minimize the chances and consequences of anything going wrong, while at the same time focusing on reducing your major customer risk through new customer acquisition and/or product/service diversification.
Don’t give credit where credit isn’t due: Small businesses often make bad decisions because eagerness (or desperation) to make a sale overwhelms the prudence of making good credit risk decisions. Since a sale isn’t a sale until the money’s in the bank, extending too much credit to an unknown or iffy customer can have far worse consequences than passing up on the business. Shipping an order and not getting paid is roughly twice as bad as not getting the order at all.
Ideally you shouldn’t offer open account terms to any customer whose creditworthiness is questionable, no matter how much you want the business. But for many companies and industries, demanding upfront payment is unrealistic or impossible. Heeding the old wisdom that you should never risk more than you’re willing to lose, you should always be willing to forgo potentially bad business.
In most cases it doesn’t have to be all-or-nothing; depending on the nature of your business, you can manage your exposure by requiring deposits and/or progress payments, offering early payment incentives, securing letters of credit (typically in international sales) or even authorizing a credit card charge but not processing it until the end of the hold window. You are also more likely to get customers to agree to your terms if they are published and consistently administered, rather than negotiated or changed on the fly.
Finally, be politely firm about timely payment – slow accounts only get worse if you don’t enforce your terms.
Watch your supplier blind-side: I have seen more than a few good companies suffer as a result of supplier problems, such as delivery failures or major delays, quality issues, financial stress or other unwelcome surprises. My main problems this year have been supply headaches. They’ve been painful, but survivable, because we never enter into major supply relationships without protection against these possibilities. Our agreements are such that in no circumstance will we be at risk of losing money in the event of nonperformance. Many companies won’t accept these terms, but others will, and those are the partners we want to work with.
We send prospective supply partners a professional, clearly stated list of our business requirements (just as our big customers send us), and ask that they confirm they can work within these guidelines before any business discussions begin. We have found that this not only saves time, but that suppliers are more likely to accept our terms if they are laid out upfront – and accompanied by excellent trade references – rather than brought up later in the process.
Note that if you are able to negotiate such safeguards, you must do your part by being a great customer: pay promptly when the supplier has met its obligations, choose your battles (be accommodating with small problems so you can stand firm on the big ones), and stay loyal to good partners (that goes a very long way). If you don’t keep up your end of the bargain, your advantageous terms won’t last long.
I’ll be happy to put this freaky year behind me, and even happier that we had ourselves set up to weather
even relatively big storms and move on. Next year is shaping up to be a great one, and I hope the same for you and your business.