August 8, 2008

Reducing revenues to reduce risk

by Brian Turner

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One of the commonest risks in a service business is known as the 80:20 rule - where 80% of your income comes from 20% of your clients.

The risk comes from the danger of any of that 20% cancelling their service, resulting in a significant drop in revenues.

This in itself is bad enough, but if your business model has required a significant investment of funds into servicing that client, the consequences can be serious.

I already know a friend whose business collapsed after over investment in a single client who backed out at the last minute, leaving such a big hole in the company’s cash flow that they could not finance daily operations.

In other words, those valued 20% clients are not simply revenue generators, they are also a liability.

Managing Risk

My approach to managing the 80:20 rule risk is simple - reduce my fees.

At first, this can seem a little crazy - after all, my business must look to increase revenues, and increase profit with it. By reducing fees, I’m reducing revenues and therefore profits.

However, I’m playing a long-term game that means client retention is of paramount importance. After all, if you have guaranteed clients, you have guaranteed revenues. So long as you have revenues, you have profit potential.

The credit crunch means that today’s business reality is one where some industries have been hit hard, not least through reduction of consumer spending.

I have had a couple of clients ask for fee reductions this year, and in seeing the trend, I’ve proactively reduced fees for other clients to bring fee levels in line.

It hurts a bit - I can’t deny that - but I see the choice as one of maximising short-term revenues, or maximising long-term revenues, and I think that is no choice at all.

After all, where’s the gain if you charge normal for a 20% client for a couple of months, only to lose them after? That’s got to hurt revenues more.

Of course, it all depends on your business model as well. I’ve been keeping a constant eye on costs over the past year anyway, and reduced costs where I felt the investment was not worth it - but also continue to increase investment in projects where I feel long term advantages are still offered.

Running a business I think is not about making money, it’s about managing risk in a way that optimises revenues and profit production. I think the difference is subtle but significant.

While I genuinely care about my clients and aim to support them, the decision to reduce revenues for long-term aims I think is also a good business decision.

In the meantime, I’m looking to reduce risks further: through client retention, client acquisition, increased diversification, and an overall more stable long-term outlook.

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