Diversify, or Suffer the Consequences

Many industries have businesses that suffer from client concentration. The company lands a desirable client, gains more market share, picks up additional business lines, and before long, that client is generating a disproportionately large percentage of the company’s overall revenues and profits. The company is now at risk. What if the client changes things suddenly and without warning? Will your company weather this storm or will it suffer irreparable harm because of it?

Accounts receivable management (ARM) businesses, like most other service businesses, are not immune to the effects of client concentration. Over the years, credit grantor clients have abruptly changed their recovery strategies and their vendors were severely impacted. We have seen this saga play out numerous times, across multiple market segments, and yet many executives don’t do anything before it happens to remove their company from harm’s way. About a decade ago, for example, we started seeing client concentration take its toll in the financial services sector. The proliferation of credit cards in the 1990s led to substantial growth among some of the largest financial institutions including Chase, Citi, Bank of America, and Capital One. As these banks grew, so did their past due accounts receivable. This was good news for collection agencies that were servicing these banks at the time. Placement volumes exploded. New streams of business emerged, and the ARM companies were no longer just collecting the bank’s charged off credit card debt. They were handling multiple business lines for the same client. Auto. Mortgage. Business accounts. Primes. Seconds. Thirds. Quads. First party. Debt sales. The collection agencies gladly accepted the new business and rapidly grew alongside their bank clients. They hired more collectors. They opened new call centers. They invested in technology.

Once a small percentage of their overall revenue, these banks grew to 30, 40, 50% or more of the agency’s overall revenue and a higher percentage of their profits. The owners were making money and everyone was happy. They ignored the concentration risk. Then the music stopped playing. The Great Recession punched the ARM industry right in the mouth. Banks stopped originating new loans. Placement volumes plummeted. Banks that once used dozens of collection agencies to handle their various needs started slashing their vendor networks. Dozens of collection vendors became a dozen vendors. A dozen collection agencies became a few agencies. Those who retained the client also suffered. They lost market share, rates were cut, and the costs associated with servicing that client skyrocketed. Compliance became more important than performance. Longstanding client relationships no longer mattered. Collection agencies that doubled, tripled, and quadrupled in size from the business they were receiving from large financial institution were cut out and left to suffer the consequences.

Fast forward to 2018. We are seeing the same saga that confronted the banking industry unfold right before our eyes in the student loan sector. The proliferation of student loan debt, over $1.4 trillion and growing, along with changes in regulation, has created severe concentration risk among the collection agencies that service the U.S. Department of Education (ED). Currently ED accounts for over 90% of all student loan accounts placed with third party collection agencies. Without notice, ED decided they no longer wanted to place accounts with large (unrestricted) collection agencies, even though they signed contracts with seven agencies last year and replaced them with two agencies this year. ED continued to retain the services of 11 small agencies under the new contract, and two large agencies that were granted an extension from the last contract. Everyone else lost the client completely. It gets worse because now they have to return all accounts that were already placed. Subcontractors and tech vendors were also severely impacted. Without exception, all of the collection agencies that service ED suffer from client concentration. The contracting agencies generate a lot of revenue and profits. For all of the large contracting agencies, the music stopped playing and they, too, have to suffer the consequences.

We are starting to see the warning signs of client concentration play out in the healthcare sector. The time to address the issue of client concentration is right away, before it becomes an issue, although many executives are too blinded by their own successes to see the potential for failure. Start making changes to your business as soon as the ink dries on the contract with the potentially large client and before first placements start flowing your way. Here are a few suggestions to consider:

1. Separate the client from the rest of the business. Large credit grantors typically want their business handled separately so they are doing some of the work for you by requiring you to have separate, secure facilities. Take this further. Create a separate Profit and Loss statement for this one client. Make management accountable.
2. Do not use the cash flow from the concentration client to finance the growth of the rest of the business. Make sure the rest of the business has the right amount of working capital, leadership, and staff to grow independent of the concentration client. It may be a lot smaller as a percentage of your company’s overall revenue but it also has the potential to grow if you support it. That’s why you took on those clients in the first place.
3. Separate the collectors and staff so they handle the needs of the concentration client exclusively. Bonuses and incentives might be different for this client and collectability rates might be significantly higher. This could create a cancer within the rest of your business. Avoid it by separating it.

Investing in these changes up front may make the difference between success and failure if things change with your largest client. And one thing is certain. Change will occur. It always does.

About Kaulkin Ginsberg Company

Since 1991, Kaulkin Ginsberg Company has provided critical strategic advice to the outsourced business services industry. Our client-centric approach covers almost every stage of a company’s life cycle and enables us to maintain longstanding relationships as trusted advisors. We provide mergers and acquisition advisory, strategic consulting, valuation and financial solutions, market intelligence and analysis, as well as litigation support and expert witness.

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