Companies with robust sales and profits and growth rates can get investors drooling. But in some cases, those shiny metrics might conceal a critical vulnerability that brings with it heaping piles of risk. Many companies' promising numbers belie their dangerous dependence on a very small clutch of customers.
Bloomberg Businessweek recently noted that several Indian outsourcing specialists are highly reliant on U.S. customers for their income. Infosys Technologies
That's not the only threat these outsourcers face. The state of Ohio recently banned the outsourcing of its information technology work to foreign companies. If other states, or possibly the entire country, follow suit, a huge revenue source for foreign outsourcers will shrivel up, even if U.S.-based rivals such as Cognizant Technology
The Wal-Mart effect
When a company is too dependent on one or a few customers or customer groups, it occupies the wrong side of the balance of power. The company may have to accept tough terms to avoid losing crucial revenue. Back in 2007, Forbes offered stark data on the dangers of an overconcentrated customer base. It looked at 333 companies that sell to Wal-Mart, and found that the greater their percentage of sales to the company, the lower their gross margin:
Wal-Mart Sales as Percentage of Total Sales
Gross Profit Margin
|Less than 10%||39.1%|
|10% to 20%||36.2%|
|More than 20%||35.4%|
Concentrate on concentration
As investors, we need to keep an eye on overdependency in our companies. Many people fear that AT&T
Companies themselves watch this issue no less keenly. Motorola
For great stock ideas, get the Motley Fool's free report, 5 Stocks the Motley Fool Owns ... And You Should Too.