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May 4, 2018
Revenue is the lifeblood of your business, fueling the economic engine that moves your company forward.
We can all agree that without revenue, values fall and businesses fail. However, it is substantially more difficult to understand that certain revenues can also be harmful to your business value. And while a thoughtful analysis of your client base is not a new concept, few business owners have the tools in place to regularly monitor and act when necessary to ensure their new and existing business drives company value forward.
When we analyze a customer base and differentiate between revenue streams, our goal is to drill down to the value drivers that exist within each project or account. And while there is always variance between industries, sectors and even geographies, the fundamentals behind these metrics are all-encompassing.
Concentration: Concentration refers to the size and number of sources that make up your total revenue. It is one of the first metrics considered when discussing value. Higher concentration, or having the bulk of your revenue from one assignment, one customer or one contract, greatly jeopardizes the security of your revenue as well as your company.
By lowering revenue concentration, you not only eliminate a significant amount of risk, but also drive up value. Ideally, your largest customer or contract should account for less than 50 percent of total revenues. And preferably, your top accounts should make up no more than 60 percent of total revenues. As revenue spreads among more accounts, more value becomes attributed to it. To improve your concentration metrics, consider increasing focus to higher-volume prospects or adding on products and services to smaller accounts.
Diversity: This metric focuses on the characteristics of each account. What industry is the project in? Where is the assignment located? What services will be needed?
Like customer concentration, a diversified client base is a key driver in building value because it spreads your risk among industries and geographic regions.
It can be natural for a company over time to gravitate to a specific industry or area. However, strategic efforts must be made to achieve a healthy level of diversity within your revenue. Are there complementary industries that can strengthen your book of business? Or is there an opportunity to grow with a client looking to expand their reach?
As these strategic options evolve, consider also the costs and benefits of opening a branch office in a neighboring area as a means to diversity. This is also a great time to consider acquisition as a tool. Acquiring a company that already has a presence in that sector or area provides a greater understanding of the mechanics of that sector or area.
And last, beyond industry and geography, a strong and value-driving revenue base will include assignments of varying size, scope and service needs.
Profitability: While third on our list, profitability is as vital as any of the value drivers discussed. It is crucial to know the cost associated with each assignment.
How does gross profit margin compare with your other assignments and the industry at large? How much overhead will be attributed to the project? What is the likelihood of cost overruns? Is there live job cost reporting to alert you to such overruns? And is there margin room to accommodate them?
Such an analysis of each revenue line brings your bottom line into focus. It gives a true assessment of the project's viability. It also helps determine whether a potential assignment will add value to your current revenue stream or take away from it.
If these variables don't fall in line with your target, the assignment has the potential to drive down your company's value. There are always reasons to take on an assignment chief among them, no one likes to turn down money. However, lower-margin work must be approached strategically and cautiously.
Recurring: Many industries are project based and don't lend themselves easily to repeat business. However, strategic thought needs to be given to this area. Revenue streams that are recurring and predictable are excellent value drivers.
Does your business have the ability to add complementary services that are recurring in certain aspects? Or is there an element of frequency that can be added or increased in an existing book of business?
Exploring these potential areas could prove to be a revenue and value builder.
The X factors: In addition to the specific metrics discussed, there are several other factors that can impact the value of your revenue. Their importance can vary significantly among industries.
Client retention rates can address the success of customer relationships, and strong customer relationship management and quality assurance programs. It can also identify any trends in need of correction. Contract terms and expiries can show how sustainable the work is, and when able to be coordinated can add to revenue strength.
Labor tracking and quality assurance programs increase the productivity of the revenue. Union agreements, minimum-wage requirements and other government regulations have their own impacts. As many of these factors are often beyond control, the key is to mitigate their impacts where possible.
Find the value drivers
There are clear value drivers that exist within your revenue lines. It is important to identify these and maximize them.
Drilling down on each client and assignment, including direct costs and overhead associated with the project, will produce this knowledge. It will also highlight areas of concern where improvements may be needed.
Create a deliberate and strategic approach to this analysis. Apply the criteria to your new business opportunities. This creates an efficient means that can also accelerate your organic growth. Out of this will come a sustainable and quality client base that increases the top and bottom lines, and improves company value.
John R. Tullius is an associate and economist at Tullius Partners, an investment banking firm that specializes in providing merger and acquisition and financial/strategic advisory services.