Who's your customer?

Last week a number of people contacted me regarding the sudden Axium/Chimes bankruptcy out of California. Apparently, the company had a large concentration of business in Hollywood and the writers' strike crippled their ability to cash flow the business. Unfortunately, thousands of companies around the company are out millions of dollars in losses because of this far-away bankruptcy including hundreds of companies here in Minnesota. Most likely, many of these companies will now follow suit and close their doors as well.

How could this have happened? First and foremost, some of the companies suffering losses had the same customer concentration problem as Axium/Chimes: one customer accounted for too much of their total revenue. Secondly, too many of these businesses didn't even consider Axium/Chimes as their customer in making business decisions, as they had no choice from the end user but to bill through Axium/Chimes. Thirdly, and most importantly, many of the companies I talked with had NO IDEA that Axium/Chimes posed any type of loss possibility to their receivables.

Customer concentration is a huge risk for all size companies, but especially small businesses. Not only does concentration give too much power to the customer in negotiating, but it usually results in lower margins. In the case where the customer isn't an "A+" credit, the concentration can be deadly as we'll see with many of the smaller customers losing their businesses.

Why didn't these companies consider Axium/Chimes as their customer? Because their RELATIONSHIP was with the end customer. They failed to fully understand the impact of having the "customer in the middle" where the risk lies. While the customer relationship may have been where their people physically resided in providing services to the end user, their real customer is the one who paid the bills: the now bankrupt Axium/Chimes. Apparently, many of them didn't have well-defined contracts and actually THOUGHT the end user was the customer.

Speaking of billing on credit, how could so many companies not understand the credit risk of dealing with this company? Easy--very few did any research on the financial stability of the customer. They secured the business, priced it, and started billing it. They thought that payments would be somehow "automatic" once you started billing. If this were true, there'd be no need for credit managers employed throughout the world.

Determining creditworthiness is sometimes a complex process, but it's critical to understand the probability of default when you decide to grant credit terms to a customer. In this case, Chimes had had a precarious financial situation for at least 4 years--the time we started analyzing them. Even before they were acquired, the company had a high risk of defaulting on payments.

Creditors have got to decide what amount of risk warrants an in-depth look at the risk. When they understand the risk, they can then employ strategies like following up immediately on past dues, billing often, and holding service until the customer is current to minimize potential loss exposures. If the risk were known in this case and the margins were insufficient to make up for any losses, a company could have chosen to walk away from the business.

Know thy customer is the #1 rule when you are deciding whether or not to take on a client and bill them on credit. It's too late for some of the creditors in this case. However, the rest can look to this as a warning to understand the risk that's left in its portfolio.