One of the key advantages to building a new SaaS business is the ability to launch a product, start generating revenue, and then scale up quickly — without a lot of overhead. Recurring revenue and predictable income streams make it possible to grow on your own steam. Stability and long-term success, however, come from your customer base.
Many SaaS startups gain early traction with only a few dedicated customers. That alone presents a potentially serious risk to your business — if one of your customers churns, can your startup survive?
Putting all of your eggs in one basket could scare off potential investors. Worse, because so much of your revenue comes from a single account, it could put you in a serious cash crisis from which it may be hard to recover.
We help you assess whether your young SaaS startup has a customer concentration problem, and how do you mitigate that risk if you do.
What is customer concentration?
Customer concentration refers to how dispersed your revenue is across your client base. For example, if more than 10% of your revenue comes from a single client or 25% of it comes from a group of five of your biggest clients, you may have high customer concentration.
How to calculate customer concentration risk (CCR)
The formula for calculating customer concentration risk is pretty straightforward. Take your largest customer or your top five customers and divide their revenue by your total revenue from the same period. This will show what percent of your total revenue comes from that customer or cohort.
Revenue from your largest customer
Total revenue (same period)
High customer concentration risks
High customer concentration can adversely impact a startup in a number of ways, including:
Less growth/scaling opportunities
Difficulty in adapting to market/industry changes
Lower chances of landing investment
How high is too high?
A good rule of thumb for early-stage SaaS startups: if you’re making $200K ARR or less, no single customer should account for more than 50% of your recurring revenue.
By avoiding heavy reliance on a single customer, you mitigate the potential challenges that can arise from their changes in purchasing behavior, financial instability, or switching to a competitor.
Guidelines for minimizing your SaaS startup's customer concentration risk
Your best business decisions are made with good data and realistic expectations. If you’re an early-stage SaaS business, you need alternative methods for evaluating your customer concentration risk, which will ensure you stay focused on your most important growth levers.
You’ll certainly want to consider your market, competition, and pricing strategy — new customer acquisition and your average customer value (ACV) are going to look quite different if you’re selling an annual subscription to enterprise businesses for a product in a new category compared to, say, a startup targeting SMBs with a monthly subscription product.
A SaaS startup selling enterprise solutions, for example, is likely to have a longer sales cycle to acquire new customers and a higher ACV. Of course, this type of business is going to be slower to add new clients and diversify its customer base to reduce their customer concentration risk; and there’s no need to hit the panic alarm as long as you set some interim guardrails.
Use the following to guide your SaaS startup from idea to product-market fit to revenue growth, while minimizing your customer concentration risk as you grow.
1. One customer shouldn’t deliver more than 50% of your revenue.
Relying on one customer to keep your startup afloat is simply too risky. If that customer churns or downgrades, you’re going to be in a tough spot financially. Additionally, that one client can exert tremendous pressure on your startup to evolve or do business in ways that aren’t in line with your best interests.
2. Aim for at least 4 customers at the $100K ARR milestone.
While it’s a bare minimum goal, this benchmark ensures enough customer diversity to make it to your next growth milestone — generally SaaS startups scale up quickly after they reach the $100K ARR mark.
3. Diversify your revenue streams.
By acquiring a diverse set of customers across different industries or market segments, you can spread out your risk and avoid being overly reliant on any one client. This approach allows your business to navigate market uncertainties more effectively and maintain steady incoming revenue. Careful market research and strategic planning are crucial to ensure successful entry into new markets and to tailor products or services to meet the needs of different customer segments.
4. Niche down and expand services.
One effective strategy to reduce customer concentration risk is to specialize in a particular niche while also expanding the range of services offered. By focusing on a specific target market or industry, your startup can become an expert in that domain, attracting potential customers with similar needs more easily.
5. Increase customer retention with longer-term contracts.
Establishing long-term contracts with existing customers can significantly reduce customer concentration risk. Securing extended commitments from key clients ensures a more stable revenue base and strengthens your business's relationship with those customers. Long-term contracts often come with mutually beneficial terms, including greater predictability and cash flow stability for your startup.
Addressing customer concentration with investors
A savvy investor will always ask "what happens to your business if a client doesn't renew and you lose a major source of revenue." Preparing for that conversation is pivotal when preparing for a successful fundraise.
Here are 4 tips for addressing early-stage customer concentration with SaaS investors:
Tip 1: Explain to investors your contract length and how locked in your contracts are. For example, are there opt out clauses, auto renewals, or anything to explain how secure a contract is?
Tip 2: Has the contract value from your biggest customers increased year over year? To an investor, that means large clients clearly like your product and see the value. This can be a positive sign to an investor.
Tip 3: Offer a customer reference or call with a key stakeholder on the accounts that hold the large contracts. If the clients explain that they are extremely likely to renew/upgrade then your customer concentration is less risky to an investor.
Tip 4: Have a detailed response to how much value your software/service has generated for the large client. If you can, clearly quantify how important your software is to your biggest clients — like how much money you’ve saved their business — or tell the story of how your biggest contract was initially landed and then expanded.
TAKEAWAYS: Concentrate on using strong customer relationships to your advantage
Customer concentration risk is a significant challenge that SaaS startups must address to avoid difficult financial situations that can cause the business to fail early on. Relying on a small number of customers exposes the businesses to various risks, including revenue vulnerability, limited growth opportunities, and difficulties in adapting to market changes. By evaluating customer concentration and taking steps to mitigate the risk, startups can strengthen their foundation and enhance their resilience.
From Lighter Capital’s perspective, revenue is necessary, but where and how many entities are sources for revenue is just as important. Young SaaS startups need to be vigilant about their customer concentration risks, but typically your first customers that grow with you are some of your best advocates — use these relationships to build a healthy, sustainable business and you’ll be set up for success long-term!