Episode 158 – Playing with Fire: The Perilous Truth About Client Concentration Risk in Boutique Service Firms – Member Case by Jamey Harvey

Episode 158 – Playing with Fire: The Perilous Truth About Client Concentration Risk in Boutique Service Firms – Member Case by Jamey Harvey

Attend this session and learn how to address one of the biggest risks for small service firms- client concentration. Items discussed will be benchmarks to measure client concentration, an early warning detection system, the impact on strategy client concentration should have on your firm, how long it takes to fix the issue, the most successful risk mitigation strategies, and how to prevent client concentration from destroying your firm.

TRANSCRIPT

Greg Alexander [00:00:15] Hey, everybody, this is Greg Alexander, the host of the Pro Serve podcast, brought to you by Collective 54, the first mastermind community dedicated to the unique needs of the unique founders of boutique professional services firms. Today’s episode we’re going to talk about client and revenue concentration risk associated with running a small services firm. The very real risk, I hope to raise the awareness of this. I’m going to talk about ways to possibly mitigate it. We have a long-standing, well-respected member with us today. His name is Jamie Harvey. He’s with a company called Agilian. Jamey, if you could introduce your firm and yourself to the audience, please. 

Jamey Harvey [00:01:02] Yeah. Great. Thank you. Greg. So Agilian provides I.T. and strategic advisory services to the health equity ecosystem. Recently, we’ve narrowed our focus to enterprises in the Medicaid ecosystem. So managed care organizations, community health networks, and providers that serve marginalized people. So it’s our vision to dramatically boost the efficacy of the $3.5 billion spend on health care equity through Mcos annually. So, we pivoted to this over the last few years from the government space where I had, started as the chief software architect for the city of Washington, DC. And, I got into government after starting three venture capital-funded companies in the 90s, be the B2C product companies. So, but I ended up, running all of the software and systems integration for the District of Columbia. And so, we developed a methodology there for fixing siloed, overcomplicated, ill-fitting it at, at big enterprises that had interoperate with each other. And it’s a process that we call digital liberation. And it turned out to be even more valuable in the health equity ecosystem than it was in local government. But, when I was starting the firm, most of our clients were with the D.C. government. I have a great network in the DC government. I have a reputation there. It’s a kind of a medium fish and small pond kind of situation. So most of our early customers were in the DC government or around the DC government are funded by the DC government. Which brings us to our story about client concentration risk. 

Greg Alexander [00:02:37] Okay. Very good. So let’s first let’s define client and revenue concentration risk. First I’ll ask you for your definition and then I’ll offer one up. So how would you define it. 

Jamey Harvey [00:02:48] Well, I mean, on some level, I feel like it’s the it’s the situation that the phrase too many eggs in one basket was designed and describe. Right? Like if you lose the basket, you lose all the eggs. And so, so, you know, the advice in a, in collective 54 is not to have so much of your revenue collected in, you know, a few number of clients. And, you know, I think, I think when we did our metrics last, Jillian has always been dead last in that metric for the collective 54%. I looked that you and I have joked about that before. I think I’ve always, always had the worst, compliance and revenue concentration risk of any of your of any of your, members. Yeah. 

Greg Alexander [00:03:34] You know, it’s a double-edged sword. Yeah, yeah it is. It’s a double-edged sword. And all of our members, struggling with this. So let me give you an academic rule of thumb or benchmark. Right. We define it as if it if your top five clients equate to greater than 30% of your revenue, you are by definition concentrated. And the implication of this is that a client or two goes away, which happens especially if you’re project-based. Then the whole PNL falls apart and it’s very damaging. Now. It’s also a plus because a small number of clients that you overserved well tend to grow. They tend to buy more, especially if they’re big. So the more successful you are, the more problematic this risk is. It gets bigger over time, so it’s a tricky one. And I’m certainly not here to suggest that I have all the answers. But the goal of today’s show is to elevate the awareness of it. So, Jenny, I understand in 2023, this reared its ugly head with you and something happened. So just briefly tell us what took place. And then we’re going to get into how to avoid it and fix it once it happens. 

Jamey Harvey [00:04:43] Yeah, I think, I think I when we went through Covid, the funny part was my business accelerated like a lot of people were really struggling, but, you know, we continued to grow. In 2022, we doubled in size. And we for the three years previous to that, we had greater than 70% growth every year, year over year. We were profitable every year we’ve been in business. And in, Q1 2023, last year I had the best quarter ever. And I wrote you a very nice note saying, hey, Greg, my margins are where they’re supposed to be. And, you know, like I’m hitting on every metric except for that darn client concentration thing. Thank you so much. And we did a podcast about how great that was. And, but what I, what I. Didn’t realize what’s going to happen. Was that because I wasn’t in the private sector, because I was doing all this government business? Government had a Covid hangover, basically. And so in Washington DC, the way the Covid hangover looked, well, Washington DC, I know the market pretty well. It’s got about 700,000 residents. And when I used to work there, 2.5 million people would flood into the city every day. So the population of the city during the day was 2.5 million people, and the population that night was 700,000. So people, people from the suburbs come into the city to work and then they go out. And the biggest employer here is federal government. So after Covid, the federal government did not require people to go back to work. All the buildings downtown are vacant. All the restaurants are going out of business. Nobody is spending any money. And the tax base for the city is really based on the, you know, the 1.8 million people that come into the city every day and spend money. So essentially the and takes a. 

Greg Alexander [00:06:27] Sales. 

Jamey Harvey [00:06:27] Tax for that. The sales tax. Yeah. Yeah. You know, normal economic activity. Right. So the city is really runs on that. And they missed their numbers that year, in 2022. And essentially the city went through giant rolling budget cuts everywhere all at once. Which is five out of six of our we only had six customers. So, you know, our client concentration was like 90%, five out of six of our customers, you know, lost all of their funding to do things, and big I.T. projects, even if they’re critical, they get paused, right? They get stopped. And so we went from having, six, six clients to two clients in about six months. And the revenue was about like that kind of drop. It was about, you know, went to a third. 

Greg Alexander [00:07:19] Yeah. Yeah. Well, I hate that you went through that. That part of that story that I hate the most is that there’s there’s nothing you could have done. I mean, Covid happened. The sales tax receipts for your customers went away. They had to cut. They didn’t have a choice. And guess what? Right. So it wasn’t like you screwed up. You know, you gave bad service or something like that. And this, this is the thing that makes it so hard and bites all of us is it’s to a large degree, sometimes outside of our control. So I’m going to ask you an unfair question right now. Yeah, but but I want to see if you can share some wisdom on this. So did you see it coming? Like, were there any early warning signs that with the power of retrospection now Monday morning quarterback this you could have saw coming in. You could have done something to prevent it or there was no way to see this coming. 

Jamey Harvey [00:08:04] Well, let me say this. First of all, every, every company meeting I ever had for the past four years when I would list the risks. Right. You know, I do my Swot analysis, right. The at the top of their list was Glenn concentration DC government client concentration. Too much reliance on our big integrator that we work with. You know taxpayers da da da da da da da. So it was a known risk. It was an accepted risk actually. Really. What we saw was in the fall, you know, there were articles in the paper, you read the Washington Post and you see, the people aren’t coming back. I used to work in the DC government. I I’ve been through these cycles before. I actually knew what it meant. Right. Like, so we were tightening our belt and we. Oh, let me let me say this. We were working our tails off to get away from government. I’m not like you. You heard me talk about the government. The company does. I don’t do government anymore. I’m out of government now. I joined Collective 54 to go build a scalable business. And part of that was, you know, maybe keep one foot in government. But like we were, we’re working on the health equity space, right? So, but we were funding that effort on these five year contracts that we were assuming we’re going to be around. So it was like our venture capitalists essentially like what happened was our series C went away suddenly, right? So, instead of having a, a three-year runway to do the pivot that we were doing, suddenly we had a one-way run, a one-year run rate to do the pivot. And, even though we saw it coming, it was like in slow motion, right? Like we could see it coming. You know, here it comes. But but there was, you know, nothing you could do about it, that we hadn’t already done because we knew that it was risk coming up. 

Greg Alexander [00:09:40] Yeah, yeah. So what I would what I would offer the listeners, and I agree with everything that Jamie just said, is that the only early warning sign, really, to pay attention to is the economic well-being of your end client. Jamie’s case. Right. This was the government and the associated sales tax. And, you know, they were writing about it in the newspaper. Right. But many of the other members that are outside of the government space, they’re not paying enough attention to how well their own client is doing. I’ll give you an example. We had a lot of marketing agencies and Collective 54. It’s one of the areas that we do well in, and a lot of them, during the Go-Go days of Covid, were living off the backs of early-stage VC-funded firms, and these early-stage VC-funded firms were not profitable. They just. But the market was going crazy, so they just kept raising more money. All of a sudden interest rates go up, people slam on the brakes. Fundraising is impossible. These VC little software companies don’t have any capital. What do they do? They cut the marketing budget. Bad client concentration rears its ugly head. So the early warning detection system I’m recommending on today’s podcast is to make sure that you understand the financial well-being, the financial health of your end client, not just your own little world like. And that example, what’s happening to the marketing budget that’s downstream? The bigger, the bigger question is what’s happening to my client’s business? Are they profitable? Are they generated cash flow? Are they growing? How are they doing against the competition? So that’s that’s what I would recommend by Jamey decision making. Let’s talk about that. So this happens you go from six clients. Two clients. The associated revenue hit takes place. What did you do? 

Jamey Harvey [00:11:15] Well. So when the when the first when we got the first calls like, hey, these these client, these are going away and you to get a little bit of warning. Right. We just happened to be walking into our semiannual meeting that we have at Agilian. And, the night before I reworked the, the presentation that I was going to give and basically declared, declared a new state of, all hands on deck. We call it we call it the Wobble because we were hoping it was going to be a wobble. And so we immediately we, we took everybody who was non-bailable or on the admin side of the company, and we tried to get them billable on projects because we still had projects at that point. Right. So like essentially like if we could top people up under, you know, become revenue producing. We were trying to save people. We had a big recruiting team, like, not a big recruiting, but for us, it was a it was a well-established team. It had a really good process. They were really great for creating team. And we didn’t have any more recruiting to do because now we were we were contracting. So we we gave them all job tryouts and other functions like right away. And then I took my I don’t know if you remember this, but I asked my senior team, all of which all of I was doing all the sales at this point, and I basically asked my senior team to to reach in their networks. And we kind of did an all-hands-on-deck sales effort, which we called the seller doer. So these were these were doers, and we asked them to become sellers and And that was that was our initial response was, you know, the in all honesty, none of those things actually ended up working that well, like, they made us feel better. The, the people that were non-billable, that got moved to projects, there were just mixed results. Some of them weren’t able to do it, some of them were able to do it but didn’t last very long, you know. But but like on some level it it wasn’t a panacea for sure. The job trials, really almost none of them worked out right. Like I took people that were a junior and had been trained in a really rigorous process. And I was moving to an area where they had to, like, do stuff on their own, and they weren’t getting much direction and were in a virtual company. And, and it was not a very good environment for them to succeed. And, and then the cellar door thing, you know, it was very educational. We learned a ton, which is important. Right. But, zero revenue. Right. So, what what did work that I, which, which wasn’t a, it wasn’t a austerity technique, but but but I would recommend everybody is we did keep doing the marketing we were doing. We kept on with the pivot. Right. Like so we we kept doubling down on getting away from government, getting into the the health equity ecosystem and the customers. And I, very happy we did that. 

Greg Alexander [00:14:08] Yeah. So let’s let’s kind of summarize, right. So, you know, you went through it, you experienced it. You, congratulations for having the conviction and the courage to continue with the pivot. A lot of times, people at the panic button and they just get into survival mode. And anything that’s futuristic, you know, gets cut instantly. But you didn’t do that. So, you know, peeking out into the future, maybe playing the role of advisor to our members right now, lessons learned. Like what are the 2 or 3 things that you would do going forward to try to mitigate concentration risk as much as possible? 

Jamey Harvey [00:14:41] So. So one, you know, on some level, the. We grew the company as a lifestyle company, kind of on relationships I had. Right. And so and we we had a lot of big deals that were long term. So we were running the business and then they were they were like our venture capital to do the pivot. So on some level, you know, I look at everything that we’ve done and Jillian has done a lot to, to to get to the scale stage and be, a commercially viable company. You know, that is self-generating everything in the Collective 54 program, if you’re doing it right, is going to be moving you towards having less client concentration risk. Honestly, like, the truth matters, like you kind of. But you kind of have to do the whole program, which means it’s going to take a while. Right. Yeah. 

Greg Alexander [00:15:37] Exactly. 

Jamey Harvey [00:15:38] One thing. It’s like start as soon as possible, right. And get going. And as you told me at the very beginning of this thing, started the first chapter of the book and get to work on those. Right. The, we had done a lot of work around our buyer journey model to try and be able people, people and like, if it works out to me, I’m, you know, I’m jealous of your size of deals. You got all these big deals, right? I’ve been trying to do smaller deals and then land and expand and grow them, which I feel I feel like will give me more consistent revenue and will help me with my client concentration risk. So I’ve done a lot of reworking to do that, and it seems to be working. I haven’t been through a full cycle yet to know whether it is working as well as I want it to be, but, the initial the lead indicators are great, right? We we didn’t see any way that we could keep doing the kinds of projects we did for government and not have this project continue to be a problem. So we the our market pivot wasn’t done mainly because of client concentration risk, but it also had the benefit that it was going to help us with that. Right. And You know. But the sad part is, even with like with all the mitigation I’ve done, it took me it took me six years to get from 1 to 6 clients. I was bringing in about one big client a year. Right. And now I’m down to two. So, honestly, like my client, I. I had felt like I was making steady progress towards making my client concentration better. And, you know, it’s, it’s it’s as bad as it’s been since the first year of business. Really now. Right? 

Greg Alexander [00:17:10] Well, however, I would say I think you’re on the right path. Just because your client has concentration rates was sector-based. You were completely dependent upon the government, right? So now now you’re diversified out of a single sector. Yes. You have smaller clients. So by definition you have more concentration. I understand the math, but you have improved in that area. 

Jamey Harvey [00:17:29] I it’s it’s it’s it is it’s different. I mean if, if politically, Congress decides to cancel Medicaid, I will be back to square one. Right. And it’s, you know, that’s not a that’s not an impossible thing in the next 20 years, there’s, there’s different people who are into that. 

Greg Alexander [00:17:47] Yeah. Yeah. True. Yeah. 

Jamey Harvey [00:17:48] No comment. 

Greg Alexander [00:17:53] Anything else? You know, before we wrap up here, any other, ideas that you want to share with the broader audience? Of course. We’ll go into much more of this when we have our member Q&A. But any other thoughts? 

Jamey Harvey [00:18:04] Yeah. So, one thing is, I would say like watch for multiple vectors of concentration, like, we didn’t lose one at a time. We lost to like, it was cascading. Right. So there was we had with the DC government, we had the, we had the risk of several projects in one agency, and then we had several projects under one prime, like subcontractors. And then they were all under the DC government. So when they got hit, we got hit like double sometimes. Right? And it was cascading right. So like that I kind of knew that I had a chart on my wall that was showing that at one point. But, you know, I think if you have that situation you want to be take it more seriously. The, the other thing that we really struggled with was in growing and growing and growing. If my financial projections were a little weak for, you know, the next couple of quarters, if I’m growing 70% year over year and a profitable, really, that’s not a big deal when you’re shrinking and like trying to figure out how much runway you have to keep people employed until you get the next deal. If you’re off by $100,000 a month, that can put you out of business, right? Yeah. And we were in the middle of implementing our our professional services automation system when this happened. And it was like halfway implemented. Right. Like so we we had some we had some weaknesses in our financial management that got exposed when the waterline went down. Right. So I would say if you’ve got this kind of client concentration risk, go ahead and sharpen your pencil and get in there and like make sure that that stuff is really buttoned down now, because when you don’t want to be trying to button that down when the water’s going out. And then I think the other the other thing that I really. Kind of came out of doing this process. Thinking about this conversation is, you know, we’re entrepreneurs. We’re in the business of taking risks, right? People aren’t people don’t have client concentration risk because it’s a bad risk. You know, if if I said to you, Greg, hey, collective 50 or the government is going to give you a contract that is going to give you $10 million a year for forever, but you have to roll the dice each year. And if you roll snake eyes, that’s going to go away. Yeah. You you take you take it. You would take it. Yeah. You take it. Right. 

Greg Alexander [00:20:15] Like that’s that’s the reality of it for sure. 

Jamey Harvey [00:20:18] And eventually you will roll snake eyes. Yeah. Eventually you’re going to roll Snake eyes. And you, you already took the risk. You already have the risk, right? Just know that eventually you’re going to you’re going to roll snake eyes and plan for it as best you can. So. 

Greg Alexander [00:20:33] All right, well, listen, we got to wrap it up here, but this was great, great advice. I really appreciate your maturity level and your ability to say, hey, you know, this is what happened to us. Your generosity of sharing this learning example with others. It’s not easy to come on and say, hey, you know, things didn’t go so well, so I really appreciate you doing that. On behalf of the members, thanks for being here. 

Jamey Harvey [00:20:54] Thank you Greg. 

Greg Alexander [00:20:55] Okay. Right. A couple of calls to action for those that are listening. So if you’re a member and you want to talk to Jamie about this, look for the meeting invite for the Q&A session that will be coming up. If you’re not a member and you think you might want to be, go to Collective 54.com, fill out an application. We’ll get in contact with you. If you just want some more information, I would point you towards our book. It’s called The Boutique How to start, scale and sell a Professional services. Until next time, I wish you the best of luck as you try to grow, scale and exit your trunk.