Customer-Base Concentration, Profitability and the Relationship Life Cycle

Abstract

Using a recently expanded data set on supplier-customer links, we introduce a dynamic relationship life-cycle hypothesis. We hypothesize that the relation between customer-base concentration and profitability is significantly negative in the early years of the relationship, but becomes positive as the relationship matures. The key driver of this dynamic is the customer-specific investments that the relationship entails. These investments result in larger fixed costs, greater operating leverage and a higher probability of losses early in the relationship, but can significantly benefit the firm as the relationship matures. Although many of these money-losing firms in early-stage relationships were not studied in Patatoukas (2012), we find a market reaction to increases in customer concentration similar to that in his paper. This result provides powerful confirmatory evidence of the value of customer concentration. We document one of the intangible benefits of customer concentration, technology sharing, and show how this benefit increases as the relationship matures.

Keywords: Customer concentration, customer-specific investments, relationship life-cycle, selling, general and administrative expenses, pro…fitability, default risk

JEL Classification: L25; M41; G31; G33