A football defensive coordinator needs to protect against an “end run,” a tactical play where your opponent sends the running back wide around the offensive line to try to evade the oncoming tackle.
Just like in football, you have to defend against an end run coming from a supplier that chooses to go around you to get to your customers. The more of your supply you get from a single provider, the more vulnerable you are to that supplier deciding they don’t need you and instead deciding to go straight to your customers. To better understand how that works, let’s take a closer look at a practical example.
Let’s take TheAmazeApp as a case in point. Sebastian Johnston co-founded TheAmazeApp in 2014. The idea was simple. Social media influencers could upload a picture of what they were wearing (i.e., a “look”) and tag the items on TheAmazeApp’s database of e-commerce wholesalers. Then, when one of the influencer’s social media followers liked their look and wanted to purchase one or more of the items the influencer was wearing, TheAmazeApp would receive a commission, 20% of which was shared with the influencer.
TheAmazeApp’s founding team raised $800,000 through the San Francisco-based accelerator 500 Startups. By leveraging their influencers to drive traffic, TheAmazeApp quickly grew to 4 million active users per month. It seemed like it was now on a trajectory to change the world, but the team never saw the glaring flaw that would keep them from achieving worldwide integration.
The app was a huge success on the outside, but a flaw in their business model held back their valuation. Simply put, that flaw was that the business was entirely dependent on data provided by others.
The Hidden Flaw
For the business model to work, influencers needed to be able to tag whatever they were wearing, so TheAmazeApp needed to get a comprehensive catalog of hundreds of thousands of the latest fashion items. That meant that TheAmazeApp relied on the data feed of five e-commerce wholesalers who uploaded their data to TheAmazeApp.
TheAmazeApp was increasingly dependent on Zalando, one of their five data suppliers. Zalando is one of Europe’s largest fashion wholesalers and controlled around 70% of TheAmazeApp’s inventory. Another way of looking at that is that Zalando functionally had control over what TheAmazeApp could and couldn’t do.
The more TheAmazeApp relied on Zalando’s data, the less leverage they had when it came time to sell. Johnston approached all five of his data providers to buy his business, and two expressed interest in buying TheAmazeApp. This buoyed Johnston’s spirits because he knew multiple bidders would give him leverage with acquirers. Unfortunately, his fortune soon took a turn for the worse, and he ended up paying the price for being so reliant on Zalando.
The Worst Case Scenario Happens
As the process dragged on, one of the two acquirers dropped out, deciding to set up a competitive app—doing an end run—and leaving only Zalando. Given Zalando knew they controlled 70% of TheAmazeApp’s inventory and that a comprehensive selection was key to their business model, Zalando knew they were in the driver’s seat.
Johnston also knew that if he pushed Zalando too hard, he risked Zalando also doing an end run around TheAmazeApp and setting up their own competing service. Functionally, this promising new business now found itself handcuffed to a single supplier, and it ultimately suffered due to that high level of dependency.
In the end, Zalando acquired TheAmazeApp for between two to three times its revenue, which was a relatively modest multiple given the traffic the app was generating just eight months after being funded by an accelerator. Sellers may think that there is no way that this could ever happen to their own successful business, but this is just a single example of the dangers regarding overdependence on a single supplier.
Learning a Hard Lesson
The lesson? The more dependent you are on one provider, the more susceptible you become to your supplier doing an end run around you. This liability drags down the value of your business and undermines your negotiating leverage when it’s your time to sell. Do what you can to diversify your suppliers to maximize the value of your business.
That may sound scary, especially if you don’t want to change up how you’re currently doing things. In some cases, you may even be wary of upsetting one of your existing supplier relationships by seeking out others. However, a good supplier will understand that this is just the price of doing business. If you’re still on the fence, just ask yourself a simple question: would you rather run the slight risk of offending a supplier or run the much more substantial risk of effectively putting your business in someone else’s hands by becoming too dependent on them?
Make no mistake: even the kindest supplier is working hard on leveraging their relationship with you to maximize their own profits. By diversifying and securing multiple suppliers, you can begin doing some leveraging of your own while also ensuring your business won’t suffer the same fate that TheAmazeApp did when it was scooped up by a former supplier.
How To Diversify Your Own Business
As a seller, diversifying your business is easier said than done. The best way to diversify is quite simple: by getting more suppliers. But knowing how and when to go about that can be confusing for even the most veteran entrepreneur.
It begins by starting small: if you only have a single supplier now, you need to start seeking a secondary supplier out ASAP. Once you have a secondary supplier, you should quietly put feelers out for other potential suppliers while keeping your eye on things that may affect the market (the COVID-19 pandemic being one of the biggest examples in recent history).
Consumers began to tire of hearing this as an excuse from businesses, but the truth is that COVID-19’s effect on the supply chain was both swift and brutal. By diversifying your suppliers now, you can better prepare your business for future catastrophes even as you better ensure that no single supplier is in a good position to do an end run around the business you have worked so hard to cultivate.
Although it is smart for businesses to focus on diversifying their business, also keep in mind the relationship you have with your suppliers. Nurture these relationships, and others in the future, as this may provide benefits for you and your business.
If you have further questions on the relationships between you and your suppliers, contact one of our experts at Twelve Points Business Advisors today!