In an earlier piece on vertical market software, I argued that generalist diligence flags customer concentration on a logo-by-logo basis when the more relevant question is the health of the underlying vertical. That argument deserves a fuller framework, because concentration is not automatically a moat any more than it is automatically a risk.
The mistake runs in both directions. Some buyers discount every concentrated customer base as risky. Others, overcorrecting, wave off concentration entirely because "it's a vertical market business." Neither instinct replaces actually testing the concentration against three specific factors.
Test one: what does it actually cost the customer to leave
Concentration in a business with a low switching cost is a real risk, because the largest customers can walk with a quarter's notice and take a disproportionate share of revenue with them. Concentration in a business where switching means retraining a workforce, re-certifying against a compliance requirement, or ripping out software wired into daily operations is a different animal entirely. The size of the customer matters far less than how expensive it is for that customer to switch.
Test two: is the concentration structural or accidental
Some concentration exists because the addressable market itself is concentrated, a small number of large players dominate the vertical, and the company has simply captured the players that exist. That is structural, and it is often close to the ceiling of what is achievable in that market. Other concentration exists because of an accident of sales history, a few early enterprise wins that happened to land, in a market with plenty of unaddressed smaller accounts still available. The second case has real diversification upside a buyer can underwrite toward; the first does not, and treating it as if it does is how buyers overpay for growth that was never really on the table.
Test three: what does the contract structure actually say
A concentrated customer base on annual contracts with broad termination-for-convenience clauses carries real walk-away risk. The same concentration on multi-year contracts with meaningful termination penalties, especially in a regulated or compliance-heavy vertical where re-procurement itself is a slow, costly process for the customer, is a materially different risk profile even though the revenue concentration number looks identical on a slide.
What this means for underwriting
Concentration is a starting question, not an answer. Running a target's top customers through switching cost, market structure, and contract terms turns a single scary-looking percentage into an actual risk assessment, and it is frequently the difference between passing on a genuinely strong business and correctly pricing one that most generalist buyers will pass on for the wrong reason.