Does Customer Concentration Correlate With Investment Returns?
Abstract (via Panos N. Patatoukas @ Empirical Finance Blog)
“This paper investigates whether and how customer-base concentration affects supplier firm fundamentals and stock market valuation. I compile a comprehensive sample of supply chain relationships and develop a measure (CC) to capture the extent to which a supplier’s customer base is concentrated. In contrast to the conventional view of customer-base concentration as an impediment to supplier firm performance, I document a positive contemporaneous association between CC and accounting rates of return which suggests that efficiencies accrue to suppliers with concentrated customer bases. Consistent with a cause-and-effect link between customer-base concentration and supplier firm performance, analysis of intertemporal changes demonstrates that CC increases predict efficiency gains in the form of reduced operating expenses per dollar of sales and enhanced asset utilization. Using stock returns tests, I find that investors underreact to the implications of changes in customer-base concentration for future firm fundamentals when setting stock prices. A trading strategy that exploits investors’ underreaction yields abnormal stock returns over the thirty-year period studied.”