Integrating client lifetime value into your firm's marketing strategy.

Olsen, Matthew

Clients are the lifeblood of a law firm, so marketing teams and attorneys strategically tailor their efforts around the needs of current and prospective clients. To determine where efforts are best invested, it is important for legal marketers to understand the lifetime value of current clients and the potential value of prospective clients.

Client Lifetime Value (CLV) is a strategic metric used to calculate the profitability of a law firm's relationship with a client throughout the lifetime of that client's relationship with the firm. Using CLV places greater emphasis on long-term client satisfaction, rather than maximizing short-term revenues. Many firms may be surprised to learn that the top revenue-generating clients of a given year are not necessarily the most valuable clients to the firm.

Examining CLV can assist a firm in recognizing that a client with one $1 million matter in 10 years may not be as valuable as a client who generates $200,000 every year, or even every other year.

By assessing CLV, marketing teams will be able to focus their efforts on the most valuable clients and will have a clear picture of their most valuable practice areas. This picture is important for not only retaining current clients, but for acquiring new ones.

Calculating CLV

Calculating a client's lifetime value is as simple as taking the present value of a client's annual profitability and assessing it against the firm's retention rate.

Present value is the concept that a dollar figure, for example $10,000, is worth more today than it will be tomorrow. Realization rate is the percentage of billed fees that are collected. (The example that follows assumes a 100 percent realization rate.) Retention rate focuses upon the length of time or percentage of a given period that a client remains a client.

A client's annual profitability is simply the sum of fees earned, plus the fees of any referred matter, divided by the length of the relationship. For example, if a client paid the firm a total of $1.5 million and referred the firm another $500,000 in fees over the course of 10 years, its annual profitability is $200,000.

It is important to factor in referral fees because this provides a more accurate picture of the most valuable clients. For example, consider an accountant who routinely refers clients who generate high fees. Although the accountant may not personally open many matters with the firm, the accountant is a highly valued client of the firm. Ignoring these referrals would give an incomplete picture and could result in a flawed marketing strategy.

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A simple way to calculate retention rate is to compare year-to-year client lists. For example, a firm's client list on Jan. 1, 2009, can be compared to its client list on Jan. 1, 2010, excluding clients acquired in 2009. If the firm had 1,000 clients on Jan. 1, 2009, and 900 of those same clients on Jan. 1, 2010, the firm's retention rate is 90 percent. Because law firms enter into contractual arrangements with clients, it is relatively easy to track retention rates.

Once these numbers are calculated, multiply annual profitability by the retention rate divided by one plus the discount rate (discount rate refers to the percentage used to calculate present value) minus the retention rate. Or:

CLV = p (r)

(1 + d - r)

Referencing the above examples, a client with annual profitability of $200,000 at a firm with a 90 percent retention rate, the client has a CLV of $1.2 million (discounted at 5 percent annually, an assumed discount rate).

This formula also assumes retention rate remains constant over the life of each client. At any one point in time, a firm is likely to have new clients who have been with the firm for a very short amount of time and others who have been with the firm for a very long period of time, as well as anywhere in the middle. The net result is a consistent pattern by which you can calculate a constant retention rate.

It is most important to understand the lifetime value of current clients because conventional wisdom says they provide approximately 80 percent of new firm business. However, clients need to be acquired before they can be analyzed, and both new and current clients need to be addressed when developing a marketing strategy.

There is a higher degree of uncertainty in predicting lifetime value with prospective clients. Ultimately, marketers must estimate the annual profit to use in the CLV equation. The CLV of similar clients may be used as an analogy to make this estimation. Other factors to consider include potential frequency of matters, referral potential and the potential client's finances. For example, a company may generate a one-time fee of $10,000 for its incorporation matters, but the company's potential CLV may be very high if the law firm receives many matters over the course of several years once that company has been incorporated and is an operating business entity. And referrals from the company may further increase CLV.

High Value and Low Value

Determining a high CLV versus a low CLV is relative to the firm. Useful ways to analyze CLV may include charting clients into quartiles from highest to lowest CLVs and grouping clients into industry or geographic segments. This allows the marketing team to easily see the value of specific clients, industries and geographic areas. This is valuable when developing a marketing strategy, including whether to target specific industries or regions.

Retention rate may be the single most important factor in calculating CLV. The difference in a couple of percentage points can lead to hundreds of thousands, if not millions, of dollars in revenue for the firm.

Retention efforts come in many forms, including once-a-year visits to clients with the highest; solicitation of feedback on the relationship; service offers or communiques via regular newsletters and updates; offer of sports tickets or other entertainment; and interest and activities involving a client's personal life, particularly if there is a shared interest (e.g., theater or golf). All of this time happens off the clock and is separately calculated as a business development investment.

These retention techniques are rendered useless if they are applied to the wrong clients. Analyzing data on the aggregate level--versus the more-detailed, client-specific CLV level--may result in some marketing strategies placing more value on clients that do not deserve priority. Similarly, there may be clients that provide much more value to the firm than may be evident based on individual annual reports.

Calculating client lifetime value will also help marketing teams evaluate the firm's current marketing efforts through origination. Value can be placed on speeches, articles, networking dinners, etc., based on referral source. If certain marketing initiatives bring in clients with higher CLVs, perhaps marketing strategies ought to focus more efforts toward those initiatives.

It is important to point out that calculating client lifetime value requires a bit of speculation, perhaps even guesswork, and reasonable assumptions regarding the client's relationship lifecycle. This kind of predictive model will not be foolproof, but CLV is an important metric to determine the trends at your firm. Incorporating analysis of CLV into a marketing strategy can be very useful, but a personal client connection and a real understanding of a client's business and needs remain essential. Understanding client lifetime value gives the firm another valuable perspective on the overall client relationship.

Matthew Olsen is a marketing specialist with Patterson Belknap Webb & Tyler and an MBA candidate at Fordham Graduate School of Business. Olsen can be reached at 212/336-2329 or molsen@pbwt.com.