Business is a simple concept where success ultimately boils down to the ability to generate cashflows. If you have positive cashflow, you’ve probably got a healthy business. If your cashflow is negative, there is a much higher likelihood of your business failing. So how can you ensure that you manage your business properly to maintain positive cashflows? The best way is through analysis of key performance metrics, such as customer acquisition costs and the lifetime value of a customer. Since these metrics are often overlooked by law firms, this post will help you figure out how to measure the lifetime value of a client.
Customer Lifetime Value (CLTV) Explained
The basic concept of customer lifetime value is very straightforward: it’s quite literally the total dollar value of a customer throughout the entire duration of the relationship with the company. It depends on several different factors, including the total cost of a product or service, the number of transactions incurred, and the duration of the business relationship.
Why CLTV Matters
CLTV is one of the most important business metrics to understand and it plays a crucial role in the health of a business. The reason CLTV is so important is due to the concept of positive cashflow discussed above.
What CLTV ultimately represents is the upper limit on all expenditures that can be attributed to a single customer during all phases of the delivery of a product or service in order to maintain positive cashflow. In other words, when your total income from a single customer (CLTV) is greater than your expenses paid to acquire and deliver goods or services to that customer, you’ve got positive cashflow!
How CLTV is Measured
Technically, the exact definition of CLTV is “the present value of the future cash flows attributed to the customer during his/her entire relationship with the company.” Basically, that means it will involve some forecasting and prediction.
A simple 4 step process you can use to measure CLTV is as follows:
- Forecast the average customer lifetime
- Forecast the total future revenues, based on average number of purchases and price per purchase
- Estimate the average cost of delivering products or services, including marketing and advertising to acquire customers
- Calculate the net present value of that total future amount
So, now that you understand the basics of CLTV, let’s explore how can you apply the concept of customer lifetime value to a law firm.
How to Assess the Lifetime Value of a Client for Law Firms
Law firms traditionally have not focused much on business metrics like ROI or CLTV. But due to changing times in the legal industry, it’s about time they begin doing so. Calculating and understanding CLTV provides excellent insight into the health of a business, so it’s a good idea for any type of business to measure it, including law firms.
Step 1: Estimate the Lifetime of an Average Client
The first step is to estimate the average lifetime of your clients. In other words, how long does a typical client relationship last? This process will largely be dependent on the type of law you practice, and the type of clients you work with.
For example, a DUI attorney is more likely to work with a client for a short period of time, i.e. for the duration of the pending DUI case. Once a DUI case is resolved, more likely than not, the attorney-client relationship will be over (although these days, repeat DUIs are increasingly common), yielding an average client lifetime of a few months.
On the other hand, a transactional attorney that works with small businesses would likely have a much longer average client lifetime because a small business will encounter all types of legal issues at different phases of the company’s lifecycle. For these types of attorneys, client volume is not generally as important as longterm client retention (which makes good customer service and providing value of the utmost importance). Average client lifetime in these instances might be 10 years or more.
It would be helpful to look back at your previous client relationships to get an idea of how long an average client works with you (if you’re a new lawyer without a book of business, read this post about how to get clients when you’re starting out).
Step 2: Estimate the Average Revenue Per Client
Much like average lifetime, this component will be largely dependent on your practice area, and it may be very hard to calculate, especially for firms that bill hourly. If you bill using flat fees or other alternative billing methods, it’s typically a bit easier.
In general, the way to calculate revenue per client is to estimate the number of matters you typically work on for each of your clients, then estimate the total amount billed for each of those matters, and multiply the two numbers together.
For instance, the DUI attorney in the example above would likely have a relatively low number, in the ballpark of $2500 – $5000 (1 matter multiplied by the average fee for a DUI which is about $2,500 – $5,000).
Longterm small business clients may work with a transactional attorney on 15 – 20 matters with an average value of $1,500 – $3,000 per matter, yielding a total revenue per client somewhere in the neighborhood of $50,000.
Revenue per client can be pretty difficult to estimate, and once again, the best way to calculate it is with actual data. Try to look back at past clients, determine how many matters they usually hire you for, and then total up the fees earned.
Step 3: Calculate the Cost to Acquire and Service a Client
Next, you’ve got to calculate your total expenses to acquire a client and deliver legal services to that client. I’ll break it down into its 2 separate parts.
Cost to Acquire a Client
The key here will be to keep track of where each of your client leads comes from (Lexicata is a great tool for doing so, FYI). So many law firms are unable to accurately answer this question. Are they from word of mouth? Referrals from other attorneys? Your website? Advertisements? Your LinkedIn profile? Avvo? Somewhere else?
When you know where your leads come from, you just have to total up how much money you spent on each channel over a given time period, how many clients you retained as a direct result, and then you can average it out to get the cost to acquire a single client.
Cost to Service a Client
You will also have to factor in the fixed costs of running your firm (rent, office supplies, utilities, etc.) and the variable costs associated with delivering services and resolving each matter. If you’re running a virtual law firm, your costs will naturally be lower than if you have a luxury penthouse office downtown.
This step is pretty easy to calculate. Just total up all the expenses of running the firm for a certain time period, and divide that by the number of client matters serviced over the same time period, and you’ll have the average cost to service a client.
Finally, you will just add these two numbers together, and boom! You now know how much it costs, on average, to acquire and service each client.
Step 4: Calculate the Net Total to Determine Lifetime Value of a Client
Now, technically at this point the whole “time-value of money” concept comes into play, and you’re supposed to calculate “net present value” of the future cashflows. To give you a basic idea of how this concept works, consider the following example:
One client pays the firm $50,000 for legal work over 10 years vs. a similar client that pays the firm $50,000 over 2 years. The total value earned from both clients is the same, but the second client is actually more valuable to the firm because the money is earned and available to the firm sooner.
Calculating the “net present value” greatly complicates the calculation of CLTV, so I’ll just keep it simple and use the more straightforward “nominal prediction” method instead. Although, you should understand that the net present value would be more accurate, and the simpler method is likely to overestimate CLTV slightly, particularly if the client lifetime is long. So err on the side of caution with your CLTV estimate.
So the last thing left to do is to put all the data together to come up with a CLTV calculation. There are a few ways you can do this, but the best way is to use actual data from past clients.
- For each client, subtract the total costs (step 3) from the total revenues (step 2) to arrive at net profit per client
- TC ($) – TR ($) = NP ($)
- Then divide net profit for each client by the lifetime of that client to arrive at net lifetime value in $/year (or $/month if you have a shorter client lifetime)
- NP ($) / CLT (yrs) = NV ($/yr)
- Now that you have the data in consistent units for every client, the last step is to average it all out, and multiply it by the average client lifetime (step 1) to get CLTV
- Avg NV ($/yr) * Avg CLT (yrs) = CLTV ($)
Wheww! I know all the numbers and math can make most lawyers’ heads spin. But, I hope that you have come away with a better understanding of CLTV, which is a core business metric and important factor to any business’ growth and success.
It’s time that the legal profession wakes up and recognizes the changing times. No longer can a law firm coast through the years, billing their clients for every hour, with no incentives for efficiency or value. With the rise of technology and alternative legal services posing a threat so the careers of traditional lawyers, law firms are having to face reality and act more like normal businesses, i.e. where streamlined operations and greater efficiency are key.
If you’d like to learn more about using metrics in your law firm to drive greater success, please get in touch! We here at Lexicata are excited about the opportunities to use technology to improve the practice of law, and we’d love to find ways to help you do so.
*Photo Credit: Photosteve101 via Flickr (Used under the Creative Commons Attribution License)