September 01, 2019

Are Your Biggest Clients Really Your Best Clients?

Learn to determine which clients are most profitable for your firm.

Jeff Schwarz

During engagements, I routinely ask firms how they identify their “best” clients. And I receive a wide range of answers, which makes it an interesting exercise. Some firms say it’s those with the highest billings. Others claim it’s clients that give them the most high-value or bet-the-company work. Still others add in factors like prompt payment; a steady stream of work, enough to keep many attorneys busy; and those who don’t ask for huge discounts.

Many of these answers have their roots in the “legal value pyramid.” For many years proponents argued that law firms should look at their roster of clients as if it were a pyramid, with commodity work at the bottom and the highest-paid and bet-the-company work at the top. The goal was to climb to the top of the pyramid and snag the “best” work while shedding commodity work.

A 21st-Century Approach

I have a different perspective. To succeed in today’s legal marketplace, firms need to rethink how they identify their best clients. Success will come to those who adopt an approach that’s attuned to the realities of the marketplace and the demands of their customers.

More specifically, this approach requires answering three questions:

  1. Do we have a strategic portfolio of clients?
  2. Are we delivering superior value, as defined by the client, across the entire portfolio?
  3. Is the work profitable (unless there is a strategic reason for it not to be)?

As you will see below, looking at clients in this more nuanced way helps build a business model and approach to servicing and growing clients that will make your firm significantly more competitive.

Building a Strategic Portfolio of Clients

Many industries use a portfolio approach to evaluate clients and develop an effective strategy for pruning, maintaining or growing some of them. The portfolio approach also makes targeting and securing new clients more straightforward and strategic.

Every law firm already has a portfolio of clients. The problem is that, up until now, there was no easy way to categorize and determine what to do with each one. Firms can get stuck at this point. Analysis paralysis is a real thing, and some have metaphorically thrown up their hands and walked away from the daunting task of analyzing their clients—and then doing nothing about it.

What they need is a method that’s simple, meaningful and leads directly to a strategy.

At Concata we’ve developed just such a method. One of the first things we do with new clients is to have them locate their clients on the Concata quadrants (See Figure 1).


Understanding the Components

Before I explain how to use this tool, let’s first learn how to apply it.

Plotting clients.

The model is designed to plot and categorize each of your clients based on the aggregate work they give you.

If your firm has very large accounts, for which you perform a high volume of different types of work, it may be more effective to subdivide those clients into smaller “clients” based on the type of work. For instance, if you perform a large volume of lower-margin trademark prosecution and a smaller volume of higher-margin mergers and acquisitions work for the same company, it may make sense to plot these as two separate clients.

Margin.

The vertical axis plots the percentage margin you make from a given client. This is calculated by subtracting what it costs you to deliver the work (i.e., direct costs and share of overhead) from the fees you actually collect divided by the total fees collected. More on this later.

Volume.

The horizontal axis plots the total volume of work you receive from the client.

Defining the Four Quadrants

Let’s take a look at the quadrants. Each identifies a category of client and is based on the characteristics of the ongoing work.

Quadrant I: Periodic.

The clients in this quadrant provide the firm with periodic or one-off work at higher margins. These are good clients who may stay in quadrant I. Your goal should be to try to move them closer to quadrant II by increasing volume. However, as you try to secure higher volume, clients usually request greater discounts, which pushes margins down.

Quadrant II: Optimal Few.

The clients in this quadrant provide a high volume of high-margin work to the firm. Only a select minority of firms are blessed to have a significant number of clients in this quadrant. Most firms have only a handful of clients like this. Your goal is to work hard, by offering extraordinary value and awesome service, to keep them in this quadrant.

Quadrant III: Steady Work.

The clients in this quadrant provide the firm with a steady stream of work at decent margins. This type of work typically keeps a large number of attorneys producing. Your goal with these clients is to increase your margins, which you can do in several ways, including delivering greater value, increasing efficiency through process improvement or better use of technology, and by developing better service delivery methods. For more standardized work you can implement value-based billing methods, which include premiums for better results and lower overall client costs.

Quadrant IV: Up or Out.

Clients in this quadrant provide a low volume of work at lower margins. On the surface these appear to be your least desirable clients. Your goal is to evaluate them for their strategic potential. You can try to move them up to quadrant I, over to quadrant III, or out. However, there may be noneconomic reasons for keeping some of these clients. One word of caution about these types of clients: they can become a drain on profitability and resources. You need to evaluate your noneconomic reasons for keeping them carefully.

Plotting Your Clients

The first step in using the quadrants is to locate each client in the appropriate quadrant. When doing this, do not compare your firm’s clients against another firm. Simply plot your clients relative to the other clients in your portfolio.

Another thing you will notice is that I used the terms “higher” and “lower” rather than “high” and “low.” This is because few clients fall neatly into one box, and clients can be plotted at the higher or lower end of a range within a box. In other words, you’re not just selecting the correct box for each client but also locating them within the box.

Example: Moving a client from quadrant I to II.

In my consulting work I often have clients who want to move their Periodic clients to the Optimal Few quadrant. Not surprisingly, when you ask for higher volumes of work, clients want lower rates, which reduces margin, thus moving them closer to quadrant III instead.

 

You can see this tug of war at work in Figure 2. The firm wants to move the client along the upper line—more work, with minimal discounts. The client prefers the lower line—more work, but at lower rates. From the client’s perspective, there has to be a reason to increase the volume of work without discounting rates. However it’s characterized, that reason always boils down to one thing: better value.

Delivering Superior Value Across the Entire Portfolio

“Value” is an amorphous term. For our purposes “superior value” refers to the combination of elements that are most important to a specific client. In short, it is the client’s tangible and intangible criteria. These can include a wide range of things: the quality of the work product, results, rates, responsiveness, likability and how you help the client achieve its objectives. It is up to you to determine what those are and which of those you can help deliver (e.g., not exceeding budgets for your type of legal work).

In other words, value is in the eyes of the recipient. You don’t define it, clients do. The only person who can tell you if you are delivering superior value is your client. And I don’t mean client in the generic, holistic sense. I mean the individual human beings you serve.

To bring this to life, a business development consultant I know, David Adams of Revenue Wise, coined the term “superior service offering.” He defines it as “[a] specific service, offered to a target group of clients, that solves a core problem and satisfies their essential functional, emotional and social needs in a way that is superior to their alternatives and at a price they consider fair.”

While this definition may seem like a mouthful, it contains some very useful distinctions.

To develop a superior service offering, you need a deep understanding of your client’s legal and business needs. Your service has to solve essential problems and deliver desired benefits. While this may seem a bit touchy-feely, great lawyers always attend to their client’s emotional needs (how they feel when you’re working with them) and their social needs (how your firm’s brand reflects on them). Lastly and most importantly, this combination of elements has to be superior to the alternatives—the other firms that want that client’s business.

Delivering Superior Value in Each Quadrant

The only way to move clients to a more desirable quadrant, then, or keep them in the quadrant you want, is by truly understanding how each one defines superior value—and then delivering it.

If you are looking for a place to start, begin with quadrant II clients and build a superior service offering to keep them in this quadrant.

Ensuring Your Clients Are Profitable

Embracing profitability.

I attended a roundtable panel discussion on firm management a few years ago. I heard the chair of a large firm say that “metrics were ruining the profession.” I remember thinking to myself, “I wonder how that person would feel if their investment advisor said the same thing.” The practice of law is a profession. But it is also a business.

Delivering high-quality legal services that provide superior value to your client should always come first, but you can only do this if you can deliver the service profitably. To do this, you need to be able to understand and measure profitability. This requires using a concept I call “true margin.”

Understanding true margin.

The final element of our three-pronged approach is ensuring that your clients are profitable.

This means you need a way to measure the profitability of each matter and aggregate these results for each client. We use true margin as a yardstick of profitability for these purposes, resulting in a margin-per-client metric. This number will help you put clients in the appropriate quadrant.

The concept of true margin could be a white paper in and of itself—it’s that powerful. For purposes of this discussion, what you need to know is that true margin is based on the cost of producing billable work from all timekeepers working on the client. This includes working timekeeper compensation.

True margin is calculated using this simple formula:

  true margin = matter revenue – (timekeeper overhead + working timekeeper compensation)

Timekeeper overhead is pretty straightforward. It is allocated proportionately to each timekeeper based on a formula established by the firm. Allocating overhead is a well-understood cost accounting concept. Working timekeeper compensation is a bit more complicated and where true margin differs from other models.

In general, compensation of timekeepers is set based on a combination of four elements: (1) doing the legal work, (2) bringing in the client, (3) managing the client work and (4) contributions to the firm. Some firms clearly break out each element when setting compensation; others consider them more holistically. Equity partners are also compensated in part for a return on their capital contributions to the firm.

Working timekeeper compensation, for purposes of true margin, should only include the cost of doing the legal work. All timekeepers get paid to do legal work. For timekeepers who get paid for other elements as well (e.g., partners who receive origination credit for bringing in clients), the firm needs to identify a method for determining the portion of that compensation that is allocated to actually doing the legal work.

There are many ways of making that allocation, but the essential thing is that the firm is consistent about it. True margin is an invaluable management tool, and if it’s used consistently, it will help the firm answer the following questions:

  • Was the client “profitable”?
  • If it was, why and how much?
  • If it wasn’t, why not, and can it be profitable?
  • How much margin is available to reward bringing in and managing the client?

Conclusion

Once you know the true margin for each client, you can locate all your clients in the Concata quadrants. You know how profitable they are, so you can locate them correctly. Their location can then be used by practice leaders and firm management to build business models targeted at maintaining and growing existing clients while more effectively developing new clients.

The goal of the 21st-century firm is to shift its paradigm and seek to have a strategic portfolio of “best” clients by delivering superior value under a profitable business model. The quadrants and true margin are very effective tools in reaching that goal.

Jeff Schwarz is the CEO of Concata LLC and a seasoned consultant. He regularly advises law firm leaders on developing market-winning strategies, optimizing profitability and firm governance structures. He has over 25 years of law firm experience, first as a partner at an Am Law 20 firm and later as an Am Law 100 firm chief information officer and then chief operating officer.