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As law firms attempt to drive greater profitability, it is common for partners to talk about “firing unprofitable clients.” But few firms have the ability to distinguish the comparative profitability of clients, and even fewer have the discipline to take action. The truth is that a large law firm’s client base goes a long way to determining its profit level, and improvement does not require a wholesale change of clients. The reason firms can’t measure client profitability is not because they lack the appropriate software or do not have access to the necessary data. Rather, firms have a problem coming up with a common definition of what constitutes profitability. The difficulty is that law firms are made up of partners who are prepared to vigorously defend their clients, regardless of their value to the firm. There is no measure of client profitability with sufficient credibility to withstand attack by a skilled advocate. Lawyers earn their living using small flaws to defeat otherwise sound arguments. So spending a lot of time on a computer profitability model is not worth the effort. Secondly, when firms are looking for unprofitable clients, what they usually find is: The smaller the client, the smaller the profit. Although some clients are small businesses but pay a large amount of money in fees, and some clients are large businesses yet do not pay much in fees, the converse is more typically true. For all intents and purposes, small total fee amounts tend to be paid by small clients. How small is small? A computer run of your clients for the last year in descending order of the billed value of work performed (to take out anomalistic payments for work from prior years) will provide the answer. It is not unusual for firms that have not been paying attention to this issue to find that one-quarter to one-third of their clients are billed less than $5,000 a year. By almost any standard, small clients are problematic for large law firms. Being sensitive to the limited financial resources of small clients, attorneys may be tempted to short-cut normal firm practice policies and procedures. Rarely is all of the time actually worked recorded, and some of the time recorded is frequently written down. SMALL CLIENTS, LARGE COSTS Since most firms do little cost accounting, they lack a standard to recognize the cost of carrying small clients. Starting with the client acceptance procedure, there are a lot of hidden costs involved in opening and maintaining a client. In many firms, new clients must be approved by a managing attorney or a client acceptance committee. A conflict check must be performed. If the check results in some form of name match, it could take a number of attorneys several hours to sort the matter out. The client number and name must be added to the firm’s financial management system and, if the firm’s databases are not integrated, they must also be entered into the document management system, the copy tracking system, the firm’s marketing database and mailing lists, and perhaps several other systems. With many accounting programs, full billing packets are generated every month for any client that has had activity or carries a balance. This material is printed and gets reviewed by the billing attorney, even if it is set aside from month to month. Of all accounts receivable, small clients represent the greatest risk of bad debt write-off. Indeed, a review of the accounts receivable delinquency lists of law firms shows that individuals and small and startup companies tend to be the worst offenders. And if a firm becomes aggressive in attempting to secure payment, small clients are the most likely to bring a malpractice suit. In fact, the nuisance claims that law firms routinely buy off are invariably brought by small clients. And by their sheer number, small clients present the risk of conflicts of interest with larger clients. Any firm that has attempted to track its entertainment expenses, particularly tickets to sporting events and use of stadium loges, will find that the small clients are entertained with a frequency disproportionate to their revenue contribution. Finally, and perhaps most important, small clients generally bring in routine work. Typically, representing small clients does little to enhance the reputation of the firm and build the skill levels of its lawyers. Considering each of these issues in isolation, it would be easy to dismiss the costs and risks of representing small clients as inconsequential. THE 80/20 RULE In virtually every law firm, 80 percent of revenue comes from 20 percent or less of its clients. Put another way, if a firm fired 80 percent of its clients, it would lose only 20 percent of its revenue or less. Consider the impact on overhead expenses of eliminating 80 percent of the client base and focusing the firm’s attention and service resources on the top 20 percent of its clients. At this point, some partner will point out that all large clients started out as small clients. Indeed, it seems that every firm has one story of a large client that started its business in a garage. But rarely does a firm have more than one such story. Therefore, if a partner can point to one such experience, it will probably never happen again. Besides, a client like that will be the target of competitors who will point out that the client has outgrown a law firm that serves small clients. TAKING ACTION It is easy to make an intellectual argument in favor of firing small clients. But in most firms, specific clients are the exclusive property of individual lawyers whose compensation is based on gross revenue, regardless of the cost of creating that revenue. No one wants to give up a source of revenue or actually tell a client that its business is no longer welcome. There are, however, some actions firms can take that do not require the actual firing of a client. • Eliminate discounts.Most businesses provide price discounts based on volume. But in law firms, often the lowest rates are charged to the smallest clients. With the next bill, simply charge the client at full rates. Explain that the firm has large clients who expect to enjoy most-favored-nation rates, which forces the firm to bring the small client’s rate up to standard. Either the client will pay the higher rates or it will seek other counsel — both good results. • Push work down.Institutionalize the process of routinely handing off small-client relationships to junior associates. The associate will pay more attention to the client, will be charged out at a lower rate, and gain experience in client relations and billing management. In fact, should the client develop into a significant opportunity, the associate probably has a better chance of maintaining the client’s loyalty. Plus, if the firm still wants to fire the client in a year or so, it can do so with less political flak from the partner. • Refer work out.Small clients are the bread and butter of small law firms. With lower overhead structures, small firms can profitably handle clients that lose money for larger firms. Many large firms have referral relationships with small firms. In exchange for a steady flow of client referrals, the small firm can use the capabilities of the larger firm for complex or sophisticated work. Explain to the client that they will be charged less and get better service from the smaller firm. • Cut out small clients at the source.The easiest way to reduce a firm’s dependence on small clients is to stop accepting them as new clients. Firms that permit attorneys to accept new clients without any approvals other than a conflict check may want to consider instituting an approval process. One approach is to decline work that particularly attracts individuals and small clients. If the firm must accept some individual work, establish a fixed-fee minimum for services such as preparing a will or doing a residential real estate closing (and make it pretty high). Another approach is to set a threshold minimum billing value for a new client. For example, some firms require that a new client be expected to generate at least $10,000 in fees during the first 12-month period. • Track and publicize the statistics.Make a point of publishing each month a list of client billings by billing attorney. It will quickly become apparent which attorneys maintain a stable of small clients. Track at the value of the firm’s average and median client in terms of annual revenue. Publish the ratio of clients paying over $100,000 in the last year to the number of partners. If that ratio is less than 3 to 1, the firm’s partners are focusing on the wrong kind of practice. Improving profitability is tough. The options available to large firms are decreasing; many will need to make significant changes in culture. For most firms, culling small clients represents a relatively easy first step. H. Edward Wesemann is a partner in the legal consulting firm of Edge International, where he specializes in strategic issues. He can be reached at [email protected]or (877) 922-2040.

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