In the last post I outlined the importance of measuring Client Acquisition Cost (CAC) and the necessity of including non-billable time at full value or opportunity cost. However, measuring CAC alone is not enough; it’s important to keep track of the customer long-term, otherwise known as the lifetime value (CLTV) of each client. This measurement is part of the simple set of Key Performance Indicators (KPIs) that will help you run your legal practice.
$ CAC < $ CLTV
Spending more money to acquire a client than the same client’s total realized billings over the entire relationship is simply not good business. Put another way: if all the money spent to land your clients is less than the amount collected from those same clients, you need to make some adjustments to continue practicing. Simplistically, you need to either spend less to acquire clients, or bill more hours over the lifetime of the client.
This concept applies equally to legal technology companies as well as to lawyer matching services because it is a core business principle. Regularly measuring and comparing your CAC and CLTV metrics is a good start to creating your practice’s KPIs.
Client Lifetime Value Calculation
While lifetime value is used in most literature, that calculation can be tricky. For example, how many months or years should be measured? And do we apply a discount rate to billings earned out of a year or two to recognize the time value of money?
There needs to be a balance between measuring precision and getting rough order of magnitude to measure trends. Overall, the objective is to make good use of your scarce resources and ensure you are not spending a lot of time and money to attract “one and done” clients.
For example, if you are unable to bill anything (or perhaps only one small matter) after spending several hours identifying issues, you’ll find you are actually losing money when you calculate and compare the CAC versus that total client billing.
I am a proponent of starting small. Therefore I believe calculating annual value is a good starting place. As you grow your metrics, you can then add in the revenue generated in the following years for clients you continue to serve (but do not forget to add in any additional CAC). Those CAC can be annual client lunches, events, sponsorship, and so on.
Please note one caveat: Depending on your practice area, this may sometimes be the nature of your client type (i.e., litigation or personal injury). You may not have the ability to generate additional matters and therefore billable hours. However, calculating CAC and the CLTV is still important!
Top KPI Questions You May Have Been Afraid to Ask:
Are KPIs an accounting concept?
As a former accountant, I understand that accounting can be a mystery to many, however your accounting system generates financial statements and information on past transactions. Your billings, collections, and expenses and amounts owed but not yet paid are recorded into your accounting software of choice.
You then use the financial information to calculate your KPIs, including CAC and CLTV, but you do not want to build that into your financial statements or change your methods of recording your accounting transactions.
How do I get started?
Again, starting small, I would take a look at your 2014 results and calculate your CAC for at least your top 10 new clients in 2014. Refer back to my previous article for a refresher on that calculation and make sure to include the hours you tracked but did not bill! Also, if you are paying for referrals, you need to include that cost in your CAC calculation.
Next, compare the CAC client by client to the CLTV equal to annual billings in 2014 for each of those clients to create a CAC : CLTV ratio. Pick the report format you understand—if you are having your accountant or administration lead prepare, make sure that you ask for this at the client level and displayed line by line in summary format.
Just for big picture purposes, I would also calculate your firm CAC versus total year billings ratio. This provides you an overall benchmark to compare each of your clients. For example if your total CAC is 25% of your total billings, it means you are spending $25 to generate $100 of revenue.
What do I do with this information?
Numbers or calculations without analysis and action are a big waste of time. I would compare each of the clients’ CAC : CLTV ratio to your firm numbers to see patterns and overall areas for improvement.
Using the numbers above, if you have a client with a negative ratio of CAC v. CLTV—(e.g., 110% or you spent $110 to generate $100 of billing), more analysis is required. Or if you have a few clients with a 5% ratio, which is significantly lower than the firm ratio of 25%, then you are have an area to examine to see whether low CAC or high CLTV is creating this positive KPI.
In summary, reviewing your initial results should yield more questions including:
- Why is this client CAC more than CLTV? (Please remember that you only have a small sample and may need to dig deeper.)
- Why are these all different? Why are these all the same?
As Francis Bacon famously said, “Knowledge is power,” and arming yourself with information on your firm’s CAC v. CLTV will be a great start to 2015.
Any burning business questions for your practice on KPIS or other topics? Do not hesitate to reach out to me at firstname.lastname@example.org and perhaps I can answer your questions in a future article. Read the next article in my series here.