Business of Law—What Is ‘Customer Lifetime Value’ and Why Is It Important?
For the many lawyers who bill by the hour, time is money.
The more time hourly billers spend on billable work for clients, the higher the expected revenue. This is axiomatic for many lawyers.
Most lawyers also understand the need to spend part of their time doing non-billable work to acquire and retain clients.
Signing up new clients for the law firm is part of the business, and a number of non-billable hours will need to be spent marketing and communicating with potential clients. The time spent on bringing in business and retaining clients in the law firm may not directly translate to billable hours, but it does significantly affect the bottom line.
Unlike other types of businesses, the time spent on attracting potential clients and retaining existing ones is often written off, inaccurately tracked, or not tracked at all in many law firms. Similarly, many law firms do not calculate or compare the expected revenues over time that various types of clients might provide, although this is a frequent practice in other types of businesses.
Utilizing these metrics can help law firms budget and balance how much money and time should be spent to bring in new clients of particular types, and to retain existing clients. These metrics will also help determine the actual and opportunity costs of converting a prospect into a client, and maintaining an existing client, as well as the potential return that the client can generate to the law firm over time.
In this vein, this article discusses two prominent metrics commonly used in the business world—“customer acquisition cost” and “customer lifetime value”—and how law firms might use those metrics to improve profitability.
What Is ‘Customer Acquisition Cost’ (CAC)?
In the business world, customer acquisition cost (CAC) is one of the most important metrics that companies track. Law firms can also benefit from using the measurement.
In the simplest form, CAC is the amount of money a company or law firm spends to acquire or bring in a single paying customer or client. Client acquisition is one of the biggest challenges a law firm will face, and it is almost always worth investing at least some amount of time and money in activities to help bring in new clients to the firm.
Customer acquisition costs come in many forms. For example, these costs may come in the form of dining with prospects or socially engaging with potential clients at parties or charities. Other forms of CACs can come from marketing campaigns by email or social media, blog posts for the law firm’s website, or print advertising. Every activity no matter how small should be recorded.
The formula for computing customer acquisition costs often expressed as follows:
- CAC = (The total amount of money spent or all marketing activities) ÷ (The total number of new customers acquired over the same time period)
This formula provides an average of how much is spent per customer for that time period. Knowing your CAC is important in setting a baseline value for your customer lifetime value, which brings us to our core topic.
What Is ‘Customer Lifetime Value’ (CLV)?
Customer lifetime value (CLV) is another important metric in any business. There are generally two types of ways CLV is most often used:
- Historic CLV is calculated to show how much revenue a customer has generated over its present lifetime, minus the cost of acquisition for the customer.
- Predictive CLV is more complicated as it uses both existing transactions and takes into account mixed behavioral variables to predict future customer value.
Why Is it Important to know CLV?
Law firms are distinct from other businesses in many ways, but the questions of whether it costs more to acquire new clients of a certain type as opposed to others, or whether it is more expensive to maintain a particular client relationship than another, or whether it is more costly to maintain an existing client relationship than it is to sign up new clients, applies to law firms and other businesses alike.
Numerous studies have shown that it costs six times more to attract new customers than it is to retain existing customers. Knowing the CLV and CAC of various types of clients will help law firms track and project performance, make important marketing spending decisions, improve processes and methods to acquire new clients at a lower cost, and optimize investments to retain existing clients.
How to Compute and Assess the Customer Lifetime Value
When applied in the context of law firms, part of the process of computing and predicting for the customer lifetime value involves using existing transactional data to predict future lifetime value for new clients.
Step 1: Estimate Customer’s Average Lifetime
The first step would be to determine the average “lifetime” of previous and existing clients. This number is an expression of how long the average client does business with the law firm or practice group.
Having a relatively lengthy average client lifetime means that clients value the service the law firm or practice group provides, and stick with firm or practice group over the long term.
Law firms can compare the value of the client’s “lifetime” across practice groups or against other clients to determine whether improvements should be made in client retention practices and methods, or whether such investments might be curtailed in certain circumstances.
Step 2: Calculate the Average Cost of Acquisition
Calculating how much it costs to bring a client to the firm (CAC) is one of the important underlying factors in determining customer lifetime value. Along with determining how much it costs to acquire a new client of a particular type, it is also important to track and record where the lead was acquired and how. This is important so the law firm or practice group can attribute which channels and marketing efforts are performing well and which are not.
Step 3: Calculate the Average Revenue a Customer Generates
The next step is to calculate how much revenue a client of a specific kind generates throughout its “lifetime” with the firm or practice group. First, you need to get the total number of matters that you have worked on with the client, and the value of all billing for each of those matters. Multiply the number of matters, and the total amount billed will give you the revenue generated for that client.
Step 4: Get the Net Total to Calculate the Lifetime Value of the Customer
Once you have determined the average lifetime of a specific kind of client, the average revenue each such client generates, and the cost of acquisition for those clients, you are then able to compute for the lifetime value of the customer.
Here are the final steps to compute for the lifetime value of the customer:
a. Determine the Lifetime Value for each client by calculating the total revenue of the individual client and subtracting the cost of acquisition for that client to determine the revenue for the client.
Total Revenue (TR) ¬ Customer Acquisition Cost (CAC) = Revenue from Customer (RC)
b. The next step is to take the revenue for the client, and divide it by the “lifetime” of the client to get the lifetime value per year of that customer.
Revenue from Customer (RC) ÷ Lifetime of Customer (LC) = Lifetime Value per Year (LV)
c. To finally compute for the customer lifetime value (CLV) you have to take the total average of the individual Lifetime Value of all of your customers and multiply it with the average lifetime of customer from the previous step to finally get the CLV.
Average Lifetime Value Per Year (Avg LV) × Average Lifetime of Customer (Avg LC) = CLV
Many law firms and practice groups at least in a general way already engage in the sort of underlying decision-making described here based on “gut feelings” and not in any systematized fashion. However, not using a defined methodology can lead to emotional or incorrect decisions that are not actually profitable, not to mention perceptions of unfairness or inequity among the attorneys in a law firm or practice group.
Armed with an understanding of how to compute the customer lifetime value, law firms will be able to empirically determine the ratio of the cost of acquisition (CAC) for each client, and the client’s customer lifetime value (CLV), in order more reliably analyze these data points and information to streamline marketing and client retention methods, processes, and related decision-making.
This article was first published in Bloomberg Law on 9/10/2019.