Can Your Firm Serve Small Clients Profitably?

In one chapter of his 2004 book, The First Myth of Legal Management is that It Exists [see the review], Ed Wesemann argues that small clients disproportionately drain the resources of law firms while providing a disproportionately small contribution to firm profits. He proposes ways to help firms focus on serving larger clients, while also improving the profitability of small clients who stay with the firm.

A&FP: For a book that's downright provocative, The First Myth is a delightful read, Ed.

Ed Wesemann: Thank you. My new book, Creating Dominance: Winning Strategies for Law Firms, is due out in March.

A&FP: Let's explore the line of thought in your First Myth chapter on small clients. You describe such problem areas as the need to limit the proportion of small clients; the difficulty of doing so due to the tendency of lawyers to defend their own small clients; the disproportionately high association of small clients with fee discounting, fee nonpayment, and malpractice suits; and the disproportionately high consumption by small clients of law firm overhead and entertainment dollars.

First, let's clarify whether the problem is small clients or small matters. Presumably large clients can burden a firm with lots of annoyingly small legal matters, while at least some small clients could bring in large legal matters.

Ed Wesemann: That is theoretically true. But realistically, the issue is small and individual clients, particularly for large law firms. Small matters for large clients tend to be worked and billed to the same standards as larger matters and, as such, are very profitable and do not have the write-offs or conflicts problems. [See below for somewhat divergent views of other authors.]

A&FP: Your saying that lawyers defend keeping their own small clients, combined with your comment on entertainment dollars and excessive discounting, suggests that many such small matters wind up in the firm because lawyers are doing favors for personal friends and relatives. To the extent that that's the case, does it make sense to give each lawyer in a firm a 'budget' for such giveaways?

Ed Wesemann: Giving a budget is something lots of firms do. Unfortunately, that simply legitimizes the problem. Look at who any firm brings to its box seats or table at the symphony ball: it's heavily small clients.

A&FP: Also, your suggestion about referring small clients to other firms leads one to wonder whether a firm couldn't just have a low-overhead practice area with no frills and somewhat lower (non-discounted) rates ' as it might for an auxiliary business. That way the firm could hold onto potential growth clients, while the small clients could happily say they were represented by a big firm.

Ed Wesemann: That's a great idea. However, it requires discipline to fund a completely isolated operation. We're talking about firms that lack the discipline to fire attorneys who don't turn their time in and send their bills out promptly. If the firm can't bring itself to manage the basics of profitable practice, you can expect an isolated small client ancillary business to look just like a branch office within 2 years.

A&FP: Given that firms are supposed to do some pro bono work, it seems illogical to suggest that people who can pay at least a little should be excluded altogether (like the working poor with respect to government aid programs). From the standpoint of serving the public, would it make sense to expand one of your guidelines ' that there should be at least so many $100,000/year clients per lawyer ' into a normal or other curve that covers clients at other fee levels as well?

Ed Wesemann: Wait a minute! Don't equate small clients with the poor. Some of the worst small clients I have ever seen are richer than Rockefeller. Plus, think of the tag line at the law day dinner: 'Our pro bono program is to serve people who can afford legal services but don't want to pay for them.' Kind of warms your heart.

A&FP: Actually, fees alone seem too partial a measure. You noted that it's hard to get agreement on exactly what constitutes profitability; but can't firms even agree on factoring in the major costs of supporting each client?

Ed Wesemann: Nope!

Taking up the discussion at this point: recent A&FP author Kurt Salisbury and A&FP Board members Joe Altonji, Bill Brennan, Jim Davidson, Ed Poll, Pete Peterson, Ron Seigneur and Mike Short.

Joe Altonji: What does “small” mean? I assume we are not talking about the $300/year stuff.

Tiny clients in a big law firm are probably not efficient, and are therefore unprofitable, but this is usually because of a mismatch in choice of law firm. Many of the same clients could be very profitable elsewhere. Meanwhile, some big clients are an economic disaster.

In our work [as law firm consultants] we encounter an amazing number of cases where, once client profitability is actually analyzed, the “big, profitable” client turns out to be unprofitable. Why? Pricing power. It's extremely hard to resist the pricing power of the large client. Read: discounts, write-offs, write-downs. Add to this the complete fear that many lawyers have of not offending their large clients, and you end up with even bigger write-downs. [See Bill Brennan's comments below for related views.]

By contrast, for firms that know how to handle smaller clients, it's very easy to get your rates if they want you to do their work.

What you really need are good clients: ones that your firm is capable of serving effectively, efficiently and with high quality work ' and who are willing to pay for it.

Ed Poll: I am all in favor of seeking larger clients with more money and more interesting challenges. This effort, however, must be balanced to assure that the firm doesn't wind up with only a few clients, larger though they may be, who put the firm at risk if they should leave.

Specifically, if a larger client makes up more than 10% of the firm's business – whether by number of matters or by dollars collected – you are at risk even if the client's “drain” on your resources is small and the contribution to profits proportionately large. If that client should leave for whatever reason, you will experience a big hole in your revenue. By contrast, if your client's contribution is only 1 or 2%, you can afford to “fire” the client without severe consequences to the firm.

In the longer term, a strategy based on fewer, larger clients will almost always lead to disaster. For the short term, however, you may be willing to accept this risk with the intent of getting more clients, so that the percentage allocation to the “larger” client is reduced while maintaining the billings at the same level for that client. But be sure that no long-term capital or other expenditures are made at the behest of such a client without some type of assurance or guarantee that the business will stay with you (at least) until the amortization for the new expenditure is completed.

Ron Seigneur: Good comments, Ed. Here is what I can add.

My business as a Certified Public Accountant and Consultant is no different than the business model of most law firms with respect to the ongoing balance between big and small clients, defined in my mind by their contribution to revenues. A key aspect I always consider is whether the client provides any opportunities for recurring work or referrals, as opposed to possibly one large project, such as the sale of a business wherein the client (eg, the ownership group) is very unlikely to have any additional needs for services in future periods. A small stable client that provides a small yet recurring contribution to revenues, such as the need for an annual income tax return, is an annuity that can add up to a significant contribution over time.

Another perspective is to look beyond the revenue contribution to the referral base the firm builds by having a broad base of satisfied small clients. I know I have received plenty of larger engagements as a direct result of satisfying a smaller client who then refers someone more substantial to our door. Most law firms I work with are no different with respect to these attributes.

Ed Poll: Ron, I absolutely agree with you. Most professionals who bill by the hour focus on their hourly rate, trying to get it as high as they can. What they forget is that the client who may contribute either a smaller hourly rate or a smaller total contribution is still a “profit” as long as they are not causing the firm to lose money or to lose other opportunities.

Of course, this analysis requires that one know one's own costs, and most firms don't. I had this conversation just yesterday with a client I coach. I pointed out to him that the client prospect was still going to add dollars to his revenue, even if at a lower per hour level, at a time when the lawyer had the time available to do the work.

As to lost opportunities, one never knows. But, as the work increases, one can hire (leverage) other professionals at a lower level to do the work.

Thus, I see small clients as providing the opportunity to grow at all levels in ways that make the firm stronger: with more diverse clients, more interesting work, and varying levels of expertise (allowing for future internal growth and succession) ' and with no one client or type of client having too large a percentage of one's revenue.

Ron Seigneur: Well stated, Ed. It's critical to focus on profit margins and on value-billing opportunities more than on sheer gross revenues. Many big-ticket projects require big-ticket overhead support and result in thin margins.

More and more firms are embracing profit center accounting concepts to take a more analytical approach to this, but I also find some firms resistant to moving in this direction. Often that's because some players within the firm would rather have their own comparatively low-margin work remain hidden within the overall scope of the enterprise.

Jim Davidson: I agree that focusing on the hourly-rate model used by most larger firms is a reason that small clients are seen as less profitable. Law firms need, as they have for 20+ years, to think outside the hourly-rate box, especially in this arena. Many boutique firms can and do make a lot of money on small clients if they concentrate on a particular area where they have special expertise ' and staff it right.

The high-hourly-rate partners spend minimal time on a given matter; they train lower priced associates and paralegals to do most of the time-consuming work. Pricing is generally done by flat fee for a given type of matter, but watched carefully by the partner from the outset to smoke out complications that would require a fee in addition to the flat fee for the routine case. This possibility is set forth up front in the engagement letter with the client. This requires management, which is not an area where lawyers tend to have much savvy. [Editor: Which bring us back to the title of Wesemann's book!]

Additionally, some types of small-client work may be tolerated as a loss leader if they lead to other, more profitable work for the law firm. Patent prosecution work that leads to patent litigation comes immediately to mind, but there are other areas as well. [Mike Short offers a different perspective on this below.]

Bill Brennan: I agree with many of the comments made above, but especially Ron Seigneur's comment regarding the need to focus on a client's profitability rather than the dollar amount of revenues a client generates for the firm, or even the relative size of the client. Contrary to the popular belief that bigger clients are better, a small client can be very profitable and a huge client can actually be unprofitable, depending on how the engagement is priced.

The idea of “firing” your worst clients does not necessarily mean terminating the smallest clients. Although that may be true, it is also possible that after factoring in all the costs of servicing a larger client, including write-downs, write-offs and delayed collections, some larger clients may in fact be some of the firm's “worst clients.” One of my clients several years ago was shocked to learn that one of its large clients, with over a million dollars in billings, was in fact unprofitable because of the enormous write-downs and write-offs that client imposed on the firm. My client actually was much better off without that business and took steps to address the problem.

Unfortunately, the concept of “profitability” can get rather complicated. This is because, as Ed [Poll] points out above, sometimes it is better for a law firm to accept work even at relatively low rates if the firm has excess capacity. A firm can realize increased profits if the fees generated by the new work exceed the variable costs required to handle the matter. That is, when the incremental revenue exceeds the incremental expenses it provides a contribution towards payment of the firm's overhead and results in a larger net profit than the firm would otherwise realize. This concept of incremental costing recognizes that when a firm has excess capacity the incremental cost of handling a matter is relatively minor.

It is important to emphasize that this concept should be used sparingly. A law firm must normally use “full costing,” which requires that all costs of an engagement be factored into the pricing of the project, or it will surely face a financial crisis in the longer term. By concentrating on client profitability, and only rarely using the concept of incremental costing, a law firm can continually strive to replace relatively unprofitable clients with more profitable ones, and thereby increase profits without working harder.

Kurt Salisbury: I agree that small clients ' mom & pop shops and individuals ' can be profitable and certainly have a place in the grand scheme. However, I still find myself advising against them for two reasons:

• Conflicts. The last thing you want is to have to turn down work from an Exxon Mobil because you had a $5000 matter adverse to them on behalf of John Smith.
• Containment. Once a small client gets in the door, it is very hard to mitigate the obvious and serious credit risk. Time and time again, I see a small client come in for a $5000 piece of work. On the front end, we do everything we can to mitigate the risk of non-payment (eg, retainers) and it looks like a happy ending. Invariably, though, many of these clients run into a large legal problem down the road and the attorney, being responsive to their client's need, runs up a huge bill. You know how the story ends: the client can't afford to pay us, yet often we can't remove ourselves from the case.

[Editor's Note: For detailed practical guidance on the latter topic, see Ed Poll's book Collecting Your Fee: Getting Paid from Intake to Invoice, published by the ABA in 2003.]

Mike Short: Small clients can be extremely lucrative if supported by the right business model. Typically such a model includes very high leverage ' including strong reliance on good paralegals ' and good technology. Proof of this is the high volume/low value boutiques that make profits similar to those at the top of the Am Law 100.

When a firm operates under a business model that is more conducive to larger clients, it's quite challenging to turn a profit with smaller clients.

Conversely, if these small clients are supported by creating a “second model” within the firm, then a tension is likely to develop around the firm's identity and strategy. Still, some firms have done this by setting up cross-department entrepreneurial services teams (one of many monikers) with the understanding through the firm that there is a difference in client bases and approaches for such groups.

I like Kurt's perspective on strategic intake. Too many law firms have a quick-gratification approach to intake, but those who manage for the long term will benefit exponentially in the future from passing on small one-offs.

Regarding the loss-leader rationale for taking on small clients: I've found in interviews with law firm clients ' even with start-ups and small companies ' that the bet-the-business work (eg, IPOs and litigation) is infrequently linked to the relationship. If we're talking about a firm with, as an example, stellar credentials in patent prosecution and litigation, then the work may stay together; but if the client has any doubt at all about the firm's litigation capabilities, then that work will quickly and easily be moved elsewhere.

Pete Peterson: [Regarding Ed Wesemann's comment on opening a budget-office for smaller clients:] I once worked with a law firm that considered establishing a lower-cost department to serve smaller clients. Momentum quickly died when associates and some partners began dubbing the idea “ABC Law Firm Lite.” Many CPA firms faced a similar dilemma when appointing a partner or senior accountant to be in charge of the bookkeeping department they ran for small clients; the task was often relegated to a retiring or new partner and, as such, was perceived by others in the firm as having little or no value. Many accounting firms later started to close those bookkeeping departments, so that they could focus on larger and presumably more profitable clients.

Instead of establishing a lower-cost department or ancillary business, some successful firms have created alternative billing systems, which are both cost efficient to the client and profitable to the law firm. These firms have done their homework and have benefited from their knowledge management systems and product profitability analyses.

I know one firm with 1,340 clients that generated only $10 million in gross fees. One problem was that the firm's top two clients had been given fee discounts totaling $500,000, which considerably eroded profits. This demonstrated to management that the largest clients are not necessarily the most profitable, and led the firm to explore alternative fee arrangements. Another problem was that the firm did not have formal intake procedures governing the types of clients it wished to attract to the firm; that perpetuated the acceptance of many clients who further eroded profit margins. Segmenting its client base enabled this firm to identify the revenue and profit contribution of clients in various industries and/or practices areas. Using this information, the firm targeted its growth and marketing plans more effectively.

I share the view that there is considerable value in serving up and coming small clients. Determining who those clients are takes vision ' a talent hard to come by in many firms. However, if lawyers making client intake-retention decisions try scanning Forbes and Fortune's listings of the “200 Best Small Companies” and the “100 Fastest Growing Companies,” maybe some light will begin generating from their bulbs. After all, those successful businesses started small somewhere.

A&FP: Thanks to Ed Wesemann for his stimulating article and comments, and to all of our additional discussants for their perspectives. We've had a variety of views on some topics, such as when and whether to take on low-margin work, and whether the credit risks and possible conflicts presented by small clients are outweighed by their growth potential, repeat-business value, and publicity benefits. We also have somewhat divergent views on whether future high-value work from current small clients is likely to stay with the firm.

On several other points we may be in agreement: that each client's profitability for the firm should be evaluated critically, regardless of the client's size; that profit margins are crucial; that incremental costing should be used judiciously; and that alternatives to hourly billing merit closely monitored experimentation.

In one chapter of his 2004 book, The First Myth of Legal Management is that It Exists [see the review], Ed Wesemann argues that small clients disproportionately drain the resources of law firms while providing a disproportionately small contribution to firm profits. He proposes ways to help firms focus on serving larger clients, while also improving the profitability of small clients who stay with the firm.

A&FP: For a book that's downright provocative, The First Myth is a delightful read, Ed.

Ed Wesemann: Thank you. My new book, Creating Dominance: Winning Strategies for Law Firms, is due out in March.

A&FP: Let's explore the line of thought in your First Myth chapter on small clients. You describe such problem areas as the need to limit the proportion of small clients; the difficulty of doing so due to the tendency of lawyers to defend their own small clients; the disproportionately high association of small clients with fee discounting, fee nonpayment, and malpractice suits; and the disproportionately high consumption by small clients of law firm overhead and entertainment dollars.

First, let's clarify whether the problem is small clients or small matters. Presumably large clients can burden a firm with lots of annoyingly small legal matters, while at least some small clients could bring in large legal matters.

Ed Wesemann: That is theoretically true. But realistically, the issue is small and individual clients, particularly for large law firms. Small matters for large clients tend to be worked and billed to the same standards as larger matters and, as such, are very profitable and do not have the write-offs or conflicts problems. [See below for somewhat divergent views of other authors.]

A&FP: Your saying that lawyers defend keeping their own small clients, combined with your comment on entertainment dollars and excessive discounting, suggests that many such small matters wind up in the firm because lawyers are doing favors for personal friends and relatives. To the extent that that's the case, does it make sense to give each lawyer in a firm a 'budget' for such giveaways?

Ed Wesemann: Giving a budget is something lots of firms do. Unfortunately, that simply legitimizes the problem. Look at who any firm brings to its box seats or table at the symphony ball: it's heavily small clients.

A&FP: Also, your suggestion about referring small clients to other firms leads one to wonder whether a firm couldn't just have a low-overhead practice area with no frills and somewhat lower (non-discounted) rates ' as it might for an auxiliary business. That way the firm could hold onto potential growth clients, while the small clients could happily say they were represented by a big firm.

Ed Wesemann: That's a great idea. However, it requires discipline to fund a completely isolated operation. We're talking about firms that lack the discipline to fire attorneys who don't turn their time in and send their bills out promptly. If the firm can't bring itself to manage the basics of profitable practice, you can expect an isolated small client ancillary business to look just like a branch office within 2 years.

A&FP: Given that firms are supposed to do some pro bono work, it seems illogical to suggest that people who can pay at least a little should be excluded altogether (like the working poor with respect to government aid programs). From the standpoint of serving the public, would it make sense to expand one of your guidelines ' that there should be at least so many $100,000/year clients per lawyer ' into a normal or other curve that covers clients at other fee levels as well?

Ed Wesemann: Wait a minute! Don't equate small clients with the poor. Some of the worst small clients I have ever seen are richer than Rockefeller. Plus, think of the tag line at the law day dinner: 'Our pro bono program is to serve people who can afford legal services but don't want to pay for them.' Kind of warms your heart.

A&FP: Actually, fees alone seem too partial a measure. You noted that it's hard to get agreement on exactly what constitutes profitability; but can't firms even agree on factoring in the major costs of supporting each client?

Ed Wesemann: Nope!

Taking up the discussion at this point: recent A&FP author Kurt Salisbury and A&FP Board members Joe Altonji, Bill Brennan, Jim Davidson, Ed Poll, Pete Peterson, Ron Seigneur and Mike Short.

Joe Altonji: What does “small” mean? I assume we are not talking about the $300/year stuff.

Tiny clients in a big law firm are probably not efficient, and are therefore unprofitable, but this is usually because of a mismatch in choice of law firm. Many of the same clients could be very profitable elsewhere. Meanwhile, some big clients are an economic disaster.

In our work [as law firm consultants] we encounter an amazing number of cases where, once client profitability is actually analyzed, the “big, profitable” client turns out to be unprofitable. Why? Pricing power. It's extremely hard to resist the pricing power of the large client. Read: discounts, write-offs, write-downs. Add to this the complete fear that many lawyers have of not offending their large clients, and you end up with even bigger write-downs. [See Bill Brennan's comments below for related views.]

By contrast, for firms that know how to handle smaller clients, it's very easy to get your rates if they want you to do their work.

What you really need are good clients: ones that your firm is capable of serving effectively, efficiently and with high quality work ' and who are willing to pay for it.

Ed Poll: I am all in favor of seeking larger clients with more money and more interesting challenges. This effort, however, must be balanced to assure that the firm doesn't wind up with only a few clients, larger though they may be, who put the firm at risk if they should leave.

Specifically, if a larger client makes up more than 10% of the firm's business – whether by number of matters or by dollars collected – you are at risk even if the client's “drain” on your resources is small and the contribution to profits proportionately large. If that client should leave for whatever reason, you will experience a big hole in your revenue. By contrast, if your client's contribution is only 1 or 2%, you can afford to “fire” the client without severe consequences to the firm.

In the longer term, a strategy based on fewer, larger clients will almost always lead to disaster. For the short term, however, you may be willing to accept this risk with the intent of getting more clients, so that the percentage allocation to the “larger” client is reduced while maintaining the billings at the same level for that client. But be sure that no long-term capital or other expenditures are made at the behest of such a client without some type of assurance or guarantee that the business will stay with you (at least) until the amortization for the new expenditure is completed.

Ron Seigneur: Good comments, Ed. Here is what I can add.

My business as a Certified Public Accountant and Consultant is no different than the business model of most law firms with respect to the ongoing balance between big and small clients, defined in my mind by their contribution to revenues. A key aspect I always consider is whether the client provides any opportunities for recurring work or referrals, as opposed to possibly one large project, such as the sale of a business wherein the client (eg, the ownership group) is very unlikely to have any additional needs for services in future periods. A small stable client that provides a small yet recurring contribution to revenues, such as the need for an annual income tax return, is an annuity that can add up to a significant contribution over time.

Another perspective is to look beyond the revenue contribution to the referral base the firm builds by having a broad base of satisfied small clients. I know I have received plenty of larger engagements as a direct result of satisfying a smaller client who then refers someone more substantial to our door. Most law firms I work with are no different with respect to these attributes.

Ed Poll: Ron, I absolutely agree with you. Most professionals who bill by the hour focus on their hourly rate, trying to get it as high as they can. What they forget is that the client who may contribute either a smaller hourly rate or a smaller total contribution is still a “profit” as long as they are not causing the firm to lose money or to lose other opportunities.

Of course, this analysis requires that one know one's own costs, and most firms don't. I had this conversation just yesterday with a client I coach. I pointed out to him that the client prospect was still going to add dollars to his revenue, even if at a lower per hour level, at a time when the lawyer had the time available to do the work.

As to lost opportunities, one never knows. But, as the work increases, one can hire (leverage) other professionals at a lower level to do the work.

Thus, I see small clients as providing the opportunity to grow at all levels in ways that make the firm stronger: with more diverse clients, more interesting work, and varying levels of expertise (allowing for future internal growth and succession) ' and with no one client or type of client having too large a percentage of one's revenue.

Ron Seigneur: Well stated, Ed. It's critical to focus on profit margins and on value-billing opportunities more than on sheer gross revenues. Many big-ticket projects require big-ticket overhead support and result in thin margins.

More and more firms are embracing profit center accounting concepts to take a more analytical approach to this, but I also find some firms resistant to moving in this direction. Often that's because some players within the firm would rather have their own comparatively low-margin work remain hidden within the overall scope of the enterprise.

Jim Davidson: I agree that focusing on the hourly-rate model used by most larger firms is a reason that small clients are seen as less profitable. Law firms need, as they have for 20+ years, to think outside the hourly-rate box, especially in this arena. Many boutique firms can and do make a lot of money on small clients if they concentrate on a particular area where they have special expertise ' and staff it right.

The high-hourly-rate partners spend minimal time on a given matter; they train lower priced associates and paralegals to do most of the time-consuming work. Pricing is generally done by flat fee for a given type of matter, but watched carefully by the partner from the outset to smoke out complications that would require a fee in addition to the flat fee for the routine case. This possibility is set forth up front in the engagement letter with the client. This requires management, which is not an area where lawyers tend to have much savvy. [Editor: Which bring us back to the title of Wesemann's book!]

Additionally, some types of small-client work may be tolerated as a loss leader if they lead to other, more profitable work for the law firm. Patent prosecution work that leads to patent litigation comes immediately to mind, but there are other areas as well. [Mike Short offers a different perspective on this below.]

Bill Brennan: I agree with many of the comments made above, but especially Ron Seigneur's comment regarding the need to focus on a client's profitability rather than the dollar amount of revenues a client generates for the firm, or even the relative size of the client. Contrary to the popular belief that bigger clients are better, a small client can be very profitable and a huge client can actually be unprofitable, depending on how the engagement is priced.

The idea of “firing” your worst clients does not necessarily mean terminating the smallest clients. Although that may be true, it is also possible that after factoring in all the costs of servicing a larger client, including write-downs, write-offs and delayed collections, some larger clients may in fact be some of the firm's “worst clients.” One of my clients several years ago was shocked to learn that one of its large clients, with over a million dollars in billings, was in fact unprofitable because of the enormous write-downs and write-offs that client imposed on the firm. My client actually was much better off without that business and took steps to address the problem.

Unfortunately, the concept of “profitability” can get rather complicated. This is because, as Ed [Poll] points out above, sometimes it is better for a law firm to accept work even at relatively low rates if the firm has excess capacity. A firm can realize increased profits if the fees generated by the new work exceed the variable costs required to handle the matter. That is, when the incremental revenue exceeds the incremental expenses it provides a contribution towards payment of the firm's overhead and results in a larger net profit than the firm would otherwise realize. This concept of incremental costing recognizes that when a firm has excess capacity the incremental cost of handling a matter is relatively minor.

It is important to emphasize that this concept should be used sparingly. A law firm must normally use “full costing,” which requires that all costs of an engagement be factored into the pricing of the project, or it will surely face a financial crisis in the longer term. By concentrating on client profitability, and only rarely using the concept of incremental costing, a law firm can continually strive to replace relatively unprofitable clients with more profitable ones, and thereby increase profits without working harder.

Kurt Salisbury: I agree that small clients ' mom & pop shops and individuals ' can be profitable and certainly have a place in the grand scheme. However, I still find myself advising against them for two reasons:

• Conflicts. The last thing you want is to have to turn down work from an Exxon Mobil because you had a $5000 matter adverse to them on behalf of John Smith.
• Containment. Once a small client gets in the door, it is very hard to mitigate the obvious and serious credit risk. Time and time again, I see a small client come in for a $5000 piece of work. On the front end, we do everything we can to mitigate the risk of non-payment (eg, retainers) and it looks like a happy ending. Invariably, though, many of these clients run into a large legal problem down the road and the attorney, being responsive to their client's need, runs up a huge bill. You know how the story ends: the client can't afford to pay us, yet often we can't remove ourselves from the case.

[Editor's Note: For detailed practical guidance on the latter topic, see Ed Poll's book Collecting Your Fee: Getting Paid from Intake to Invoice, published by the ABA in 2003.]

Mike Short: Small clients can be extremely lucrative if supported by the right business model. Typically such a model includes very high leverage ' including strong reliance on good paralegals ' and good technology. Proof of this is the high volume/low value boutiques that make profits similar to those at the top of the Am Law 100.

When a firm operates under a business model that is more conducive to larger clients, it's quite challenging to turn a profit with smaller clients.

Conversely, if these small clients are supported by creating a “second model” within the firm, then a tension is likely to develop around the firm's identity and strategy. Still, some firms have done this by setting up cross-department entrepreneurial services teams (one of many monikers) with the understanding through the firm that there is a difference in client bases and approaches for such groups.

I like Kurt's perspective on strategic intake. Too many law firms have a quick-gratification approach to intake, but those who manage for the long term will benefit exponentially in the future from passing on small one-offs.

Regarding the loss-leader rationale for taking on small clients: I've found in interviews with law firm clients ' even with start-ups and small companies ' that the bet-the-business work (eg, IPOs and litigation) is infrequently linked to the relationship. If we're talking about a firm with, as an example, stellar credentials in patent prosecution and litigation, then the work may stay together; but if the client has any doubt at all about the firm's litigation capabilities, then that work will quickly and easily be moved elsewhere.

Pete Peterson: [Regarding Ed Wesemann's comment on opening a budget-office for smaller clients:] I once worked with a law firm that considered establishing a lower-cost department to serve smaller clients. Momentum quickly died when associates and some partners began dubbing the idea “ABC Law Firm Lite.” Many CPA firms faced a similar dilemma when appointing a partner or senior accountant to be in charge of the bookkeeping department they ran for small clients; the task was often relegated to a retiring or new partner and, as such, was perceived by others in the firm as having little or no value. Many accounting firms later started to close those bookkeeping departments, so that they could focus on larger and presumably more profitable clients.

Instead of establishing a lower-cost department or ancillary business, some successful firms have created alternative billing systems, which are both cost efficient to the client and profitable to the law firm. These firms have done their homework and have benefited from their knowledge management systems and product profitability analyses.

I know one firm with 1,340 clients that generated only $10 million in gross fees. One problem was that the firm's top two clients had been given fee discounts totaling $500,000, which considerably eroded profits. This demonstrated to management that the largest clients are not necessarily the most profitable, and led the firm to explore alternative fee arrangements. Another problem was that the firm did not have formal intake procedures governing the types of clients it wished to attract to the firm; that perpetuated the acceptance of many clients who further eroded profit margins. Segmenting its client base enabled this firm to identify the revenue and profit contribution of clients in various industries and/or practices areas. Using this information, the firm targeted its growth and marketing plans more effectively.

I share the view that there is considerable value in serving up and coming small clients. Determining who those clients are takes vision ' a talent hard to come by in many firms. However, if lawyers making client intake-retention decisions try scanning Forbes and Fortune's listings of the “200 Best Small Companies” and the “100 Fastest Growing Companies,” maybe some light will begin generating from their bulbs. After all, those successful businesses started small somewhere.

A&FP: Thanks to Ed Wesemann for his stimulating article and comments, and to all of our additional discussants for their perspectives. We've had a variety of views on some topics, such as when and whether to take on low-margin work, and whether the credit risks and possible conflicts presented by small clients are outweighed by their growth potential, repeat-business value, and publicity benefits. We also have somewhat divergent views on whether future high-value work from current small clients is likely to stay with the firm.

On several other points we may be in agreement: that each client's profitability for the firm should be evaluated critically, regardless of the client's size; that profit margins are crucial; that incremental costing should be used judiciously; and that alternatives to hourly billing merit closely monitored experimentation.