There is a tactic used in many businesses that is known as throttling.  Throttling involves taking actions that cause less profitable customers to change their behavior so that they become more profitable.  The theory is that if the business is successful in changing customer behavior, the profits go up.  If they are unsuccessful, the customer gets angry and takes his business elsewhere – which effectively prunes the customer base and permits the business to focus on its more profitable buyers.

Examples of throttling are all around us.  Netflix, the leading DVD rental-by-mail company, admits to giving priority to customers who use the service less frequently than those that are active renters.  Because the company charges a fixed monthly price for its services, the occasional renter is at risk of canceling their contract because their price per rental ends up being high.  Netflix, therefore, wants the occasional renter’s experience to be extremely positive to enhance the value. By the same token, they want to make it more difficult for the frequent renter because if they rent less frequently, Netflix’s costs go down.  So, if a frequent and an infrequent renter both want the same recent hit movie, guess who gets it first?

Banks use high fees for out-of-network ATM access, low account balances, NSF checks and a variety of other customer behaviors the bank wants to change.  Wal-Mart and other stores selling clothing have instituted re-stocking fees on returns to change customer behavior about buying several items of clothing with the intent of subsequently returning some of them.  FedEx cuts off services if an account becomes more than 14 days delinquent.

We recently worked with a law firm to assist them in identifying their least profitable clients and to consider whether some form of throttling could be used to change the clients’ behavior.  It was an interesting exercise.

We started by identifying those clients we considered to be low profit.  There were so many variables and justifications for lower-than-average profitability that we decided to construct profiles of types of clients that typically were under-profitable.  We were able to use the firm’s data warehousing system to identify a profile of clients that represented below average profitability.

Low Profit Clients
The statistical information bore out what we already knew, but it was nice to have the confirmation.  The least profitable clients were:

  • Clients who took more than 90 days to pay
  • Clients whose bills were typically written down by more than 10%
  • Clients whose average standard hourly rate was more than 10% below the firm-wide average
  • Clients with a large number of small matters charged on an hourly rate basis, e.g., slip and fall defense for a big box retailer
  • Clients with annual billings of less than $25,000

In the process of assembling this information, we discovered two additional pieces of interesting information.  First, there was a correlative relationship among the least profitable clients.  That is, clients whose annual billings were under $25,000 had an extremely high correlation with over 90 day receivables, high write-downs at billing and below average hourly rates.  Clients that displayed one of the hallmarks of less profitable clients tended to display one or two – or even all – of the indices.  The second discovery is that clients with annual billings of under $25,000 made up half of the firms client base – but only 7% of the firm’s revenue.

So, we found that unprofitable clients are generally unprofitable from multiple sources (what we came to call “bad to the bone”) and the amount of revenue at risk, if we addressed the problem, was relatively small.  Because these were low margin clients, the profit at risk was even smaller.

We went about attempting to create economic actions that would cause the low profit clients to change their behavior or take their work elsewhere.  It was not lost on us that some of the profitability issues involved causing partners to change their behavior, but the principle remained the same.

The specific throttles the firm elected to use are, of course, proprietary to that firm but one good generic example is delinquent receivables.  The management of unbilled time (WIP) and accounts receivable (AR) is ignored in many firms until the end of the year.  The theory is that this is strictly a timing issue and the only loss to the firm is the time-value of the money.  In fact, this is a legitimate profitability problem because aging of receivables directly affects the likelihood of their eventual collection.  Using the firm’s data warehousing software (Redwood Analytics – a really cool program) we were able to track the collectability percentage of receivables at various ages (we asked, for example, when a receivable reached a certain age, what was the percentage likelihood that it would ever be collected? )  What this revealed was that at 90 days only 78% of receivables would ever be collected, and at 120 days that drops by about 8% every 30 days.

Throttling-1
The firm had always told itself that the value of uncollectible accounts was about 5% of revenue.  In fact, when the firm looked at its revenues with a reasonable reserve for uncollected accounts based on the information that Redwood gave us, the real write-off level was best expressed as zero for the 20 percent of its clients that make up 80 percent of its revenue, and close to 25 percent for the 80 percent of its clients that make up less than 20 percent of the revenue.

The traditional attitude of this firm had been that receivables were the problem of the attorney responsible for the client relationship and, if enough embarrassment, financial penalties and management harassment could be heaped upon that attorney, the attorney would take care of collecting the receivable.  There is no profession, other than law, where the professional takes on the role of debt collector.  Here, we decided that to effectively throttle the client, it was necessary to remove the responsible attorney from the process.  We concluded, through experience, that usury laws make charging interest difficult and clients will often ignore the interest anticipating that most law firms will not aggressively follow-up when the fee portion has finally been paid.

We decided that non-economic throttles would be most effective for slow paying clients.  For clients with a history of holding bills for more than 30 days, receivable follow-up was taken away from the billing attorney and an in-house collector would frequently call the clients.  On the 61st day the client was advised that the firm could no long work on the current matter until payment was made.

One of the difficulties with attempting to management the behavior of clients (indeed, in implementing any kind of initiative involving clients) is the immediate and predictably negative response from the lawyers responsible for those clients.  The firm prepared itself for the predicted three responses from the attorneys responsible for the clients:

Attorney: “We’ll lose a good client.”   Management response: “Good — clients who don’t pay their bills are not good clients.”
Attorney: “We can’t withdraw without court approval.”  Management response: “Apply to the court with a copy to the client. If the court says no, so be it.”
Attorney: “The client will sue us for malpractice.”  Management response:  “We’re better off knowing that while the receivable is still relatively small.”

The result was an incredible speed up of the payment cycle and the loss of less than 15% of the client base totaling under one-half of one percent of firm revenue.

I’m sorry I can’t brief you on some of the ingenious throttles we came up with for billing rates.  But the point is that a good brainstorming session at an executive committee meeting can result in some inspired and extremely functional means of adjusting client behavior.