LegalBizDev

The latest post from Jim Hassett’s blog Legal Business Development.


Book excerpt: The challenge of measuring law firm profitability (Part 1 of 3)

This series was adapted from my new book Client Value and Law Firm Profitability.

Based on our confidential interviews with managing partners and other leaders from 50 AmLaw 200 firms, there can be no question thatclients are demanding more value than ever before, and it is putting pressure on the bottom line.  There is, however, much less agreement about the best way to measure the bottom line.  Earlier in this chapter, we discussed the many problems of relying on profits per equity partner, realization, leverage and other traditional measures.  So it may seem obvious that the way out of all this confusion is to move toward the approach used in almost every other business: applying cost accounting to measure profit. The basic formula looks deceptively simple:

Profit = Revenue – Cost

Cost accounting establishes rules for defining both revenue and costs, but it’s not as simple as non-CPAs might think.

Before we started working with law firms, my company spent almost 20 years developing training programs for financial services clients and for government agencies. Many of the government contracts we worked under were “cost plus,” in which an hour of a person’s time must be billed at its “true cost,”—as defined by many pages of government accounting rules—plus a negotiated fixed fee.  (In our experience, the negotiated fixed fee on government contracts was typically between three and five percent of cost, which seems laughable by the standards of many law firms.)  So you’d think that if anyone could identify the true cost of labor, it would be a government contractor.

But we gradually learned that government contractors have a number of options for calculating both the direct cost of what a person is paid per hour and allocating the indirect costs of benefits, rent, general and administrative overhead, and so on, to different groups within the company. So there was no single number for the “true cost” of a particular hour of labor, despite all the rules and regulations. The answer depended on a number of assumptions and interpretations.

Still, many law firms see cost accounting measurement of profit as the Holy Grail, with potential benefits to both themselves and their clients. As ACC Value Co-Chair Michael Roster has summed it up:

Once a firm or practice group shifts to a true profitability set of measurements, the firm finally has incentives to:

  • Keep reducing its cost of production—meaning moving matters to those with appropriate expertise while lowering leverage and hourly rates, where hourly rates are now used to monitor the cost of production, not how to maximize what can be billed
  • Measure and deliver better outcomes and be rewarded for that
  • Learn how to fix the cost of any given type of work
  • Along the way, improve profitability

However, in one leading text on law firm accounting, CPA John Iezzi explained that in working with law firms, he learned that this is much, much harder than it sounds:

My first article [on law firm profitability was]… written in 1975… after I had recently left public accounting, convinced that one could apply the same cost-accounting techniques to the service profession as one did to any other industry. [However], this was not the case, as I later determined once I began attempting to apply various cost-accounting practices to the legal profession.

The result for many firms is that, as one managing partner admitted:

We struggle with a standard profitability model, and we don’t really have one right now.

Another managing partner pointed out the underlying problem:

There’s really more art than science as to what you count as revenue, and similarly what the cost allocations are going to be. Lawyers will debate all day long about those things. So it’s important to have uniform or reasonably well-accepted best practices for profitability analysis. I don’t think our practice is there yet.

As far as we can tell, neither is anyone else. When I talked to several members of our Research Advisory Board about this, Don Ware, chair of Foley Hoag’s Intellectual Property Department, said:

I’ve never heard of a law firm that has a good way to measure matter profitability. Many say they do, but when you push on the details it becomes clear that they really don’t.

This is not for lack of trying. A growing number of software programs are available to handle the calculations. The two long-time leaders in the field—Intellistat Analytics from Data Fusion and Redwood Analytics from Aderant—have been providing sophisticated tools to quantify law firm profitability for several decades. But to use these tools, one must make a series of assumptions, and that’s where the trouble starts.

A slightly edited version of this series was published in the October 2014 issue of Of Counsel:  The Legal and Management Report by Aspen publishers.  The complete article can be downloaded from our web page

      


What clients want: New results from Altman Weil’s 2014 CLO survey

Question:  What is the single most important topic for law firms to focus on in today’s increasingly challenging environment?

Answer:  Whatever clients want.

Of course, different clients want different things, so lawyers should start by improving the dialog with their own clients.  There are a variety of free resources on the web to help structure these conversations, including a list of questions from the Association of Corporate Counsel and my posts several years ago in this blog entitled Value questions to ask your top clients

For those who want the big picture on client trends, there is no better source than the Chief Legal Officer Survey which Altman Weil has been publishing for the last 15 years.  (Full disclosure: LegalBizDev is a strategic alliance partner of Altman Weil, but I would have written exactly this same post even if we had no relationship with them.) 

When the 2014 survey was released yesterday by author Daniel J. DiLucchio, the first question I turned to was on page 27: “Of the following service improvements and innovations, please select the three that you would most like to see from your outside counsel.”  The answers from 186 CLOs were greater cost reduction (58%), more efficient project management (57%) and improved budget forecasting (57%). 

Since better legal project management (LPM) leads to cost reductions and to improved budget forecasting, you could say that the top three client requests were LPM, LPM, and more LPM.  Interestingly, these same three issues were at the top of the list in Altman Weil’s CLO survey last year although this year the percentages were a few points higher.

The main conclusion of this year’s report was that “corporate law departments are wielding their buying power to drive down expenditures on outside counsel” (page i.)

The survey included a number of questions related to cost reduction, starting with the fact that 91% of the law departments in this survey received price reductions from outside counsel in the last12 months.  The median discount – or halfway point -- remained in the 6% to 10% range, just where it was in the 2013 survey.  But for those above the median, the percent of law departments that got discounts over 10% increased substantially in the last year (from 28% to 36%).

The summary also noted that “The survey asked about preferences for outside counsel pricing on work other than ‘bet the company’ matters. Thirty-seven percent of CLOs said they prefer transparent pricing in which they understand how and why the price is set and have the opportunity to discuss changes. Twenty-seven percent chose guaranteed pricing, and 26% opted for value-based pricing, defined as a variable price based on the CLO’s assessment of value received. Only 10% of respondents said they wanted the lowest price available.  Initially it may seem that law departments just want to pay less for outside counsel. But these results show it’s more complicated.” (page ii)

I respectfully disagree with this interpretation.  I don’t think it’s that complicated at all.

Cost is certainly not the only element in value, but it is by far the biggest one.  In our recent research on Client Value and Law Firm Profitability, when we asked, “When your clients ask for more value, roughly what percent of the time are they simply asking for a lower price,” the average response was 63%. In other words, nearly two-thirds of the time, “value” is nothing more than a request to pay less and all other interpretations pale by comparison. 

In our experience, all of the pricing approaches mentioned in the Altman Weil survey – transparent, guaranteed, and value-based – are not alternatives to lower prices, they are usually part of a larger negotiation to reduce price.  Soon after clients ask for transparent pricing, the next thing that happens is that they point to line by line examples of ways to cut the price.  When they want a guaranteed price, it may come as a result of a reverse auction in which all bidders are required to guarantee a price, and the lowest price wins.  And when clients look for “value pricing,” somehow that almost always seems to mean “give us more for less.” 

Meanwhile, the demand for outside counsel is going down (26% plan to decrease the use of outside counsel while only 14% plan to increase it), placing still more downward pressure on prices.

What are firms doing in this increasingly cutthroat environment?  Some are burying their heads in the sand in the hope that the good old days will return.  Some are giving bigger and bigger hourly discounts in the kind of “suicide pricing” that Bruce MacEwen has described as unsustainable in his book Growth is Dead. And some are getting serious about increasing efficiency and cost-effectiveness through LPM, so they can deliver the same quality at a lower cost in hours and dollars.

Which approach makes sense to you?

      


Tip of the month: Embrace experimentation aimed at quick wins and developing champions, one practice group or one lawyer at a time

Lawyers love precedent, and many law firm committees are postponing action until they see evidence proving the value of a “one size fits all” perfect solution that will fit their entire firm.  But there is no silver bullet, and firms that continue to look for it could go out of business while they wait. The key to success is, as Stuart J.T. Dodds put it in his book Smarter Pricing, Smarter Profit, to “think big and start small.” 

The first Wednesday of every month is devoted to a short and simple tip to help lawyers increase efficiency, provide greater value to their clients and/or develop new business. This month’s tip is explained in detail in Chapter 7 of my new book Client Value and Law Firm Profitability.

      


Business development best practices: Follow up

This is one of a series of occasional posts summarizing the most important best practices from my book the Legal Business Development Quick Reference Guide which is now also available in a Kindle edition.

There’s no way around it: business development takes time. To build new business, you must follow up, week after week, month after month, and year after year.

In The Sales Bible (p. 197) Jeffrey Gitomer sums it up this way:

Most sales are made after the seventh no…It takes 5 to 10 exposures (follow-ups) to a prospect to make the first sale…[so] you’d better have what it takes to persevere through the follow-up process and not quit.

For many busy lawyers, the best way to assure that you will follow up is to “make an appointment with yourself” for one or two blocks of time that will be devoted to business development every week, such as 2-4 PM every Tuesday and Thursday. Put the time in Outlook or your weekly planner, and try to avoid scheduling anything else at that time. When something comes up that is more critical, as is sometimes inevitable, reschedule your marketing time.

We recommend setting this time block in the middle of the week, at a time when you are likely to be able to reach clients and prospects. If you think Mondays and Fridays are the best times to discuss new business with your clients, try it, track the results, and then decide.

It also helps to share your results with a colleague, a coach, or even a relative or friend. Simply knowing that someone else is watching will make you more likely to follow up.

Finally, you will need a good system for tracking To Dos.  Different lawyers prefer different approaches, and the best format is the one that contains the information you need, in a form that you will keep up to date.  My favorite is a simple list with three columns like this:

Who

Priority

To Do

Tom French

High

Hold telecon, based on key questions from the Quick Reference Guide 

COO at ABC Corp

High

If COO provides info for press release, finish a draft ASAP

Ms. Johanssen

Medium

Send agenda listing questions for the next meeting

Mary K.

Medium

Hold satisfaction interview

Tom S

Low

Call to set up a meeting

Falco Inc

Low

Meet in early June

This type of overt prioritizing will help you assure that if something simply doesn’t get done due to lack of time, it is likely to be the item that will have the least impact on the future of your practice.

Or better yet, use Outlook or any other program to keep your list.

And then don’t forget to actually follow up.  Week after week, month after month, and year after year.

      


Book excerpt: What should law firms do to improve profitability and LPM? (Part 4 of 4)

This series was adapted from my new book Client Value and Law Firm Profitability, which was published at the beginning of this month.

Given all the options and competing claims about LPM, what should a firm do to get started? Our answer is explained below at the end of this book: embrace experimentation and, as one of our clients put it, “just do something.” Start small, and find out what works for your firm.

Once you have grassroots support from influential internal champions, then you will be in a position to decide whether you might benefit from professional project management staff, depending on the unique needs of your practice area and your clients.

Remember that in this study’s ranking of LPM issues in Chapter 4, the two most critical were defining scope and communicating with clients. Neither can be delegated to project managers. Lawyers must first be committed to changing their approach before it makes sense to hire others to help them.

The big picture recommendations in the next section about starting “one practice group or lawyer at a time” include evidence that the development of internal champions and quick wins has proven its value in changing behavior in a wide variety of professions. So it is not surprising that a number of participants in this research cited the same approach:

I try to find an internal champion to move things forward. I worked with a partner in one department that bought into LPM and we gave a joint presentation on it. Word got out and another department asked to provide the same presentation to them. Many times once attorneys get a taste of LPM they get interested and want more. – Senior executive

We’ll have to have to have some guinea pig partners who are willing to try it and then be willing to testify as to how it has helped their numbers and their client relationships. – Senior partner

Because we’ve had some demonstrable LPM successes, enthusiasm for it is growing. – Senior executive

However, even with the support of champions, LPM is not quick or easy to implement. As one senior partner emphasized, there are no magic solutions:

Top management has to make it a priority and communicate it all the time, make it part of the culture. It will have to be ingrained in people, and it’s slow. When people use the tools and the resources, and they are successful, they will communicate their success to their partners. Others will want to use it, and LPM will work its way around. But that will take some time. We don’t know exactly how long it will take.

Some firms will find it valuable to hire professional project managers to support lawyers’ efforts, as in this quote from one chair:

We’re going to start hiring different people to manage the non-legal aspects of the practice, not the relationships. That’s what has to be done. Lawyers are notoriously bad managers. You could be a fabulous trial lawyer but not be able to get your hours in on time or bill on time. You might not be able to collect on the bill. With all these different components, it’s better to look to a project manager on accounts receivable, on AFAs, on collections, rather than the lawyer.

Another firm chair that has gone down this path has been very satisfied with the results:

I think that project management skills are absolutely critical to achieving value and managing well, which is why we have people who actually make this their life’s calling. People who are certified project managers, who are trained in it, who actually know what it means when you talk about Agile Scrum, as opposed to somebody thinking it’s a flexible rugby player. Project management is a profession, and the people in the profession need to understand how the legal business works, how lawyers think. How you would manage a project at IBM is not the same way you would manage a project in a large law firm. But when we have good project managers working as part of the client service delivery team with the clients, clients love it. They just love it. It adds so much value, it’s unbelievable.

(Agile Scrum is an approach to project management that starts from the assumption that customers often change their minds about what they want and need as a project proceeds. It therefore replaces extended upfront planning with rapid development of partial solutions which can be tried out on clients and adapted until they meet true needs. Many professionals believe that this will become an increasingly common approach to LPM as it evolves.)

There can be little doubt that the trend of using LPM professionals will continue to grow, especially in large firms. It is also safe to predict that the level of LPM sophistication needed to compete effectively will continue to increase.

In the next few years, the most interesting developments in LPM are likely to involve moving away from traditional project management models to cutting edge alternatives. For example, in one of the most widely quoted texts on LPM, Robert Wysocki talks at length about how traditional project management solutions apply only when the client’s goal is clear and the steps required for a solution are clear. In many legal matters, neither precise client goals nor complete solutions are known at the start. These complex and ambiguous situations will therefore require the more modern LPM approaches explained in Wysocki’s text, notably Agile project management that is derived from the “Agile Manifesto” signed in 2001 by 17 influential software developers and says in part:

We are uncovering better ways of developing [products] by doing it and helping others do it. Through this work we have come to value:

  • Individuals and interactions over processes and tools
  • Working software over comprehensive documentation
  • Customer collaboration over contract negotiations
  • Responding to change over following a plan

That is, while there is value in the items on the right, we value the items on the left more.

Agile project management is an iterative trial and error process that focuses on continuous improvement and responding rapidly to situations when they change in order to minimize the total work required.

But before firms can get to that level of sophistication, they need to start with the basics. And as one chairman in our research summed it up:

Most of our clients are no better at understanding or applying legal project management than we are. But in the future, the fact that you can actually do something on time and within budget is going to become an important indicator of whether or not you really are a good lawyer.

A pdf of this entire series can be downloaded from Altman Weil Direct, where it originally appeared.

 
      



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