LegalBizDev

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


Bloomberg interview regarding my new book (Part 1 of 2)

This interview originally appeared in Bloomberg BNA’s Corporate Counsel Weekly.  A pdf of the complete interview can be downloaded from our web page.

Bloomberg BNA: Tell us about your new book Client Value and Law Firm Profitability – what was your goal and who did you talk to?

Jim Hassett: In the last few years, millions of words have been written by law school professors and consultants about how the demands of the clients of major law firms are changing and what law firms should do about it.

The only thing that’s been missing from the conversation is statements by the people who actually run large law firms. These senior decision makers deal with these issues every day, and their very livelihood depends on coming up with the right answers. I wanted to hear their honest opinions about these highly sensitive issues but knew they could not speak openly if they were quoted by name, so I devised a research approach built around anonymity. I conducted every interview myself, and promised that while firm names would be listed in the report, the name of every individual I interviewed would remain confidential and no quote would be linked to a particular person or firm.

Leaders from 50 of the AmLaw 200 agreed to speak with me for this book. Forty-two percent were managing partners or chairs, and the remainder were senior partners and staff, including CEOs, COOs, and CFOs. They were indeed unusually frank in their responses, including the AmLaw 200 chairman who said that “Lawyers are about as dumb as you could possibly be about understanding how our product is made. The lawyers who understand how to make it and who can manage that process efficiently are going to be the winners.”

They also spoke freely about both problems and solutions, like the managing partner who noted that “I have a $10 million practice. But that could be a disaster for a firm, because it could cost them $11 million to get $10 million. But nobody ever talks about it that way.”

Bloomberg BNA: What was your most surprising finding?

Jim Hassett: While almost everyone agreed that client demands for greater value and lower fees have been putting pressure on law firm profits, firms were remarkably inconsistent about how they measure profits. When I asked, “If you compare profitability for two lawyers in your firm, is there a software program or formula used to calculate profitability or is the comparison more intuitive?” a surprising 26% said there was no such formula or program and that the answer was intuitive. For the other 74%, definitions and formulas varied widely, including total revenue, profits per equity partner, leverage, several different types of realization, and a variety of approaches to cost accounting.

To dig more deeply into this important issue, we conducted follow-up interviews with industry leaders from firms that sell software to analyze law firm profitability. Jeff Suhr, a VP at Intellistat/Data Fusion, reported that his company currently has 91 clients actively using their tools. How do they calculate profitability? Ninety-one different ways. The fundamentals are basically the same, but there are important differences in the assumptions and details. These differences can have significant implications for the way profitability is interpreted and can affect the way in which the figures are used to motivate lawyers to change their behavior so that they can better meet client needs in a way that can be sustained.

Bloomberg BNA: What are law firms doing to protect the bottom line?

Jim Hassett: They are trying lots of things, with mixed success. According to our data, the two most effective ways of protecting profitability are quite new to the legal profession: legal project management (LPM), and new staff positions in such areas as pricing, value, and LPM.

Other tactics have led to more mixed results, including relying on new technology, knowledge management (KM), and contract attorneys and outsourcing. The book includes many quotes from proponents saying that technology, KM, and outsourcing were the most valuable steps they took, and from others who said that they were a waste of time and money. These differences of opinion can be traced both to the different needs of different firms and to the details of how they tried to implement change in each of these areas.

Bloomberg BNA: Lots of people seem to agree that legal project management is important, but what exactly does it include?

Jim Hassett: That is an excellent question. The field is so new that experts disagree about what should be included and excluded from the concept. This has slowed progress, as seen in the remarks of one senior executive who noted: “We were just at a board meeting last week where we were talking about whether we should do formalized project management training. My answer to that is obviously yes, we absolutely should. But first we need to agree on what legal project management is.”

In my book Legal Project Management, Pricing and Alternative Fee Arrangements, I reviewed the short history of this movement and proposed the broad definition we use in our coaching, our training, and this research: “Legal project management adapts proven management techniques to the legal profession to help lawyers achieve their business goals, including increasing client value and protecting profitability.”

This broad definition includes everything from budgeting and communication to process improvement, knowledge management, and personal time management. We believe splitting hairs over what is and is not LPM is just another excuse to avoid action. Law firms need to move as quickly as possible to the real problem: What must we do today to meet client needs while remaining profitable and competitive?

Bloomberg BNA: Where is the pressure for LPM coming from?

Jim Hassett: From clients. One of the best sources of information about client demands is 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.) One key question in the 2014 survey, which was released in November 2014, was, “Of the following service improvements and innovations, please select the three that you would most like to see from your outside counsel.” This year’s answers from 186 CLOs were greater cost reduction (58%), more efficient project management (57%), and improved budget forecasting (57%). Since 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. 

In business, everything starts with meeting client needs. But lawyers who understand LPM and apply it to their practice are still a tiny minority. As one senior executive put it: “One of the problems that we have, and frankly that most firms have, is just teaching lawyers how to manage a project, getting them out of the habit of just automatically starting out with some rote process. Just because the client says, ‘I think I might have a lawsuit’ doesn’t mean you go off and conduct 40 depositions. Lawyers need to sit down and talk about what the client is trying to accomplish. It might turn out that we are able to accomplish the client’s end goal without taking any depositions.”

When I asked about which aspects of LPM were most critical to firms’ short-term success, it is interesting that the top two areas participants singled out were defining scope and managing client communication. These issues cannot effectively be addressed by the expensive software that so many firms see as a starting point. They require partners to change their behavior and become more efficient.

Adapted with permission from Corporate Counsel Weekly Newsletter Vol. 29, No. 48, December 10, 22014. Copyright 2014, The Bureau of National Affairs, Inc. (800-372-1033) www.bna.com.   

      


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

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

The questions about assumptions raised in Part 2 of this series go on and on, and they raise the kind of awkward issues that sow resentments and dissension. As one partner interviewed for and article by Michael Roster noted:

Many of us have long believed that the non-attorney costs of the various practice groups are wildly different. At most firms, no one wants to hear that, probably because it might open Pandora’s Box.

Some experts believe that this box should be opened, and when it is it will reveal that different practice groups can afford to charge different rates. One expert we consulted, who preferred to remain anonymous, put it this way:

Cost accounting should be kept very simple lest the lawyers argue about it forever more. That said, it should not be the same for the higher cost of production groups that need a lot of work rooms, support services, etc. (such as litigation) versus the very low cost of production groups that can work in a cubicle and only occasionally might need a conference room (such as trusts and estates). GM charges a lot less for a Chevrolet than for a Cadillac, and yet the overall Chevrolet division may be far more profitable that the overall Cadillac division.

Others disagree and feel that analyses that compare relative costs will become divisive by focusing lawyers on their short-term individual interests rather than the long-term benefits of working together. The labor and employment group may come to question the wisdom of belonging to the same firm as the M&A group that needs more expensive space. Lawyers from the Cincinnati office may begin to ask whether it is really worth having a New York office with much higher overhead.

To explore the real-world solutions that law firms are using most often, we interviewed two of the leading consultants in the field: Russ Haskin, director of consulting services at Aderant Redwood Analytics and Jeff Suhr, vice president of products at Data Fusion Technologies/Intellistat.

According to Haskin:

If a firm has hired a pricing director but does not look carefully at profitability in a sophisticated way, it is doomed to fail.

Haskin said that very few large firms do more than pay lip service to the concept of profit margin—and those that do are far ahead of the game. Among other things, they are ready to respond to AFA proposals in a way that will be profitable for them. A firm that looks at profitability in the “old” way by examining gross revenue rather than profit margin as seen at the client or engagement level is simply not equipped to respond intelligently to an AFA request.

Both consultants agreed that the key to success is to simplify assumptions, and one way to do that is to look at gross margin (revenue minus direct costs). Suhr argued that at the matter level, gross margin is a better measure than any that includes overhead because issues like office space can’t be controlled at the matter level.

Haskin suggested that to simplify the cost analysis, the firm should allocate a standard cost rate to each lawyer or group of lawyers, for all clients, like the senior partner we interviewed who said:

We have a model that takes into account cost not based upon actual draws or salary, but it takes into account junior associate, mid-level associate, senior associate, junior partner, partner, and senior partner typical costs.

At the end of the day, there is a reason why Data Fusion’s 91 clients use 91 somewhat different methods to measure profitability. Companies like Data Fusion and Aderant Redwood work with each client to come up with a consistent approach that has grass-roots support within each firm.

As John Iezzi summed it up at the end of a chapter on cost accounting:

The subject of profitability at [the matter] level is one that is very difficult to grasp for those not fully versed in cost-accounting concepts. Whatever methodology is used, it should be agreed to by a consensus of the partners so that the results are accepted once the methodology is applied.… Make certain that everyone buys into how the process is going to be done, and more importantly, why it is being done and what decisions will be made from the information once the analysis is completed.

Jeff Suhr made a similar point more succinctly:

The right way to measure profitability is one that is accepted in your firm. The art is to measure it in a way that keeps everybody happy.

And as one managing partner in this study summed it up:

You can argue all day about what the right profitability metrics are or what you’d include. We argue about it a lot.

Many participants, like this senior executive, think that the cure is worse than the disease and that firms should stick to more traditional measures:

We’ve used realization as a surrogate for profitability to this point. True profitability has been reserved for senior management analysis. We haven’t wanted lawyers arguing about indirect allocations and whether they only use 10% of a legal administrative assistant’s time versus 33%.

The profession may never find the perfect solution that some lawyers seem to want, but less than perfect estimates are absolutely essential in helping firms adapt to a rapidly changing world.

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

 
      


Tip of the month: Tie compensation to results

In 2011, I quoted managing partner Joe Morford about Tucker Ellis’ philosophy of compensation “If you pay for hours you get hours, and if you pay for results you get results.”  Since then, the vast majority of firms have done little or nothing to adapt their compensation to client demands for better results in fewer hours.  But a major step was taken a few weeks ago when Jackson Lewis announced that associates will no longer be compensated for billing more hours, and will instead be rewarded based on factors tied to results such as efficiency and client service.  Other firms are sure to follow.

 

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. The relationship between compensation and profitability is discussed in my new book Client Value and Law Firm Profitability

 
      


Book excerpt: The challenge of measuring law firm profitability (Part 2 of 3)

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

At the 2014 LMA P3 conference in Chicago, Jeff Suhr, vice president of products at Data Fusion, noted that his company currently has 91 clients actively using their tools, including 10 of the top 35 AmLaw firms. Exactly how do these 91 clients calculate profitability? Ninety-one different ways. The fundamentals are the same, but there are important differences in the details, which can have significant implications for the way profitability is interpreted and used to motivate changes in behavior.

Suhr distinguished between the relatively straightforward science of calculating profitability and the art of determining the exact methods that best fit the needs of each firm. He also discussed the different challenges of “macro strategies” for analyzing profits for a firm, an office, or a practice group, vs. “micro strategies” for analyzing a book of business or a particular matter. These sometimes require different assumptions and different approaches.

For starters, you would think it would be easy to measure the revenue associated with a matter, but it’s not. Iezzi’s text notes that:

There are three different revenue numbers you can use. One is the accrual basis revenue number, which is hours worked multiplied by hourly rate. The second is the bills rendered number. And third is the cash receipts number.

The first two numbers reflect theoretical revenue. After client write-offs and write-downs, a significant amount of this may never be received. So a profitability system based on either accrual or bills rendered rewards lawyers for putting in more hours even if they produce no revenue. This is particularly troublesome with fixed fees and other AFAs, where lawyers with too little to do may pile on the hours “since it costs nothing and could help the client relationship.” Not to mention that in many firms attorneys get paid more if they bill more hours, whether the client ever writes a check for the hours or not.

In the LegalBizDev Survey of Alternative Fees, one AmLaw 100 decision maker told us that:

It often happens that alternative fee matters, particularly large ones, end up being adumping ground for individuals who may not be fully employed because you are reportable to the client for the result, not the cost. When lawyers work unnecessarily on a project your profitability looks bad, so in order to really determine the profitability, we need to deal with that issue.

As one chair in this research put it:

What you’re trying to do internally is change the mindset of the attorney who is used to billing hours. In the past, if you billed 2,000 hours, you were better than somebody who billed 1,200 hours. But with an AFA, you have to be more efficient and more concerned with delivering the value to the client in a way that makes this a productive relationship.

That’s why the best measures of profitability must ultimately be tied to cash received. But there’s no way of knowing that figure until a matter is completed and the bills are paid. In a large firm with tens of thousands of simultaneous matters, each on their own schedule, comparisons between matters must be based on a long list of assumptions about what will happen in the future, or postponed until the end of a case, which could take years to resolve. And this can lead to arguments and gamesmanship.

One senior executive at a firm that bases compensation partly on accrual-based profitability highlighted one such problem:

We use dashboard tools including Redwood Analytics and Intellistat to track key metrics and responsibilities for each attorney as a working, billing, and originating attorney. This information is directly used in each person’s annual review and compensation setting, along with qualitative and subjective elements. They have visibility to this key information every day, and it begets a whole different sense of responsibility and accountability.

Determining cost is even harder. In order to truly determine the cost of delivering services for a particular matter, one must answer two basic questions: what was the cost of the direct labor of performing the work, and what overhead indirect costs (such as rent, clerical staff, etc.) should be allocated to that particular matter?

The problems start with how to estimate the cost of each hour of a partner’s time. If a rainmaker partner was paid $1 million last year, how much of that was her direct cost for working on legal matters vs. origination fees, payment for time spent on management, profit distribution, and other factors? A number of different systems of “notional compensation” are used to split compensation between the amount allocated to billable activity and the amount allocated to everything else. The details of how to do this could easily go on for many pages, but in this context the most important fact is that every single system includes arguable assumptions. And if there is one thing that lawyers do well, it is argue, especially if a calculation affects the way their financial results are perceived. And if matter profitability is tied to compensation and perhaps even to job stability, the debates on how to calculate these figures will rapidly get louder and more passionate.

If you think that since associates are on salary, it would be easier to calculate their direct costs, you’d be right. But even there, important decisions must be made. For example, suppose two mid-level associates earn the same $300,000 salary, but Associate A billed 2,000 hours last year and Associate B billed 1,500 hours. To keep this example relatively simple, we will ignore the cost of their health insurance and other benefits and focus strictly on salary. Some firms say that the direct cost of Associate A is $150 per hour ($300,000 divided by the 2,000 hours she billed) while Associate B is more expensive at $200 per hour ($300,000 divided by her 1,500 billable hours).

Now suppose that relationship partners are rewarded for managing matters more profitably. Of course they will try to assign more work to the busy $150 per hour associate than to the $200 per hour associate who has more time available. In this case, the attempt to measure profitability to develop a more efficient system rewards behavior that is actually likely to reduce efficiency by overworking the busiest associates.

Discussions of other aspects of overhead can also get into heated debates about such details as:

  • If one practice group heavily uses the services of the marketing department and another doesn’t, should the first group pay more marketing expenses through higher overhead?
  • If one lawyer has office space in a high-cost city like New York, and another has an office in a lower-cost city like Cincinnati, do they have different overhead rates?
  • If one lawyer in New York has a 600-square-foot office and another has a 300-square-foot office, should that be reflected in different overhead rates?
  • If one lawyer’s assistant makes more than another’s, should that be reflected in their personal overhead?

 

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. 

 
      


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

      



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