The latest post from Jim Hassett’s blog Legal Business Development.
Altman Weil has done it again. Every spring they publish the most important survey of the year, and the 2015 Law Firms in Transition Survey they released last week is more thought provoking than ever. (Full disclosure: LegalBizDev is a strategic partner of Altman Weil, but I’d write this blog post even if we weren’t.)
Their 124 page report can be downloaded for free and summarizes the opinions of 320 managing partners and chairs on topics ranging from leadership to market forces. I turned right to the section entitled “Efficiency of legal service delivery” and found data unlike anything I’d seen before.
For the last seven years, Altman Weil has found that the vast majority of law firm leaders say that there has been a permanent change in the legal profession increasing the focus on practice efficiency (this year 93%). On the other hand, their surveys have consistently found that only a minority of firms are doing anything about it (37% of firms said that they had “significantly changed their strategic approach to the efficiency of legal service delivery”).
What’s new this year is data correlating this strategic change to financial results to suggest that firms benefit financially by becoming more efficient. This can best be seen in profits per equity partner (up for 76% of firms that changed their approach to efficiency vs 61% of those that didn’t) and revenue per lawyer (up for 76% of firms that changed vs 62% of firms that didn’t).
While there is a great deal of anecdotal evidence that legal project management (LPM) improves financial results, this is the first national survey data verifying the link.
Similar results were found in this year’s data on AFAs. Altman Weil reported that 68% of the firms that used non-hourly billing described it as “primarily reactive (in response to client requests),” while only 32% said it was “primarily proactive (arising from your belief in the competitive advantage of alternative fees).” Interestingly, when the profitability of AFAs was compared to hourly work, the proactive firms were far more likely to say they were more profitable (29% vs 10%) and less likely to say they were less profitable (12% vs 41%). Proactive firms have also been getting better at it. When this question was first asked in 2010 only 17% of proactive firms said AFAs were more profitable than hourly work, compared to 29% this year.
While the survey did not directly ask why profitability was improving, there are only two possible answers: either matters are being priced better at the outset, or the work is being performed more efficiently within budget. We have no doubt that both are true for proactive firms. And given the intense competition that is often driving prices below desired levels, our guess is that LPM was the more important of the two.
As a reformed academic, I feel it is necessary to add two caveats to our claims about LPM and profitability. The first is that there is still some controversy about exactly how to define LPM, and our statements above apply to the broad definition we use, as described in my book LPM, Pricing, and AFAs. When Altman Weil asked firms how they were increasing efficiency, seven of the eight factors they mentioned come up routinely in our LPM coaching: technology, knowledge management, training, contract lawyers, paraprofessionals, using non-law firm vendors, and re-engineering work processes. (The eighth efficiency factor is usually not involved in our coaching, but is extremely interesting: an amazing 49% of firms now say that they are “rewarding efficiency and profitability in compensation decisions.”)
The second caveat could come from my brother the mathemetician, who likes to remind me that a correlation does not prove causality. Of course, technically he’s right. But if I were a managing partner in this highly competitive profession, I would not wait for a long term double blind experiment to prove that the link was cause and effect. I would just start promoting greater efficiency through LPM, and see for myself if it seemed to improve my bottom line.
Another thing managing partners will want to do is to improve efforts to understand client needs. I found it quite interesting that of the ten tactics to improve client understanding in this survey, post-matter reviews came in dead last at 24%. In our LPM coaching, this is often one of the first things we recommend, since it is so revealing of how clients feel about your work, and can be as simple as asking “what did we do well” and “what could we do better.” (For a review of more sophisticated techniques, see the third edition of my Legal Project Management Quick Reference Guide.) But in this survey, post-matter reviews finished far behind other tactics that are extremely useful, but far more difficult and expensive to implement such as participating in client industry groups (75%) and formal client interview programs (49%).
I was also interested to note that 61% of firms said that overcapacity is diluting their profitability. Equity partners in 47% of the firms, and non-equity partners in 41%, simply need more work. That’s one of the most common reasons behind what Bruce MacEwen has described as “suicide pricing” in his book Growth is Dead: “Bids from name-brand firms… that are so breathtakingly low one wonders how they could possibly make any money. The short answer is they can’t.” As the chair of one AmLaw 200 firm put it in my book Client Value and Law Firm Profitability (p. 80) “Lawyers will look at a case and say ‘I know you don’t want to get 70% realization on a $200,000 matter. But 70% of $200,000 is a whole lot better than 100% of nothing.”
There’s a whole lot more to be learned from this survey beyond the core topics of this blog. So if you have any interest in how the legal profession is changing, I would strongly recommend that you download your own copy today.
If you don’t find it useful I’ll send you double your money back. Oh wait. It’s free.
A guest post by Gary Richards
Talented lawyers are sometimes bypassed for future assignments because they slipped a little on work that was delegated to them in the past. Partners may sometimes solve the problem by deciding to not put them on future assignments rather than giving them corrective feedback from which they could benefit.
For example, consider the following scenario: You have a competent set of lawyers and paralegals working with you on an important matter. However, one of the more legally talented members of the team has recently been coming in late with assigned tasks, or has not done it exactly as assigned, or both.
He always seems to understand exactly what you want when he accepts the task. After handing off a task, you always seek confirmation that he understands by asking questions like, “Do you have any questions?” or “Do you understand exactly what I want and when?” He always assures you that he has “got it.” Yet there is a recent pattern of incompleteness and lateness you would like to avoid in the future.
You are reluctant to complain to him because you know that he is quite busy working on other matters for other partners. By and large, his work quality is good and clients like him. You also don’t want to seem dictatorial when you hand off work for fear of insulting him or demotivating him, because you could really use his help if only he were accurate and timely.
However, unless this situation improves, you are considering not assigning him to any future work that is deadline-sensitive or has nuanced issues requiring significant attention to detail. That way you would save time dealing with his performance problem and wouldn’t have to waste your time coaching him on how to improve. You believe that any intelligent and experienced matter team members should do what he says he will do, on time. After all, you don’t recall anyone ever having to pressure you to correct your lack of detail or timeliness.
This is a fairly common situation. Unfortunately, deciding to save time by not assigning him to future matters is also fairly common. But it is a costly and shortsighted solution to deprive the offending lawyer of needed coaching. Furthermore, taking that approach would mean failing your responsibility as a partner to provide professional development of those working on your team.
The tension in this situation stems from your natural preference to avoid conflict, compounded by not knowing how to ensure clarity at the moment of handoff.
A better solution is grounded in two simple concepts: tactfully require people to repeat your instructions, and schedule a mid-point review.
Tactfully require people to repeat your instructions
When you encounter a performance problem like the one above, the best first step is not to ask “What is wrong with him?” Instead, ask “What can I do differently?” The truth is that getting work done on time, as expected, is usually much more dependent on how the work is handed off and monitored than it is affected by a flaw in the recipient.
The usual solution to this situation is to do a better job finding out exactly what he actually understands to be required and by when, no matter how well you think you have presented it. Simply asking a question like these will not uncover true understanding:
Even if they are less than certain of the details, most people are not comfortable admitting that they are unclear or confused, especially if you outrank them. So those kinds of questions usually do not learn what it is they actually understand.
He may even demonstrate rapt listening and industrious note taking as you describe what you want, all creating the illusion of clear understanding even though some details may be missed. It is likely that the listener believes that he does understand it, because he is clear on what he thinks that he heard.
There is only one way to know for sure what he understand: Have him immediately repeat his understanding of your instructions so that you can compare what he says to your intended instructions. Such a request to repeat instructions received is rarely made because it could be taken as an insult to his ability or a veiled accusation of inattention. But there is a skillful way to request that instructions be repeated without being insulting or accusatory: Format the question as an “I” message, not as a “you” message.
Faulty way to request feedback of instructions (insulting and accusatory “you” message):
Effective way to request feedback of instructions (non-insulting and non-accusatory “I”):
As you listen to his repetition of your instructions, you can compare it with what you intended. In effect, this way you are comparing what is in his brain to what is in your brain. If you hear an omission or misunderstanding, you can immediately say, “What I meant to say was…” and provide the correction, possibly rephrasing it more clearly or in a different way to highlight its importance. It doesn't matter whether you did say it correctly the first time or not. What does matter instead is to correct the misunderstanding immediately, not to assign blame for the misunderstanding by saying something like, “No, you have it wrong.”
Schedule a mid-point review
Once it is established that the instructions are understood, the next thing to help ensure performance is to schedule a follow-up midway through the duration of the task. You have a right, even an obligation, to follow up to ensure that the work is on schedule, especially if there have been past problems with timely performance. Get agreement at the time of hand-off as to when you will follow up midway, and why. Unscheduled follow-ups like, “How are you doing on….” will appear that you don’t trust him. Also, he may have work appropriately scheduled on the task at a time closer to the deadline than when your surprise follow-up occurs, causing your question to be an unfair irritation that results in no information.
Instead, it is much better at the time the task is handed off to schedule a time-certain mid-point follow up. For example, if you hand-off a task on Wednesday and the deadline for completion is the following Tuesday by noon, say something like this: “How about I touch base around 10:30 A.M. Friday to be sure that you have everything you need and see if there are any questions?”
When a mid-point follow-up time like that is agreed upon, several things are put into play:
These two simple tactics can solve delegation problems, save you time by avoiding performance problems, and fulfill your obligation to constructively develop the skills of those working on your teams.
To provide clients with the value they are demanding, you may need to devote more time to actively managing the members of your team. Start with these questions:
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. More information about this tip appears in the third edition of my Legal Project Management Quick Reference Guide.
Law firms’ problems measuring profitability cannot be attributed to 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.
At the 2014 LMA P3 conference, Jeff Suhr, vice president of products at Data Fusion, noted that his company had 91 clients actively using their tools, including 10 of the top 35 AmLaw firms (Jeff Suhr, “Best Practices in Leveraging Profitability Analysis to Better Price, Staff and Manage New Engagements,” presentation at the LMA P3 conference, Chicago, May 13, 2014). Exactly how did 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. John Iezzi’s Results-Oriented Financial Management: A Step-by-Step Guide to Law Firm Profitability (p. 132) noted that:
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 my LegalBizDev Survey of Alternative Fees (p. 118), one AmLaw 100 decision maker told us that:
As one chair in this research put it:
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:
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:
The questions go on and on, and they raise the kind of awkward issues that sow resentments and dissension. As one partner interviewed for Michael Roster’s article noted:
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:
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, Jonathan Groner contributed to my research by interviewing 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:
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:
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 in Results-Oriented Financial Management: A Step-by-Step Guide to Law Firm Profitability (p. 145):
Jeff Suhr made a similar point more succinctly:
And as one managing partner in this study summed it up:
Many participants, like this senior executive, think that the cure is worse than the disease and that firms should stick to more traditional measures:
The profession may never find the perfect solution that some lawyers seem to want. But it is absolutely clear that firms which want to survive and prosper in the current environment must find an answer that fits their culture and allows them to clearly distinguish between the matters that make money and the matters that lose it.
This series is an excerpt from my book Client Value and Law Firm Profitability. An edited and abridged version of this series appeared in the March 2015 issue of MP magazine. The MP article can bedownloaded from our web page.
Challenge #5 The problem with leverage
As Toby Brown and Vincent Cordo explain in the book Law Firm Pricing: Strategies, Roles, and Responsibilities (p. 18):
Software programs that are designed to help lawyers bid in a way that maximizes profitability often do so by encouraging partners to push more work down to associates.
This concept is tied to the “old normal” pyramid model of profit, in which it was assumed that clients would have all their work performed on an hourly basis and would generally pay all their bills. But the legal world has changed to a “new normal” in which these assumptions are often incorrect.
For example, in a fixed price environment, efficiency is king and leverage can lead to higher costs and more unbilled time. Suppose a $1,000-per-hour senior partner can solve a problem in one hour, but a $300-per-hour associate will require 10 hours to come to the same solution. If the firm is paid the same fixed fee regardless of who does the work, it is obvious that solving the problem at the unleveraged partner “cost” of $1,000 is more profitable than at the leveraged associate cost of $3,000. (Of course, billable rates are a very approximate indicator of cost, but they are used here to keep this example simple.)
The result has been an award winning and highly profitable organization that Bartlit describes in the same article as:
One member of our Research Advisory Board summed up this view:
At this moment in time, the role of leverage in profitability depends on the client and the fee arrangement. For clients on a fixed fee basis or for hourly clients who refuse to pay portions of their bills due to inefficiency, greater leverage may decrease profit. If you have hourly clients who don’t question their bills and pay in full, greater leverage will still produce more profit. But it seems reasonable to ask how long this will continue.
Challenge #6 Problems applying cost accounting
The obvious 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:
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. (Note: 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.
Many law firms see cost accounting as the Holy Grail, with potential benefits to both themselves and their clients. As ACC Value Co-Chair Michael Roster summed it up in an article entitled “Facing Up to the Challenge: Law Firm Metrics”:
However, in the widely quoted text Results-Oriented Financial Management: A Step-by-Step Guide to Law Firm Profitability, CPA John Iezzi explained that in working with law firms, he learned that this is much, much harder than it sounds:
The result for many firms is that, as one managing partner in my research admitted:
Another managing partner pointed out the underlying problem:
In the final part of this series, we will describe what firms doing to get closer to this goal.
This series is an excerpt from my book Client Value and Law Firm Profitability . An edited and abridged version of this series appeared in the March 2015 issue of MP magazine. The MP article can be downloaded from our web page.