This is the second in a series on partner compensation and client profitability written by Ron Paquette, consultant with Redwood Analytics, now part of LexisNexis.  The first article, titled Client Profitability: What Is The Cost Of Partner Time?, was an introduction to the concept of allocating partner cost in calculating client profitability.  This article is focused on pitfalls of some firms' methodology in allocating costs to partners.

Some firms have chosen to exclude costs all together from billable hours worked by partners.  Generally it has been requested for one of two reasons: the firm would like to keep actual partner compensation out of the profitability model (a closed compensation system), or the firm is thinking about a P&L model where partner compensation is simply a distribution of firm profits.  While this methodology does accomplish those goals, from a client profitability perspective, it introduces its own set of issues.   

What results is a model where client profitability is maximized by only using partners to perform the billable time.  In the example below, there is a timekeeper with a 66% profit margin and two partners, both with 100% margins.  Any hour that the Associate performs for a client will in essence drag down that client’s profitability and a matter manager might be tempted to use a Partner where an Associate would suffice in an effort to ‘game’ his clients profitability.  This is contrary to the proper use of leverage and economic theory which would have the partners working on tasks for which lower level timekeepers are not qualified such as originations and the management of matters and attorneys.  For this reason alone, there needs to be some cost associated with each billable hour of a Partner’s time, if not for any other purpose than to represent the opportunity cost of them not performing these other tasks.  Besides, every firm that we have encountered expects their partners to perform a certain quantity of billable hours for their clients which would imply that some of their compensation should in fact be allocated to the client.

Role	Compensation	Std Rate	Cost Rate	Profit Margin
Rainmaker	$1MM	$250	$0	100%
Dept. Manager	$500M	$200	$0	100%
Associate	$80M	$100	($44)	66%

 

 

 

 

 

 

 

 

 

Another methodology that has been requested in an effort to support a closed compensation is what we call a fixed (or capped) partner cost.  In this scenario, every partner is given the same direct costs.  Aside from the privacy of actual compensation, firms make their case by stating that above a certain point, all partner compensation is for contributions besides the billable hour.   However, since billable rates vary significantly even in the upper echelons of partners, it is hard to justify those hours having the same cost rate.  Regardless, like the methodologies we have already examined, this too creates some unfortunate outcomes. 

The biggest concern with this methodology is the reversed leverage that it creates (similar to having no costs at all).  In the example illustrated below, we see a firm that has chosen $270,000 as the partner direct costs.  Any partner whose compensation exceeds this threshold has their compensation limited and as a result, all have a $150 cost rate for their time.  The result is that the highest rate timekeepers have the highest profit margin, 40% in the case of the Rainmaker, while those with lower compensation, like the Jr. Partner, have minimal (or zero) profit margin for their work.  Certainly, the cost to the firm for these 3 timekeepers is not the same.

The alternate version (and preferable to the former) is to use the dollar amount as a limit to partner compensation and not a flat amount for every partner.  In the example below, we see the Jr. Partner whose actual compensation is below the $270,000 mark.  In the fixed methodology his profit margin is 0% but if it were capped, his direct costs would be his actual compensation and therefore would have a more favorable profit margin of 44%. This still does not relieve the cost similarity between the Dept. Manager and the Rainmaker but it is a slight improvement over having all partners at one cost rate.  Of course this methodology does not meet the requirements of a closed compensation system (unless the firm is primarily interested in the privacy of Sr. Partner compensation).

 

Role	Compensation	Std Rate	Fixed Cost	Cost Rate	Profit Margin
Rainmaker	$1MM	$250	$270M	($150)	40%
Dept. Manager	$500M	$200	$270M	($150)	25%
Jr. Partner  (Fixed)	$150M	$150	$270M	($150)	0%
Jr. Partner  (Capped)	$150M	$150	$270M	($83)	44%

 

 

 

 

 

 

 

 

 

 

 

 

The next installment will focus on better ways to calculate partner cost in measuring client profitability.

 

Related posts

• Client Profitability: What Is The Cost Of Partner Time?
• Why Law Partners Hoard Work?
• What Corporate Clients Read Into Law Firm Bills
• Measuring Your Law Firm's Billing Cycle
• Working with the Law Firm Business Model to increase income

No matter how much you work, until you convert it to cash it is worthless.  The average days in the law firm cash flow cycle (from worked to collected) is 169 (source:  2007 Law Firm Economic Survey from LexisNexis).  Shortening your cash flow cycle has a positive impact to liquidity and thus your cash flow cycle should be measured.

 

There are two metrics that need to be measured:  days to bill and days to collect.  Determining these numbers on a timekeeper level identifies those timekeepers who are efficient and those who aren't.  The opportunity then is to set a standard and work towards compliance by all timekeepers.

 

What is this standard?  It depends on the area of practice.  Many insurance companies just won't pay under 60 days of accepted electronic invoice and will only accept these invoices quarterly.  In this case, 150 days isn't so bad.  Some areas of law (many domestic relations situations come to mind)  should, by default, be prepaid.  Any work in process should be billed immediately and applied against the prepayments.  In these cases a cash flow cycle of 60 days should be cause for concern.

 

Tools such as Juris from LexisNexis' Active Information can help you track this key performance indicator so that you can improve your liquidity. 

 

We have begun taking submissions for the 2008 Law Firm Economic Survey.  If your firm is interested in participating, please contact Brian by clicking here.

 

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• New Contributors For More Partner Income
• Want To Have A Record Year For Your Law Firm?
• Spring 2008 Managing Partner Advocate Is In The Mail - And Online
• Midsized Firms Have Available Capacity and a Pricing Advantage
• Measuring Your Law Firm's Billing Cycle

The Harvard Business Review is rapidly becoming my other magazine I read cover-to-cover (the other being The Economist).  In the March, 2008 issue there is a short article related to Web Retailing that I believe is a good example of why attorneys need to be spending more time blogging.  Andreas B. Eisingerich and Tobias Kretschmer surveyed online customers on what drives them to purchase from a retailer.  What they found is that online customers do more research and are more likely to purchase from a retailer that engages them than one who simply tries to sell product.  They found that "exploiting consumers' desire for engagement is the single dominant driver of superior shareholder value for e-commerce companies."

". . .[Providing informational content] helps customers search for solutions, invites them to think of all the ways the core products might add value to their lives, wins their loyalty, and entices them to buy."

How does this translate into an endorsement of blogging?  It is no different than creating a brochure or newsletter - it helps clients understand the law of their particular interest or need.  It drives them to seek you when they need someone to represent them regarding related subject matter.  Blogging is a continual dialogue, with very little in the way of up front cost (other than the pain involved in updating content regularly).  Not only does blogging display the expertise of your firms and lawyers, it is a mechanism to drive business development. 

To determine how blogging increases revenue (ie, to measure performance), you must track how clients come to you.  Make sure your business software can track source of business.  With a blog, you can provide downloadable content and require registration to download.  This also helps in determining source of business.  You can determine a lot from who visits your site as well.  You can capture location, frequency of visits, what pages they visit, what they download, etc.  All of this is valuable information for business development purposes.  For example, if your area of expertise is Estate Planning and you write a post related to a new law that fundamentally changes how investment vehicles are treated that increases hits in a specific geographic location by 30%, then you can surmise that the public in that location is interested in this topic; thus, you can focus advertising or public speaking opportunities to get your firm's name out as an expert in the area - not only for those reading the blog, but also those who aren't online. 

As clients become more web-savvy, it will be the law firms with a strong web presence that will dictate the standards by which other firms compare.  Providing information for your clients is good - providing updated analytical content written by attorneys in their specialty places your firm in a position to engage current and potential clients and drive superior shareholder value.

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"Best Of More Partner Income" highlights some of the best posts over the three years of its existence.  This article was originally posted on August 14, 2006 and is titled Strategic Planning Will Not Predict the Future, But It Will Prepare the Law Firm for It:

 

If you don’t believe in strategic planning, you must read Rob Millard’s post Creating Prepared Minds. His post includes an excerpt from an article by McKinsey & Co.’s Eric Beinhocker titled Creating Strategy in an Unknowable Universe.

Breinhocker gets it right. If you think strategic planning is about predicting the future, you are dead wrong. If that is why you are not doing it, you need to revisit the issue. Assumptions (predictions) are inaccurate. If you get one right, it is just the luck of the draw. The first rule of the planning process is that you must plan to change the plan. As the future gets closer, you continually change your expectations and reactions to it until you arrive on target.

Planning gets the entire law firm team playing from the same play book. It prepares the team for the future and capitalizes on its opportunities. Rob’s post is a must-read that may inspire you to read Beinhocker’s entire article.

Chance does favor the prepared mind. Top performing firms do it. If you want a good reason to start, consider this reason: more than an eight fold difference in per-partner income.  [The 2006 Law Firm Economic Survey] . . . discloses that the top performing 25 percent of firms earn more than eight times the per-partner income of the bottom 25 percent. That seems to be a good enough reason to start.

Three important rules for successful planning include:

• The planning plan must be to change the plan. Strategies are temporary targets based on inaccurate assumptions and estimated capabilities.
• The planning document should consist of words and phrases to facilitate frequent updating.
• The structure is a critical part of the process.

The structure for the strategic portion of the planning process that I have successfully used includes nine main areas to be addressed by the planning team in the order listed. The nine subject areas are:

1. Nature of the law firm (or activity, e.g., practice area or department)

2. Environment in which firm operates

3. Opportunities/Capabilities (SWOT)

4. Assumptions about the future

5. Objectives–Mission/Strategic Thrust

6. Policies/Procedures (changes or new ones needed)

7. Strategies–How we are gong to achieve objectives

8. Priorities and schedules for programs, new resources required, measurements

9. Organization and delegation

For more step-by-step suggestions, reread the earlier post The Structure to Structured Planning. I also suggest a reread of Consensus Building for a discussion of the role of the structured planning process in building a consensus, i.e., preparing the mind to deal with an uncertain future in pursuit of a common vision. 

Morepartnerincome.com is sponsored by Juris®.  For information about Juris products and services for increasing law firm performance and partner income contact Juris National Sales Center:

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Tom Collins hasn't exactly taken to the "retire" part of retirement.  Working on his second book, he took time to send a list of blogs he recommends for law firm managers:

 

Adam Smith, Esq.	http://www.bmacewen.com/blog
Adventure of Strategy	http://www.robmillard.com/
Amazing Firms, Amazing Practices	http://www.gerryriskin.com/
Creating Blue Oceans	http://blueoceanstrategy.typepad.com/creatingblueoceans/
Cotterman on Compensation	http://blog.altmanweil.com/
DennisKennedy.blog	http://www.denniskennedy.com/blog/
Jim Calloway's Law Practice Tips Blog	http://jimcalloway.typepad.com/lawpracticetips/
Larry Bodine Law Marketing Blog	http://www.bloglines.com/myblogs
Law Department Management	http://lawdepartmentmanagement.typepad.com/
Law Practice Management	http://www.pa-lawpracticemanagement.com/
Legal Ease Blog	http://legalease.blogs.com/
Legal Marketing Blog	http://www.legalmarketingblog.com/
MorePartnerIncome	http://www.morepartnerincome.net/
the legal thing… by Mike Dillon	http://blogs.sun.com/dillon/
The Marcus Perspective	http://themarcusperspective.typepad.com/
Thoughtful Legal Management	http://www.thoughtfullaw.com/
Passion, People and Principles	http://davidmaister.com/blog
Strategic Legal Technology	http://www.prismlegal.com/wordpress/
Stark County Law Library Blog	http://temp.starklawlibrary.org/blog/
What About Clients?	http://www.whataboutclients.com/

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Legislation has been introduced in Georgia to provide more cost accountability to state-funded defense of capital cases.   What has caused the uproar?

 

In March of 2005, Brian Nichols was awaiting trial for rape in Fulton County, Ga.  While changing clothes to prepare for his court appearance, Nichols overpowered a deputy, walked into Judge Rowland Barne's courtroom through the judge's chambers and shot both Judge Barnes and a court reporter.  During his escape, he injured several and killed two others.  The manhunt that ensured culminated in an unlikely ending:  Nichols in the apartment of a drug user who was soul-searching and through an 11 hour conversation softened Nichols enough to let her leave.  She called 911 and Nichols eventually surrendered without further violence.

 

Since then, Georgia has seen one of the longest murder trials in state history take place.   Since Nichols qualifies as an indigent under Georgia law, the taxpayers are footing the bill for his defense.  The Atlanta Journal Constitution reported that the cost of the trial has exceeded $2 million in defense costs alone.  That has outraged the Georgia Legislature enough to change the law regarding representation of indigents in capital cases.  According to the AJC:

 

The bill . . . could reduce the financial burden on the Georgia Public Defender Standards Council, which oversees the statewide indigent defense system. Under the bill, the council would pay for the first $150,000 paid to private lawyers defending an indigent capital case and 75 percent of the next $100,000, with the county paying the other 25 percent. Beyond $250,000, the state and the county would split defense costs.

 

Here's the kicker:  The measure recommends that the council set contracts with flat rates for attorneys' fees and expenses in death cases.  Sound like a good idea?

 

Perhaps if defending capital cases were akin to filing Chapter 7 Bankruptcy.  However, for private sector attorneys who represent indigents in capital cases, does it remove the incentive to take on these difficult matters?  Would a criminal defense attorney zealously defend a suspect for a flat rate for both fees and expenses when you have Judges saying things such as"[e]veryone in the world knows he did it" (as the New York Times reported Judge Fuller said before having to recuse himself from the case)?

 

Is Georgia trying to limit the representation of indigents in capital cases?  Or are they only limiting the financial incentive to defend them?  If it is the latter, then ostensibly an attorney may lose the zeal to defend a client once the money runs out - unless they believe that the defendant is innocent. And that might be the point of the legislation.  [poll=8]

   

Morepartnerincome.com is sponsored by Juris®.  For information about Juris products and services for increasing law firm performance and partner income contact Juris National Sales Center:

 877/377-3740, e-mail info@juris.com or go to www.Juris.com.

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It's not that I am against value billing.  I am just against the proposition that the hourly billing model is an inherent source of evil.  When reading Ed Poll's post on Professionalism versus Competence, a sentence caught my eye that appears to be another slam against the billable hour.

 

The post is about a recent USA Today poll asking whether co-worker's rude or unprofessional behavior should be tolerated if they otherwise do a good job.  Thankfully the answer was overwhelmingly no.  No one wants to work with rude people.

 

Poll notes the new firm Patrick Lamb co-founded this year that focuses on value billing.  There is much positive press when law firms move to this model so the marketing upside is a good thing.  But then came this:

 

As more lawyers succeed in this business model, perhaps others will follow. Then, perhaps, will civility in the profession be achieved.

 

Am I to conclude that without this business model (value billing), civility can't be achieved in the legal profession?  First, I don't want to mistake Poll's point:  that providing value to clients and a team mentality within the firm adds civility to the profession.  Agreed.  However, how is this at odds with hourly billing?  Is it because some (and unfortunately many) are sloppy in their billing process?  Or worse, unfairly padding their hours?

 

Assuming this is a widespread problem, does value billing fix it?  Maybe, but not by its presence alone.  If you sell services at a fixed fee, you had better know the price of your services or you won't be in business long.  Tom Kane explains in a recent post the importance of tracking time even if you bill at a fixed fee.

 

Understanding that in all but a few routine transactions there are variations in the time it takes to provide a service depending on the variables surrounding the case, you will need to account for differences in the price of particular tasks.  So while on the surface everyone may be paying the same for a service, some will be paying more for a task while others pay less.  It depends on how difficult the task is and how efficient the attorney. 

 

In fact, if anything, value billing helps budgeting for lawyers since you can set goals on how many tasks you sell clients.  Crafty firms can then weed out the difficult cases through case assessment to maximize profit.  Finally, marketing efforts can sway those who would buy into the "value" concept unaware of the higher price they are paying for a simple legal task. 

 

Am I saying this is how firms who "value bill" operate?  No.  Can they operate this way?  Yes.  Is that a better value to clients?  No.  And to answer the presumptive rebuttal, "with value-billing, if the client doesn't like the fee, we will adjust it for them" I would answer, "and how is this different from hourly billing?"  I've yet to meet a lawyer that is unfamiliar with post-bill adjustments.  Some attorneys have a chronic habit of reducing their fees prior to billing as well.   The biggest attraction to the value billing model isn't the savings to clients (marketing notwithstanding), it's the potential for higher revenues for well-managed law firms who price margin into the fee.  The value of value billing to the client is nothing more than trading actual cost for pre-performance cost certainty - that apparently can still be negotiated after the service is provided (at least when firms open the door for negotiating fees after performance).

 

Once again, it comes down to trust.  If there is a trusted relationship between attorney and client, then attorneys shouldn't overbill their clients and clients shouldn't question attorneys' fees (after-the-fact) - regardless of the method.  As Poll states in an earlier post, "there is a very small percentage of 'bad apples' in the legal profession."  The devil isn't in the billable hour.  It's in those bad apples.

 

Morepartnerincome.com is sponsored by Juris®.  For information about Juris products and services for increasing law firm performance and partner income contact Juris National Sales Center:

 877/377-3740, e-mail info@juris.com or go to www.Juris.com.

 

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Planning is an oft-referenced theme on this blog.  Plan for increasing wealth, plan for economic down cycles, plan for disasters.  What about during interruptions such as the recent blackberry outage?

 

There are many things that can cause business interruptions.  Planning for them will mitigate the consequences those interruptions have on your firm's operations.  Not planning for them will cost you money.

 

What are some things you can do to prepare?  There are companies that make a living selling plans to businesses, but basic guidelines include:

• Business Impact Analysis:  Determine the effect an outage would have on the  firm's most crucial systems and processes. More or less identifying the important processes subject to interruption and how that interruption will affect business.  In a law firm, this includes (but is not limited to) telephone systems, computers, staff, software systems.  
• Plan what you will do if business interruption takes place:  This, of course, is the hard part.  Planning means taking the time to think of ways around the interruption - and gain approval for the procedure.  For example, if your office is unavailable, where are critical staff?  They need to have a place to meet to put in effect the plan.  Remote communication is easier now than it's ever been.  Cell phones help but what about email?  If your email servers go down, you will need a backup plan to send and receive communications.  There are services such as Mimecast Unified Email Messaging that can provide a seamless transition that clients won't notice - making it appear as if there were no interruption at all - so long as you have access to high speed internet or have a data-enabled mobile device.  In the case of an interruption of internet access, there needs to be a secondary plan to know where your people are.
• Always have good, redundant, and off-site backups available:  All the benefits of technology are in vain in a disaster situation if you have no backups.  It has been reported that 25% to 30% of backups don't save properly.  When was the last time your office checked to make sure the backups were working?   Services such as LexisNexis Data Backup and Protection Services provide continuous automatic off-site storage of your data.
• Run a drill or two to test the processes: It is paradoxical to interrupt the business day to test processes geared to mitigate interruptions in the business day.  But it has to be done.  Otherwise you may not find the flaws in the plan until you put the plan in action - not the time you want to find out that you left out an important facet.
• Review the plan annually:  Don't just dust off the Y2K disaster readiness plan and change the cover page.  Times change, technologies change, and needs change.  Make sure you are up to date on all your systems and their effect on your business.

A sample business continuity and disaster preparedness plan, courtesy of ready.gov, can be downloaded by c