Since 2000, law firm PEPP (profits per equity partner) have increased on average 11% for Amlaw 100 firms and 8% for Amlaw 200 firms.  Some observers fear that, like other markets that have sustained growth periods at or near double digits in the past 10 years, the law firm partner profit "bubble" may soon burst as well.

Looking at Amlaw 200 data, PEPP increased by 2% in 2001.  In 2002, the increase was 7%.  2003 saw an increase of 11%, 8% in 2004 and 2005, and 10% in 2006.

This increase doesn't only apply to Amlaw 200 firms.  Looking at the differences from 2005 and 2006 for the top respondent firms in the Law Firm Economic Survey  by Juris Inc. and LexisNexis, respectively (the only two years available), firm PEPP increased 11%.  It is likely that most firms in the mid-market and small market increased incomes by respectable if not similar percentages over the same period.

What can you do to prepare for a stunt in the growth (or decline) of PEPP?  Bruce MacEwen posted an article May 5th  on his blog Adam Smith Esq., titled A "Bubble" in PPP? that looks at some short term ideas to help "mitigate the downward trend" and predicts a change in the las firm business model over the long term:

Short term ideas:

• Redeploy lawyers in troubled practice areas to healthier ones;
• Use the opportunity of "shared pain" with your key clients to get closer to them;
• Adroitly stand by while the normal waves of attrition take their toll;
• Build or at least safeguard capacity in selected practice areas that you anticipate will emerge strongly from the downturn;
• And always, always, keep a sharp eye on costs–although, truth be told, you don't have much material flexibility here. You're not moving your offices to Brooklyn and you're not paying less than market for partners and associates.

Long term predictions:

• the billable hour, lamented by many but eliminated by few, will eventually replaced with a more "value-based" model, though MacEwen stresses that he is not "holding [his] breath" on this;
• the traditional associate/partner model changes to include more non-equity partners and more contract attorneys;
• at least fundamentally, "the core processes by which law firms manage cases and deals must and will change" (ie, more project management, more team philosophy centered around practice groups to become more efficient).

Ultimately, MacEwen believes that due to increased demand (at least for Amlaw 100 firms), finding work won't be the problem.  However, he sees the traditional model as being unsustainable based on the limits placed on things such as productivity (>2,400 hours?), rates (>$1,000 per hour?)and realization (>100%?).  Because of this, if PEPP does suffer a downturn for an extended period of time, the long predicted changes to law firm dynamics may happen.

If this occurs in large law firms, it is incumbent on smaller firms to adapt quickly.  The predictions above are all point towards efficiency that allow firm profits to increase through efficiency rather than increased rates and worked hours.  Much has bee written about the "unmanageability of law firms".  Despite this, firms have continued to make exceptional profits - due in no small part to their enviable margins.  With good management, law firms can see profits that far exceed anything that firms receive currently.   And if partner profits start decreasing, your firm will be in crisis -  just as it is not a good idea to go to the grocery store on an empty stomach, it isn't a good time to contemplate an overhaul in processes during a crisis.

Much of the allure of smaller firms is quality service at a lower price.  Some large firm partners charge rates in excess of $1,000 per hour.  If large firms realize they can offer similar services at lower prices and still increase profits, smaller firms can be squeezed out of the marketplace.

Think Walmart.  As Walmart entered the scene, small businesses were unable to compete based on their lack of purchase power.  Walmart could offer more product selection at a lower price.  Home Depot and Lowes did the same to small hardware stores.  The small shops that survived did so by using their secret weapon - customer service and personal engagement.  Still, you won't find many of these shops who don't struggle on a monthly basis and have to watch as their clients often come to them for advice, then go to Home Depot to buy the big-ticket items.

For small and mid-size firms to compete in this changed environment, they will have to embrace workflow efficiencies that meet or exceed that of the larger firms - and use their "secret weapons" of personal engagement with clients and responsiveness.  However, without the fundamentals of an efficient business in place, your firm will suffer under the weight of your processes.  

There will always be individual clients available, but more dependable sources of income often come from business clients and their leaders.  These clients are already demanding more cost certainty.  If larger firms are able to provide this value to business clients first at a price that isn't so different than yours, your firm may be in trouble.

The time to act is now.

Related posts

• Survey Targets Business Development In Law Firms
• Reflections on the 2007 ALM Billing Rates & Practices Survey
• Law Firms with Non-Lawyer Management Achieve Higher Per-Partner Incomes
• Law Firm Survey Shows Link between Leverage and Partner Income
• Law Firm Business Model: Margin

ALM Research recently released the 2008 Law Firm Business Development Practices Survey, which targets two "tiers" of law firms:  those listed in the AmLaw 200, The Global 100, and the NLJ 250 (Tier 1) and those not listed (Tier 2).   Though the survey is mostly focused on large firms, the average number of attorneys for Tier 2 firms was 85, within the higher range of the mid-market. 

Business development is difficult to assess in mid-size firms simply because many don't track it.  However, firms do see the importance.  In the 2007 Law Firm Economic Survey by LexisNexis, 25% of respondents claimed business development was the best strategy to improving profitability, second only to increasing rates.  Likewise business development is one of the 5 highest rated factors for financial growth in the ALM survey.  The extent to which these activities are tracked and measured will determine the extent to which firms can gauge the effectiveness of their methods.

Some other key findings:

• More firms are dedicating resources to business development that are separated from a marketing role;
• Budgets for business development have increased over the past year;
• Around 50% of respondents employ client interviews and surveys (the highest rated business development activity among respondents);
• Just under 50% employ "client service teams" focused on clients who generate the most revenue;
• Over 50% receive some sort of sales training;
• Nearly a third of Tier 2 firms reported that they were "not sure" if revenues increased, decreased or remained flat in the past year.

The last finding listed is surprising.  If your firm is not tracking revenues, there is no way of knowing whether your firm is in trouble financially or not.  Further, you can't accurately forecast if you don't benchmark.   The importance of measuring performance can't be emphasized enough. 

The above is just part of the findings of the survey.  To purchase the survey, visit the ALM Research site by clicking here.

Related posts

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In the April, 2008 issue of CFO magazine, the cover story reads:  "Goodbye GAAP:  It's Time To Prepare For the Arrival Of International Accounting Standards".  These international standards, called the International Financial Reporting Standards (IFRS), are being sought to replace generally accepted accounting principles (GAAP), an evolving set of accounting standards in the US since the Securities and Exchange Commission (SEC) was established in the 1930's.

What started as a reconciliation of the two is now seen as "more of a takeover than a merger of equals - many who favor a single global standard hope to wipe out GAAP altogether".

Grant Thornton has a paper outlining the major differences between GAAP and IFRS that can be viewed by clicking here.  James Turley, Chairman and CEO of Ernst & Young, also makes an argument for the move to IFRS that was published by the Wall Street Journal in November of last year.

How does this affect firms who are currently not even using GAAP?  Many small and mid-size firms have historically kept their books on a cash basis.  In the  2007 Law Firm Economic Survey by LexisNexis, the failings of cash basis accounting were exposed - in particular, the lack of reporting on work in process gives firms only half of their financial picture.  And, based on the respondents in the 2007 survey, there is no correlation between per partner income and cash basis accounting.  The fallacy of having to report to the IRS on an accrual basis if you reported internally in this manner were reiterated.

Many of the requirements of GAAP and IFRS apply only to publicly traded companies.  This lack of mandate is tempting to law firms, who are not forced to change their accounting methodology.  However, one of the main management priorities respondents in the 2007 survey reported was better benchmarking.  What are other firms doing?  How do we compare? 

Using tools such as Lexis® Insight helps.  But these tools are meant to be starting points for analysis.  As Stephen Collins noted in the Introduction of the 2007 Survey:

"Without applying the accrual concept, law firms can't reliably forecast cash flows or anticipate funding needs.  The unrealized value of unbilled fees and accounts receivable are clouded.  In fact, cash basis accounting may contribute to the industry-wide experience of very slow cash flow cycle times.  Key financial metrics such as realization cannot be accurately measured by matching the appropriate revenue to the related adjustments.  As a result, many firms are losing significant amounts of fee revenue to adjustments and they don't even know it it."

 For nearly 80 years, the answer was generally accepted accounting principles.  It appears that due to the expansion of free trade agreements and globalization in general, there may be a new standard.  For firms who want to improve profitability and are looking to move from cash basis accounting to accrual to help measure performance, take heed.

Related posts

• The Case Against Income Partners
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In the February, 2008 Managing Partner Magazine, a case study was published regarding the international firm Herbert Smith, who recently implemented a financial management system that focused on measuring performance.  The case study mimics everything we promote on More Partner Income and thus deserves highlight.

The study begins with a quote from William Thomson (Lord Kelvin), who said "if you cannot measure it, you cannot improve it".  They may have done well to also quote "don't reinvent the wheel", since most of the sweat put forward in devising their system is already developed by software vendors such as LexisNexis.  It is the process, though, that bears note.

The firm adopted a "phased approach" to implementation that focused on basic needs first, then expanded to add functionality as the basic needs were met and a comfort level established by the users.  The firm initially only gave access to the system to the partners and used three phases:

1. Easy access to key financial reports
2. Financial planning and reporting
3. Time recording and "universe" design

The first phase entailed providing easy access to the important financial reports that had previously been distributed on paper.  This not only provided the partners with the information they needed, it helped them become accustomed to viewing this information electronically.

Phase two was focused on budgeting and management accounts.  They also placed some forward-looking indicators of performance and trend analysis.  This helped the firm make future projections through modeling.

Phase three provided real-time information for fee earners, including alerts when time entries were late or incomplete.

In my opinion, phase three should have been phase 1, phase 1 should have been phase 2, and phase 2 should have been phase 3.  However, whatever works is the right solution.  The important thing is that the firm set up their implementation with the highest probability of success by not cramming an entire new method of consuming information to all fee earners at once.  Instead, they focused on getting partners on board first, then eased them into the solution by first getting the most important information (read:  what they had already been getting) to them first.  Then incrementally adding new value to the system until it became an indispensable tool for managing the firm.

When your firm is looking to invest in a software solution: 

• If considering to develop it internally, which will require specialized staff to maintain, make sure you research to see if software vendors have already developed the solution you need;
• When you implement the solution, make sure you do it in phases to ensure adoption by all those who will benefit from it.

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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On the plane coming back from Philadelphia  I was asked by a colleague of mine, Tiffany Poulton, what I thought was an obstacle to change.  After a brief pause, I mentioned that perceived difficulty would be an obstacle to change.  She responded, "what about fear?"

It brought to mind a book and a play I read in college.  The book, Henry James' Beast In The Jungle, is about a man who spends his entire life waiting for an awful event that is to happen to him.  The play, Eugene O'Neill's The Iceman Cometh, is about a group of drunks who waste their lives living in the tunnel of a pipe dream, refusing to change and face their own realities.

In both of these works of fiction, fear is the main driver inhibiting change.  John Marcher, James' protagonist, is so self absorbed in fear that he can't see that he has many opportunities to free himself from the chains he has attached to his life.  Only when realizing his lost opportunities does he see that the "beast" is his own lack of action that has cost him the only thing that brought him comfort in life.

In O'Neill's play, his protagonist, Hickey, has already overcome his obstacle to change, self realization (never mind that it was done by murder), and though he attempts to share that knowledge to his peers, their own fear to accept who they are prevent them from waking from the intoxicated blur of their lives.  As the antagonist Harry exclaims, "Stay passed out, that's the right dope. There aren't any cool willow trees–except you grow your own in a bottle."

What is the obstacle that prevents change in your office?  Is it comfort?   Perceived difficulty?  Or is it fear? 

Why do some attorneys refuse to enter their time as work is performed?  Is it that they are too busy?  Or afraid of the expectation of adding another chore to their workload?

Why do some firms not establish and maintain a strategic plan?  Is it that planning is too time consuming and difficult?  Or are attorneys afraid of being held accountable to the results?

Why do some partners refuse to share work with associates?  Is it a lack of trust?  Lack of motivated associates? Client demands? Or fear that they won't be able to replace the work and thus their compensation may be adversely affected?

It's been said that the only constant in life is change.  However, embracing change for the sake of it alone won't improve income.  Any movement to change processes or habits should be looked at through the effects it can have to your bottom line.  How would it affect productivity to require attorneys enter time as work is performed?  What would happen to the relative tranquility of the firm if you implemented a strategic plan and held everyone accountable for the results?  How would requiring partners to shift work to associates affect the quality of services provided your clients?  How would it affect compensation?

When addressing concerns, be mindful of fear.  Fear may be underlying every reason why the change is fought.  The pipe dream of the status quo may have your attorneys in a self-absorbed state of fear of change.  At all costs this must be defeated to enact meaningful processes that will increase value to the firm, its clients, and its members.

Otherwise, as is written to end O'Neill's play, "The days grow hot, O Babylon. Tis cool beneath the willow trees."

 Tom Collins has written many times on the subject of change in the law firm.  All of them are highly recommended.  Some are linked below:

• Law Firm Plan Is To Change The Plan
  
• The Right Way To Manage Change In the Law Firm
  
• Getting Agreement To Change From Law Firm Partners
  
• A Law Firm's Future Depends On How Well It Can Change
  

 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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The Estrin Report is a great resource for paralegals and other legal support professionals.  The March 22nd post quotes a Maryland Daily Record article where an attorney has been suspended twice - TWICE - for mismanagement of client trust funds.  He never took one penny, however.  Instead, he was the victim of two consecutive bad hires.

The Maryland solo practitioner hired a paralegal, among other things, to manage a client trust account.  The paralegal, without oversight, embezzled nearly $150,000 before being caught.  After being disciplined, the attorney hired another paralegal to "clean up the financial mess left by " the predecessor.  This one took over $170,000 from his clients.

The attorney complained that he had several hundreds of cases he managed and was in court a lot.  "You’ve got to delegate things. You can’t be there to sign every check.”   

Whether these were paralegals or not isn't the point.  What is noteworthy is the exposure attorneys have, especially in small firms, when trusting unmanaged staff to control firm finances.  Embezzlement is more common than we'd like to believe.  (Admin charged with embezzling over $200,000 from firm; Bookkeeper embezzles over $400,000 from firm;  New Orleans firm dissolves after Chief Financial Officer embezzles $2 million;  Office Manager embezzles $700,000 from firm;  Bookkeeper accused of taking over $4.3 million from escrow accounts)  

Ignorance is no defense.  You can't spend all day watching your staff either.  “You’ve got to have some trust in your employees,” the aggrieved attorney said. “You pay them good money.”  In his case, you'd think a little skepticism would have been prudent.

What are some things that can be done to avert a would-be-embezzler?  Tom Collins wrote the following in his September 6, 2006 post:

First, select business software with built-in audit trails and controls. Remain alert to the reality that it can happen in your firm. Keep your eyes and ears open. Obtain professional assistance to implement appropriate internal controls including segregation of duties. Insist that employees take vacations on consecutive days under an arrangement where others assume their duties. Do not let a crisis take over and circumvent normal controls and procedures. Budgeting, comparative financial results, and detailed review and questioning of monthly financial statements are an essential function of law firm management and play a vital role in protecting and preserving the assets of the firm.

Scott Barrett wrote an article in 2004 that addresses ways to avoid being a victim of embezzlement.  Read it by clicking here.

 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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I have suggested utilizing a non-equity partnership tier as a way to reward attorneys who are not yet ready for firm ownership.  Jim Cotterman has made an argument against it.  In my assessment, non-equity partnership can be a tier to place attorneys who excel in some things, such as working files, but don't have the skills to bring in new clients or matters or don't have the requisite discipline to be a firm owner.  Cotterman, however argues that non-equity partner tiers can end up being dumping grounds for the mediocre.

Cotterman cites a May 2006 study, An Empirical Study of Single-tier Vs. Two-tier Partnerships in the AmLaw 200, by Professor William Henderson at the Indiana School of Law.  The study documents that average per equity partner income in single tiered partnerships are significantly higher than two-tiered partnership firms.  The study noted:

The higher profitability of single-tier firms appears to be a function of higher levels of prestige, which enable single-tier firms to (a) attract and retain a more lucrative client base, and (b) run a more rigorous promotion-to-partnership tournament in which associates work longer hours and are less secure in their futures with the firm. 

Cotterman does believe there are certain situations where establishing income partners could be a good idea, including the reasons I mention above.  How do you feel about this?  In the 2008 Law Firm Economic Survey, we are asking respondents if they have a non-equity partnership system in place.  With this information, we will be able to determine whether equity partners in two-tiered partnership firms make more or less than those in one-tier firms.  It will be interesting to see if our results, which focus on small and mid-size law firms, mimic or contrast the findings in the Amlaw 200.

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.

Related posts

• Survey Targets Business Development In Law Firms
• For Long Term Increases To Income, Partners Must Delegate Work
• The End of Generally Accepted Accounting Principles?
• Reflections on the 2007 ALM Billing Rates & Practices Survey
• Billable Hours vs. Head Count Leverage in Law Firms

 David Maister, management consultant and author of several books, has made an offer on his website to give a free copy of his book, Strategy and the Fat Smoker, to a senior executive or managing partner of your firm.   Maister in 2006 declared that law firms are unmanageable - could his "Give a Copy to Management" campaign be a sign that he has regained some hope?

 

In larger firms, at least, there are strong indicators of more management - the number one indicator being skyrocketing per partner income.  Law firm consultants know that the service industry model is enviable.  There are no fluctuations in price due to factors beyond their control (such as gas prices).  The main cost to the law firm is also a source of its revenue.

 

The main obstacles to improvement in management are the firm owners who don't want to follow the key drivers that affect income (usually due to entrenched "firm culture" no one is able to alter).  In any other company this would be the fatal flaw that calls in the Grim Bankruptcy Trustee.  In law firms, the margins are typically good enough to deceptively cover the lack of attention to these drivers until a preventable event occurs that causes a firm to split or fail.

 

However, many are predicting change in the fortunes of law firms.  Interest rates are above 4%.  Firms who otherwise wouldn't necessarily see a difference in their bottom line by not measuring performance may soon see falling incomes and may not know about it until it becomes a crisis.  The signs are everywhere and many firms are taking note.   It is to these firms that Maister's book is so important a read.  Tom Collins has written about Maister's book in the October 25th, 2007 post The Strategy Problem in Law Firms. 

 

You can take advantage of this offer by clicking here.  Do it quickly.  The offer is only good for the first 100 eligible senior executives or firm managing partners.

 

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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In a February 29th article for Corporate Counsel titled Big-Firm Associates: Why They Go and How to Keep Them, Ben W. Heineman Jr. and David B. Wilkins discuss associate attrition at the top 250 law firms.   According to the story, firms are losing up to 50% of their associates after three or four years with half to two-thirds of them being the associate's decision to leave.  Heineman and Wilkins talked to students, associates, partners and inside counsel and came away from their discussions with the belief "that for a significant number, their first professional experience after at least seven years of higher education is too unprofessional and demoralizing."

Some of the problems listed:

• Early in their careers, far too many associates are given a steady diet of drudge work: reviewing documents; reading e-mails; organizing schedules for transactions; researching small, tangential issues.
• Associates work on large teams and are not given individual responsibility of any consequence.
• Partners may not take time to communicate the overall issues and strategy in a large matter, but just send younger associates off to till a small part of the North 40. Too often the junior associates have to work for senior associates whose goal in life is their own advancement, not the well-being of their younger colleagues.
• Partners, who have huge workloads and unceasing pressures to produce, do not spend much time worrying about the professional development of young lawyers nor provide adequate mentoring, education and training.
• Firms may not communicate candidly about their finances, their business strategy and the partnership prospects for young lawyers, who are not treated as young professionals but viewed as generators of "rates x hours" for annual revenue models.
• Corporate clients are unwilling to take risks on young associates and unwilling to pay their rates, so associates may not have interesting opportunities such as doing important work, meeting with businesspeople, or traveling to depositions, hearings or arguments.

Wow, this sounds a lot like many small and mid-size firms too.   So how can this benefit midlaw firms?  By correcting the above problems to the extent they persist in your firm, you can get the talent that biglaw firms can't keep.  For those firms who are having a hard time finding associates motivated to work, here's your opportunity.

Change in large corporations and large law firms is slow.  Mid and small law firms can make change occur much more rapidly (though historically no law firm is immune to procrastination when it comes to change).  To the extent that your firm is bitten by any the above problems, take action now to remedy them. Give more responsibility to associates.  Mentor associates and give them more ownership of matters.  Encourage associates to become better "firm citizens" by instituting an "upward review process" and providing opportunities for them to participate in strategic planning.  And, although you can't force a client to take associate work if the client is not comfortable with "taking a risk" with associates, you can help form client perception of the quality of your associates.  Allow associates to be more active in discussions to display the competence of your attorneys.  If you don't feel confident that your associates have the abilities to take on such added responsibilities, mentor them and if that doesn't work, they may not be a good fit with the firm.

According to the article, the attrition is made up of :

1. some just paying off school debt and intended to leave once the debt was satisfied;
2. some who follow spouses taking jobs in different locations;
3. some taking higher paying jobs in banking, etc;
4. some wanting a better quality of life; and
5. some who don't want to work themselves to death only to get denied partnership status. 

An amazing number that was listed in the article was that 25% of the 40,000 law school graduates were hired by the top 250 largest law firms.  10,000 graduates going to the top 250!  The number may be inflated a bit and the article did qualify the number, stating "by some estimates", but that is a pretty high number of recent graduates concentrated into a few firms. 

How many of those lawyers leaving biglaw firms will be willing to take a pay decrease?  With an attrition rate of 50%, just 20% of the 5,000 would provide 1,000 lawyers for mid and small law firms to hire at a better cost than you would when those same lawyers were more expensive and didn't have 3 to 4 years of experience.  Sounds like a deal to me.

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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A recent article in the New York Lawyer entitled "Getting Fired" (requires free registration to view content) addresses a task that all managers would prefer not to have as part of their responsibilities: that of releasing employees.

The article is geared to the attorney as releasee, helping them not miss the subtle ways they are "shown the horizon".

If a conversation starts: “You seem to be distracted lately, and we are concerned that maybe this isn’t the right fit for you anymore.” - you might be getting fired.

If a conversation starts: “We think maybe you would be happier somewhere else. Let’s reassess where you are in six months. Hopefully, by then you will have found the right opportunity.” - you might be getting fired.

Suggestions when hearing words like the above? Start job hunting. In the second example, the firm is clearly giving the attorney a 6 month notice to find other employment. It isn't likely that the firm is going to reassess the attorney's performance in 6 months. More likely they will have had a replacement for 2 months and will be ready for the performance-challenged attorney to go.

Although geared to those near the door, it is also a reminder to managers of their responsibility to the firm. No one likes to fire someone, but without that part of the employment cycle, those who drag down the margin won't change. This helps neither the firm nor the employee. Not fitting into your firm culture doesn't mean the attorney is not a quality attorney. It means the attorney is not a good fit for your firm.

As the article noted, "[t]here is another . . .firm out there just waiting to snap you up! They love laterals!"

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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