The summer issue of the Managing Partner Advocate is now in the mail.  This issue is focused on ways to combat the effects of a contracting economy.  Highlights include retaining talent, managing associates, planning for the unexpected, measuring marketing activity and measuring timekeeper profitability.  There is also a guide to minimizing facilities costs written by guest author Luke Raimondo, an attorney and commercial real estate broker, and a guide on how much debt a law firm should carry.

The summer issue provides excellent guidance for law firms to help improve profitability even as the GDP struggles to grow.  If you are a subscriber to the site, you may download the summer issue by clicking here.  You may also have the advocate mailed to you at no cost by clicking here and requesting a subscription.

It is with great regret that I am leaving LexisNexis and will no longer be associated with the Managing Partner Advocate and More Partner Income.  I took over the blog from Tom Collins in January of this year, a mere 6 months ago.  In that time I have moved the site to a new host, completely re-built the blog and have enjoyed record numbers of readers, building on the solid foundation Tom Collins built over the past 3 years.  I sincerely appreciate all of you who have read this blog and utilized it as a resource to help your firm.

This is my last post as editor of this blog.  I have enjoyed my brief time hosting More Partner Income and hope that you have found value in the posts I have written. 

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This is the last in a 6-part 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.  The second article, titled Partner Cost And Client Profitability, (Part II), is focused on pitfalls of some firms' methodology in allocating costs to partners.  The third article, titled  Partner Cost And Client Profitability, (Part III), is focused on basing a partner's direct cost on a "minimum margin percentage".  The fourth article, titled Partner Cost and Client Profitability (Part IV), is focused on basing a partner's direct cost on a "minimum margin dollar amount".  The fifth article, titled Partner Cost and Client Profitability (Part V), is focused on allocating a partner's direct cost using a variation of both the "minimum margin percentage" and "minimum margin dollar amount" based on different partner "ranks" using a sliding scale.  This final article compares the different methodologies to help a firm decide which one to utilize in their environment.

Over the past several weeks, I have explored a number of methodologies for determining the appropriate amount of partner compensation to consider direct cost and allocate to clients for purposes of evaluating client and matter profitability. Since a partner is compensated for a multitude of contributions to the firm (billable hours, originations, matter & client management, attorney management & development, and for firm ownership), the issue is complex. Through my last five postings, I have evaluated half a dozen methodologies, all of which are used by at least one firm Redwood has worked with, but not all are recommended. 

• Simplicity. If the methodology is not easy to understand with a minimal number of decisions, it will prove difficult to build partner buy-in.
• Positive margin. There is value associated with every hour of partner time at standard rates. While discounting may be a planned strategy to acquire a client or matter, at full rates, every hour should have some margin.
• Rate based. Compensation can be affected by a large number of factors including discretionary bonuses and overall firm performance in a year (cash received from a litigation case). As a result, it is possible for compensation to decrease from one year to the next.   Since we are trying to assign costs to the client for the billable time only, it is important to ignore these effects. Instead, direct costs should be based on partner’s standard rate,
• Leverage. While not the only measure, leverage is extremely to increasing firm profitability. Any methodology should (through the resulting margins) encourage the use of lower cost timekeepers over higher cost (and highly compensated) partners.
• Closed Compensation system. If this is a concern for your firm, it can generally be accomplished by using a rate-based methodology and leaving out any actual compensation figures.

Related posts

• Partner Cost and Client Profitability (Part V)
• Client Profitability: What Is The Cost Of Partner Time?
• Partner Cost And Client Profitability, (Part IV)
• Partner Cost And Client Profitability, (Part III)
• Partner Cost and Client Profitability (Part II)

This is the fifth 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.  The second article, titled Partner Cost And Client Profitability, (Part II), is focused on pitfalls of some firms' methodology in allocating costs to partners.  The third article, titled  Partner Cost And Client Profitability, (Part III), is focused on basing a partner's direct cost on a "minimum margin percentage".  The fourth article, titled Partner Cost and Client Profitability (Part IV), is focused on basing a partner's direct cost on a "minimum margin dollar amount".  This article is focused on allocating a partner's direct cost using a variation of both the "minimum margin percentage" and "minimum margin dollar amount" based on different partner "ranks" using a sliding scale. 

Figure 2

• It ensures that every partner has a positive margin associated with his/her hours when valued at standard rate. While one may purposely choose to lose money on specific matters through discounting, there should be margin on every hour of time when valued at published rate.
• It is based on the partner’s published rate. While total compensation can rise and fall with firm profits, this relative cost will not fluctuate and this method is in line with thinking about compensation for a partner’s work effort.
• If executed properly, a leverage model will be supported by forcing the highly compensated partners to a lower margin % than lower compensated partners.
• It supports a firm with a closed compensation system since actual compensation will not be revealed through profit model.

• Higher complexity. With either bucketing (fig. 1) or the margin curve (fig. 2) the firm will still have more decisions in this methodology than in either minimum margin approach. More decisions open the door to more disagreements and dissenters.

Like the other Redwood recommendations, the weaknesses are overshadowed by the strengths in the model. And, if the firm can build agreement around the (semi-arbitrary) decisions necessary for this methodology, Redwood believes this creates the most robust model of all those explored, allowing the firm to assess relative client profitability without having to exclude a client due to high/low partner costs. In the last entry of this series, we will detail the list of criteria we have developed to better understand the strengths and weaknesses of a new methodology that we may encounter. 

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 This is the fourth 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.  The second article, titled Partner Cost And Client Profitability, (Part II), is focused on pitfalls of some firms' methodology in allocating costs to partners.  The third article, titled  Partner Cost And Client Profitability, (Part III) , is focused on basing a partner's direct cost on a "minimum margin percentage".  This article is focused on a related methodology:  using a "minimum margin dollar amount" to allocate partner direct cost.

• It ensures that every partner has a positive margin associated with his/her hours when valued at standard rate. While one may purposely choose to lose money on specific matters through discounting, there should be margin on every hour of time when valued at published rate.
• It is simple. Firm leaders need only to decide on one variable that can be based on firm analytics and margins for other titles (e.g. income partners or senior associates).
• It is based on the partner’s published rate. While total compensation can rise and fall with firm profits, this relative cost will not fluctuate and this method is in line with thinking about compensation for a partner’s work effort.
• The most highly compensated partners will be forced to the minimum margin ensuring they appear less profitable than junior partners, therefore supporting a leverage model.
• Multiple partners hitting the minimum margin level will have different margin % if they have different standard rates, further promoting a positive leverage model.

•  A firm will need to decide on the minimum margin. While strong arguments can be made for a certain threshold, there may still be dissenters. 
• Each partner who is affected by the minimum threshold will have the same margin (in dollars), leaving discounting as the only differentiator of profit on billable time

Like the Minimum Margin %, the strengths of this methodology prevail over the weaknesses and many firms have found this option easy to implement and easy to gain support for (due to minimal arbitrary decisions). In the final two entries, we will discuss some variations on the two minimum margin methodologies (% and $) and discuss a set of criteria to help a firm determine the pros and cons of each.

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• Partner Cost And Client Profitability, (Part III)
• Partner Cost and Client Profitability (Part V)
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• Client Profitability: What Is The Cost Of Partner Time?

This is the third 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.  The second article, titled Partner Cost And Client Profitability, (Part II), is focused on pitfalls of some firms' methodology in allocating costs to partners.  This article is focused on basing a partner's direct cost on a "minimum margin percentage".

 When it comes to allocating partner direct costs (compensation) to a client the answer, unfortunately, is not a simple one.  After exploring options with various law firm leaders at a number of firms, we heard consensus on one key point — that “it depends.”   “Depends on what?” you might ask. Well, it depends on the current state of affairs of the firm, the long and short term goals of the firm, the relative level of partner compensation, and maybe most importantly, how the firm thinks about client profitability. As a result, we have developed a handful of options to address the analytic needs while considering firm goals and philosophy. In my next several entries, I’ll explain some of those options, and their pros and cons. Today’s option is basing a partner’s direct cost on a minimum margin percentage for each partner.

• It ensures that every partner has a positive margin associated with his/her hours when valued at standard rate. While one may purposely choose to lose money on specific matters through discounting, there should be margin on every hour of time when valued at published rate.
• It is simple. Firm leaders need only to decide on one variable that can be based on firm analytics and margins for other titles (e.g. income partners or senior associates).
• It is based on the partner’s published rate. While total compensation can rise and fall with firm profits, this relative cost will not fluctuate and this method is in line with thinking about compensation for a partner’s work effort.
• The most highly compensated partners will be forced to the minimum margin ensuring they appear less profitable than junior partners, therefore supporting a leverage model.

• A firm will need to decide on the minimum margin percentage. While strong arguments can be made for a certain threshold, there still may be dissenters. 
• For those who have the minimum margin %, the only profitability differentiator relative to how they  affect client profitability is the realization on the hours worked. If too many partners are at the minimum, there is virtually no difference in leverage within the partner ranks.

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• Partner Cost And Client Profitability, (Part IV)
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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.

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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.

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).

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

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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.

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The following is the first in a series of posts on compensation written by Ron Paquette, an analyst with Redwood Analytics, now part of LexisNexis.  Ron is a new contributor to the blog who we hope will write regularly.

Most law firms want to evaluate client and matter profitability. When deploying profitability models, one of the most common questions Redwood receives has to do with determining the cost of partner time on billable work. Since most matters in the legal industry today are billed on an hourly rate, the most effective means of allocating costs is on an hourly cost basis. There are two components to costs, direct and indirect (overhead) – the focus of this discussion is on the direct component, e.g. partner compensation. And since most firms set billable hours expectations for their partners, the question becomes:  How much of a partner’s compensation should the firm consider when calculating this “hourly cost rate” allocated to each billable hour he/she works?

• Billable hours;
• Originations;
• Matter & client management;
• Attorney management & development;  and
• Their status as a co-owner of the firm.  

Related posts

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• Partner Cost and Client Profitability (Part V)
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One of the observations in the 2007 Law Firm Economic Survey by LexisNexis and a focus of the 2008 Survey (in progress) relates to cash flow.  According to the 2007 Survey, all firms had a slow billing cycle.  On average it took firms 170 days from providing a service to collecting payment on it.  In non-service industries that would be a recipe for bankruptcy.   Law firms enjoy high margins, so once the firm initially weathers the 80 or so days before the cash starts coming in, it can survive the slow cycle.  Unless the cycle stops.

How will you know when clients stop paying?  How long do you have until your cash flow reduces to a trickle?  Measuring your billing cycle times is critical in answering these questions. 

Long billing cycles hide what may be slowly killing your firm - inefficiencies, declining business, etc.  If you aren't measuring your performance in converting work to cash, you may not know that your firm is in a crisis for several months, wasting valuable time to act.

Below is an example chart that shows how you can measure the billing cycle by just tracking your unbilled fees, billed fees, and collected fees. 

 To determine unbilled fees, take your work in process that is currently unbilled and not subject to mark-down (to the extent known) for the prior "rolling" 12 months.  Do the same for fees billed and fees collected.  From that you can determine your average days to bill, days to pay and average AR days fees outstanding.  Lowering any of these numbers will increase cash flow and provide additional liquidity to the firm. 

The above takes a look at the billing cycle from the firm perspective.   You can also do this analysis on a timekeeper or practice area.  Tools such as Juris' Active Information can not only track your billing cycle but can also drill down into the "why", exposing inefficiencies that are hampering your ability to maintain liquidity and giving you an opportunity to act to increase cash flow before it slows.

Click on the graphic above to download a spreadsheet to use with your firm's numbers.  You must be a registered user to download content.

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