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.

Related posts

• Partner Cost And Client Profitability, (Part III)
• Partner Cost and Client Profitability (Part V)
• Partner Cost and Client Profitability (Part II)
• Partner Cost and Client Profitability (Part VI)
• 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.

Related posts

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

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.

Related posts

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

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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• The End of Generally Accepted Accounting Principles?
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 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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The 5 key performance indicators all law firms should measure are:

• Rate
• Realization
• Utilization/ Productivity
• Leverage
• Margin

This week each day I will focus on one of the above. Today the focus is on margin.

Margin is partners' profits divided by firm revenues. It is the percentage of revenue left after all operating expenses have been paid (not including partner salaries and distributions). For previous posts on margin, look here, here, here, here, and here.

There's no secret to increasing margin. Do a good job, be fair to clients, focus on client development, bill what you are worth, never devalue your time, and make sure costs rise proportionately to revenue. You don't increase margin over the long term by cutting costs. Reducing expenses is either done to correct a past mistake in investment or to replace lost revenues. Neither are positive causes. If you want to grow, you have to spend.

The point is made in the 2007 Law Firm Economic Survey from LexisNexis as well. The firms who had the highest per partner income spent the most. The firms with the highest margins spent the most.

The firms with the highest per partner income are represented in the Q1 column. The operating margin is at nearly 51% and their expenses per head are nearly $100,000. Compare that to the lowest performing firms. In the Q4 column, margin is a paltry 29% but they saved money - only $84,000 per head cost. You can't grow with a constrictive operating budget. Note that both the best performing and worst performing firms also spent a nearly identical percentage of their budgets on technology. This could mean that technology isn't being utilized properly in the poor performing firms (due no doubt to a lack of services if experience tells me anything) or that poor performing firms are attempting to utilize technology to manage their practice. I am encouraged to think the latter and am curious as to whether those firms are improving their practice as a result. There are so many variables to successful implementation of a process, but looking at these firms in 5 years might be a good follow up.

The way to improve margins may be different for each firm depending on where they start, but there are still two constants: cutting costs do not equate to long-term increases in per partner income and measurement improves results. With any action geared to improve the financial performance of your firm, you must measure it and adjust when you get off track.

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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Dennis Kennedy in making his 2006 Blawggies Awards selected morepartnerincome.com as the Best Overall Law Practice Management Blog with David Maister's Passion, People and Principles and Bruce MacEwen's Adam Smith, Esq as runner-ups.   To be selected as the best blows me away; just being in the company of Maister and MacEwen is an honor in and of itself!

While the name morepartnerincome attracts the attention of most managing partners, there are some who are put off by the name. What they miss is its core message. More partner income is the result of “doing the right things and doing them right”.

You do not have to make a choice between higher income and better client services.  Higher income is the result of better client services.  It is not a choice between placing the interest of clients first or driving income higher. Higher income is the reward for serving the client’s interest.  It is not a choice between higher margins and the proper concern for treatment of the firm’s talent.  Higher income comes from the quality of the team and their environment. 

To think of those alternative choices is to have fallen victim to what Jim Collins refers to as the “Tyranny of the OR”.  Excellent organizations practice “And Thinking” rather than “Or Thinking”.   For example, how do we provide exceptional services to our clients and exceptional compensation to our legal professionals and employees?  These are not incompatible choices.  To the contrary, the very process of “And Thinking” leads to breakthrough innovations.  The genius of “And Thinking” is that greater success results from the effort to achieve both rather than limiting an organization’s efforts based on the belief that we could only have one or the other.

Morepartnerincome.com is sponsored by Juris, Inc.  For information about Juris® products and services for increasing law firm performance and partner income, go to www.Juris.com.

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The recent Law Firm Economic Survey conducted by Juris, Inc. illustrated the relationship between the fees charged by midsized law firms and their per-partner income. While that relationship might seem unsurprising, it should be thought provoking.

The above chart divides surveyed firms into quartiles according to per-partner income and then shows the comparison between their average fees. The actual realized blended rates, as well as reported standard rates, were lower for each subsequent quartile. Partners of law firms in the first quartile earned twice the per-partner income of the second quartile and seven times the earnings of partners in the fourth quartile. Is this a blinding glimpse of the obvious—law firms that charge more make more?

Here are the important questions: Are the lawyers in the top 25 percent of surveyed firms better lawyers? Are they smarter? Did those firms pick more profitable practice areas? Have they done a better job at branding?

Let me suggest a simpler answer. Midsized law firms with higher rates simply set them higher to start with! If we take a look at individual firms, we can find clear reasons why one firm can charge higher rates than others. But when I review the 2005 survey results, these reasons don’t appear to explain the aggregated results in the survey. The composition of each quartile appears to be similar mixes of practice classes and size.

Law firms regularly increase rates from year to year to cover increased operating expenses, including associate salaries. In most cases, such increases do not contribute to higher margins. They simply recover higher expenses. If a firm starts with lower fee rates, they tend to stay lower in spite of annual or periodic increases.

Midsized law firms need better information about competitive prices in the marketplace. Rather than think in terms of annual increases to the existing fee structure, they need to reset those fees based on market information. They need competitive and peer group intelligence. Traditional surveys provide some insight, but they are often 18 to 24 months behind the curve, and matching your individual firm to a meaningful peer group is an imperfect task. Better information is on the way through new benchmarking services such as those from Redwood Analytics, Peer Monitor and Juris Insight.

Even with better information, individual law firms can have a difficult time restructuring rates. Compensation plans often lead to partner resistance toward anything other than moderate increases. Partners dependent on origination credit for a significant portion of their income can feel threatened by possible client defections. The best approach may be an incremental one. Reset fee structures for new business and develop an incremental plan to rework existing relationships over time. A helpful guide to price increase implementation was suggested in the prior post Law Firm Rate or Fee Increase Letter.

Morepartnerincome.com is sponsored by Juris, Inc. For information about Juris® products and services for increasing law firm performance and partner income, go to www.Juris.com.
 

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