Make More Rain : blog

A New Year for All

MichelleStPierre — Tue, 05 Jan 2010 15:50:00 GMT

After suspending his blog back in June of 2008, David Maister has officially announced his retirement today , not just from blogging, but from all consulting, speaking, and writing engagements. We here at MPI wish him well in retirement, but recognize...(read more)

Happy Thanksgiving!

MichelleStPierre — Wed, 25 Nov 2009 14:00:00 GMT

I want to take this chance to wish all of our readers a very Happy Thanksgiving! As our CEO Mike Walsh reminded all of us here in LexisNexis US Legal Markets via email yesterday, "Today, Thanksgiving is marked by football, the Macy's Thanksgiving...(read more)

Part Two of Leverage: Friend or Foe

Admin — Tue, 14 Apr 2009 20:02:00 GMT

In Leverage: Friend or Foe of Maximized Profits per Partner I discussed an approach that a firm could use to address the dropping demand for legal work. In short, this approach suggested that a firm could reduce their supply of legal work to match current demand by cutting heads in its most junior ranks, the ranks that produce the lowest $PP contribution. This is simply de-leveraging. By doing so, the firm would ensure sufficient utilization and would generate the highest possible $PP for existing partners . At the same time I also hinted at a second alternative that would enable a firm to deliver greater PP$ than simply de-leveraging.

Previously I had described the firm structure that delivered the highest possible $PP, which I called the Managerial Maximum. In essence, the Managerial Maximum is the highest amount of leverage that a firm can effectively manage. By having the maximum # of associates working (Sr., Jr., etc.) per partner, they are generating the maximum $PP contribution which results in the maximum $PP, assuming 100% utilization. Any deviation from this maximum leverage ratio will deliver lower $PP. (see example pyramid below)

But what should a firm do if demand for legal work decreases and they can no longer maintain 100% utilization? What most firms are doing in today’s environment is de-leveraging, which is taking them away from the Managerial Maximum. I propose that firms should not be making cuts exclusively to lower level associates as the current de-leveraging strategy espouses, ie. cutting off the bottom of the pyramid. Instead I suggest that firms cut the side of the pyramid off, “thinning”, which entails cutting partners and the appropriate ratio of non-equity associates/staff until they reach a point where their supply of legal work matches the demand for legal work. (See example pyramid below)

By adopting this approach to matching supply and demand a firm is also ensuring that the maximum leverage ratio is maintained, which will result in the maximum $PP possible. For a given amount of legal work, this approach will generate more $PP than will de-leveraging. However, it will require cutting into the partner ranks, which may be culturally and politically challenging.

Below is an example that shows the impact to $PP of the different ways a firm can react to a decline in demand.

In the Base Case, demand is 200,000 hours. This firm is fully leveraged and is delivering $4,350,000 PP$.

Now demand has dropped to 140,000 hours and the firm cannot maintain 100% utilization or the Managerial Maximum leverage. The firm can de-leverage, “thin” or a combination of the two in order to increase utilization and improve leverage.

Below is a table that shows the PP$ result of the various lawyer combinations the firm can choose depending if they decide to de-leverage or “thin”.

If the firm chooses to address the decline in demand solely with de-leveraging the PP$ will drop to $3,600,000, however, if they also adopt a “thinning” approach their PP$ can increase back up to the $4,350,000 they had delivered in the past. In a vacuum, my recommendation to this example firm would be to “thin” down to 6 partners as this would permit the firm to stay fully leveraged while matching hours demanded as close as possible to hours worked (ie. supplied).

Overall, there are two ways a firm can react when demand for legal work declines: 1) they can de-leverage or 2) they can “thin”. De-leveraging will deliver the maximum $PP for existing partners, “thinning” will deliver the maximum $PP possible. Note: I recognize the challenges of eliminating equity partners from a firm. This recommendation is strictly the result of objective considerations.

--Scott Nickerson

Scott is an analyst in the Redwood Think Tank.

Martindale-Hubbell Connected Launches Networking for Lawyers

Admin — Tue, 31 Mar 2009 21:27:00 GMT

Social networking has evolved significantly from pressing the flesh at boring seminars and dinner events to the online world of LinkedIn and other such sites, and at LexisNexis we’re proud to be a part of that world now. Today marks the launch of Martindale-Hubbell Connected.

At Redwood we have always endorsed the idea of business development from within – it’s easier, faster, and less expensive to bring in new business from existing clients than to pound the pavement in search of new clients, and given today’s economic client, this is even more important. However, the cost effectiveness of online networking can change that equation. The opportunity to connect online – in a private, authenticated network – with General Counsel and other legal professionals across the globe through existing trusted relationships is one key to the success of business development in a time of budgetary constraints.

From martindale.com -

Martindale-Hubbell Connected combines the largest global resource of legal contacts - more than one million lawyers and law firms around the world - with social networking technology to create a dynamic, authenticated network enabling corporate counsel and private practice attorneys to uncover new relationships and trusted referrals, share information and insights, and to identify their connection to firms, corporate legal departments or other lawyers.

To join Martindale-Hubbell Connected, lawyers can visit www.martindale.com/connected. We’ll see you over there soon!

LEVERAGE: Friend or Foe of Maximized Profits per Partner?

Admin — Mon, 30 Mar 2009 15:21:00 GMT

There has been a significant amount of debate on the subject of leverage over the past few weeks, and there appears to be some passion around the concept. Articles have attempted to show that it does not work, while others tout its value. My belief is that regardless of economic conditions, more leverage is better than less leverage if the end goal is generating the maximum possible Profit Per Partner ($PP).

In order to discuss leverage, it is important to establish some groundwork, so that we can build examples to illustrate key points.

All examples discussed assume 100% utilization unless otherwise noted. There are many variables in the leverage equation, so in order to keep things orderly and understandable some of the variables, such as utilization, will be kept fixed until it makes sense to free them up.

Leverage is defined in several ways depending on who is discussing it. For this discussion we don’t get into specific leverage ratios, so a standard mathematical definition isn’t required, however, we do need to establish the upper and lower extremes of leverage.

The lower limit of leverage (ie. the least leveraged) is a firm that is made up of one partner and no associates. The maximum Profit per Partner ($PP) that can be generated in this case is however much the one partner can bring in.

In order to determine the upper limit of leverage (ie. the most leveraged a firm can be) we need to consider the main constraint that limits leverage, managerial effectiveness. There are other relevant constraints that limit leverage but for now we are assuming that we can find associates to hire and offices for them to sit in. Managerial effectiveness is simply the measure of how many people each level at a firm can manage effectively while still delivering on their other responsibilities. In our examples we are assuming a partner can effectively manage 3 Sr. Associates, and a Sr. Associate can effectively manage 1.3 Associates and 1.7 Jr. Associates. When a firm is structured so that each level is managing their effective maximum number of subordinates and they have in place all levels that are applicable (ie. Partner, Sr. Assoc., Assoc., Jr. Assoc.), the firm is considered fully leveraged and will be generating the maximum possible amount of $PP.

Why is this true? Because each incremental non-partner employee will bring in some incremental $PP given that their billing rate is higher than their cost rate and utilization is at 100%. This structure has the maximum number of employees bringing in their maximum $PP contribution, which generates maximum possible $PP. This is the upper limit of $PP, the upper limit of leverage and I refer to it as the “Managerial Maximum”. If firm structure was viewed in the shape of a pyramid (shown below), it would be the size and shape that maximizes $PP. There would be no other size or shape (ie. structure) that could deliver more $PP and in fact, most changes to the structure would negatively impact $PP.

Note: There are a variety of reasons why this theoretical “Managerial Maximum” may not ever be reached, but it provides a yardstick to measure other potential structures against. Regardless, given 100% utilization, more Leverage will generate greater $PP than will less Leverage.

The above pyramid displays the organizational structure that will generate the greatest $PP given sufficient hours demanded to deliver 100% utilization. But what happens when hours demanded declines and the firm can no longer maintain 100% utilization? This situation is what many firms today are facing and there are two conceptual approaches to how they can handle this. In both approaches, firms are attempting to better match their supply of legal work to the newly lowered demand for legal work.

Approach #1: De-leveraging

This is the approach that most firms have chosen during these down times. In de-leveraging, a firm pulls work back from some levels (and reduces headcount) in order to keep other levels fully utilized. In this example and in reality, it is usually the case that the higher on the pyramid a fee earner is, the more $PP per hour they are generating. That is, a Sr. Associate will generate more $PP for an hour worked than an Associate will, etc. Because this relationship exists, the optimal approach to leveraging is to always have work done by the highest level in the organization and only push it down to lower levels after higher levels have reached capacity. And when de-leveraging, the optimal approach is to pull work back from lower levels first in order to keep higher, more profitable levels fully utilized.

Note: This exercise is ignoring the impact of billing rates on demand for hours and the fact that legal work is not always fungible, but in the interest of gaining a conceptual understanding in a perfect world, this is how a firm would roll out and roll back leverage.

In the pyramid below, the color of the lowest level has been changed to indicate the removal of work and the reduction in headcount. This approach to leverage, both increasing and decreasing will generate the maximum $PP possible, for the hours demanded, for the group of existing Partners.

As I have explained the optimal approaches to leveraging and de-leveraging, I have been very careful to emphasize that optimal leveraging will maximize $PP for existing partners. Earlier in this blog I had presented a theory that the upper limit of $PP would be achieved only when a firm was leveraged to its “Managerial Maximum” and any deviation from this point would deliver lower $PP. Therefore the approach that most firms are taking, de-leveraging, is taking these firms further away from their “Managerial Maximum” and as a result they are leaving incremental $PP on the table. Later this week I will propose a strategy (Approach #2) that will permit firms to match their supply of legal work to existing demand while also chasing the more profitable “Managerial Maximum” and will permit them to recapture some of the $PP they left on the table when they de-leveraged. In the meanwhile, I welcome your comments.

--Scott Nickerson

Scott is an analyst in the Redwood Think Tank.

Too Good To Be True

Admin — Tue, 24 Mar 2009 22:04:00 GMT

Shortly after I graduated college I had just been dumped by college sweetheart, was not happy with my original career choice, and my billfold was getting smaller and smaller as the country was in a recession. Safe to say I was in a bit of a quarter-life crisis and my confidence was slightly south of nothing. That said, within my larger circle of friends I had noticed and briefly met a girl whose beauty was so striking that the room stopped every time she walked in. I and my friends...and pretty much everyone else thought there was no way she would ever be interested in a guy like me. I am no Brad Pitt to say the least. Yet to my surprise she started to actually pursue me (That should have been the first sign that there was clearly something wrong with her). On our first date we went to a bar and I remember immediately hearing whispers from other male patrons about how in the world a loser like me could be with a gal like her. Those whispers made me feel pretty good, important even.

Now here is the reality. Within five minutes of that date I realized that this girl had so much baggage that even United couldn't lose it all. In addition every time I talked with her I wanted to claw my eyes out. Even my friends who at first thought she was a knockout quickly changed tune and told me I was a moron for dating her. Every moment was full of drama, I could never make her happy, she messed with everyone's mind, had a temper that would make Chuck Norris cry, and Chuck Norris can't cry. My billfold was not only gone but would not feel the touch of debt free cash for quite some time. I still bang my head against the wall every time I think of those days. Why did I date her??? Why would I have subjected myself to that torture??? Well, reflecting back, it was because I was on the rebound, I didn't have many other prospects at the time, my self esteem was way down, the whispers made me feel like a somebody, and I just didn't have the skill yet to pick the right people to date.

Now that I have bored you with part of my dating past there is a reason why I bring this up in a law blog. Travelling from firm to firm I have heard many stories about risky clients that have been taken on within the recent past. Some of these clients promised big returns on contingency cases, yet even though the likelihood of success was slim the firms took on that work. Why you may ask? Well, in this down economy where attorneys are starved for hours worked the mere chance that maybe just maybe they could win made them take on the matter. How did it turn out? Nine times out of ten, just as you would expect. Resources were poured into the case, the firms played with house money and at the end of the day there was absolutely no return.

In other cases I have seen very risky clients being brought in who not only have poor payment history but are demanding the world when it comes to fee arrangements and terms of payment. Again the primary reason is that work is down and attorneys need hours. Right now in many minds any hour is a good hour. Sadly this is a major problem that needs to be addressed. Just like I was down in the dumps after college, so too now are many firms. Self esteem is low after a downturn in growth, layoffs of peers, and pressure to bring in any originations. Yet the idea that any work is good work is simply false. As my colleague Bo Yancey recently mentioned, understanding the opportunity for the firm with respect to what the client is offering is essential for long term sustainability. A lot of firms would be better off not taking any of this overly risky work and focusing their efforts on identifying prospects, (most likely internal ones) that can help get acceptable work for lagging practice areas until while dust clears.

We know all too well how hard this economic downturn has hit not only the legal industry but the industries that firms serve. It is a depressing time for many of us, but we still have to keep our wits about us and make the right decisions. I made the mistake of taking on a very risky venture in my dating past. Not only that but even after I knew it was a failure I kept it going for months afterward. I challenge firms to not make a similar mistake and analyze your intake process. Try your best to make the right decisions on clients despite the pressure for originations. Finally, if you realize you made a big mistake, correct it as quickly as you can before you drain additional resources. I'd like to think that my billfold would be twice as big now if I hadn't made the choices that I did. Perhaps the same can be said for many firms ten years down the line, long after this recession.

-Russ Haskin

Russ Haskin is Director of Consulting for Redwood Analytics/Lexis Nexis

The Lost Measure: Cost of Capital - Stress Test Your Firm

Admin — Tue, 10 Mar 2009 19:13:00 GMT

When I started working with law firms in 1999, I used to have heated (and futile) debates about the importance of the time value of money in assessing firm (or practice, billing lawyer, etc.) performance. My argument was simple. Take the law firm business model to any venture capitalist and pitch them: “I have a great business for you. An illiquid minority position in a talent-based, service business with few tangible assets, subject to capital calls. What do you think?” The scenario provoked a lot of chuckles. When I then suggested that the minimum necessary return for that scenario was probably north of 50%, outrage ensued. Cash, after all, was cheap (multiple people suggested Libor as a cost of capital) and easy to get. Collections were predictable.

I think it’s time to revisit the argument. Of course, interest rates today are even lower. Capital, however, is scarce from both internal and external sources. Moreover, the risk component to working capital, the largest component of most firms’ capital base has dramatically changed. For years, Redwood has utilized a model of “discounting” outstanding A/R based on historic collection patterns versus different points of the aging curve. This has allowed firms to more quickly grasp and manage the devastating impact of aging receivables. I think the time has come for more aggressive modeling. At a time when corporate America is scraping cost savings from anywhere they can get it, in a buyer’s market for legal services with utilizations tanking and with rising unemployment (including among lawyers), I think the time has come for law firms to utilize the same sort of “stress tests” being run elsewhere. Can my firm survive 85% or even 80% collection realizations? What if these are combined with 30/60 day extensions? What is the impact on my working capital? Where is my point of “no mas”? In my example below, under a “Perfect Storm” scenario, the firm has tested a deterioration of realizations and an extension of cash collections and has seen a total decrease in available working capital of $20 million plus an incremental $4.5 million of capital costs.

I believe firms that incorporate cost of capital assumptions this way will be better prepared to deal with adversity, and I suspect all who do so will come to the same conclusion that I have. Namely, that the cost of capital for firms is much higher than most realize and that the firm would be very well served by aligning the reward/punishment components of its compensation schemes with much higher costs. These higher costs can provide a measure of protection firms need in today’s climate.

--Norm Mullock

Norm is the Redwood Product Champion for LexisNexis. Since 1999 Norm has helped firms of all sizes deploy solutions that reduce the effort needed to produce existing analyses and enhance firm performance.

RFPs: A Necessary Evil

Admin — Mon, 09 Mar 2009 21:58:00 GMT

As we’re all aware, in today’s economic climate there is a big focus on cost reduction. It’s no surprise, then, that RFP’s are being used with even greater frequency by purchasers of legal services. The concept is not new, but the extreme focus on price across a large percentage of those companies probably is. For law firms, this is not a happy consequence. Law firms incur significant expense by simply responding to RFP’s, with no guarantee of work at the end of the process. Of course, a primary reason for companies using RFP’s to begin with is to get the lowest price across all parties—which means that the “winner” of the RFP may not be getting profitable work. In an RFP process, it’s not a guarantee that the lowest price will get the business, but it’s nearly certain that “bidders” with pricing substantially above the lowest prices will be eliminated quickly from consideration.

...(read more)

Closing the Barn Door

Admin — Fri, 06 Mar 2009 01:06:00 GMT

It seems like every article, blog, lecture, or memo now starts out with the words, “In these economic times,” and then goes on to explain what should be done. In fact, I am sure we could find many articles starting out with some slight variation of this premise reading back a few days in this website. While many of the business practices and choices currently being made are a direct result of the poor performance of the economy in general, from a management consulting standpoint, there is nothing like necessity to make people actually take notice of good ideas. I would surmise that if you are using the current market conditions to employ a sound business decision, you are probably well behind the curve. A good idea today was probably a good idea 2 or 3 years ago in the days of double digit growth.

Of course I am being somewhat facetious and coldhearted. Many of the decisions made today are both painful and undesirable to all involved, but necessary due to existing conditions. That does not change the fact that, in the past, there were many ideas that could have been taken advantage of in order to improve the well-being of individual firms while they still had the option.

Suggestions on how to increase profitability and streamline efficiency have always been out there, but in good economic times it hardly seems necessary to make a change to a practice that could create more work and stifle growth in the short term for potential long term gain and stability. Just ask my wife, who has insisted for years I either paint or replace the railing on my front stoop. Why would I when, in my opinion, the railing looked fine? While there were a few cosmetic blemishes, they were barely noticeable unless you were specifically looking for them. However, as if tempting the inevitable, I leaned up against the railing last month and fell into my holly bush. Sure, my parable of reckless abandon with marital bliss and home repair may seem silly but I knew that eventually the unpainted sections of wood were suspect to rot. I also knew what my wife said made sense but it would have taken time and money, both of which I did not want to spend.

I bring this up because I was recently speaking with an individual at a firm I have worked with quite regularly over the years; they thought the idea of me thrashing about in a holly bush quite amusing. This firm has been quite successful in past years and while they understood the concept of cross selling work and that introducing additional partners to certain client relationships would potentially yield more work overall and lead to greater client retention, this firm was satisfied with their current profitability strategy did not think it necessary at the time to encourage this behavior within their firm.

I can’t say I blame them, after all “if it ain’t broke, don’t fix it,” right? Well, we won’t know for sure, but I do know that double digit growth is no longer on the horizon, or even in the rearview mirror. This client, like many others, is struggling to keep certain practice groups viable due to lack of work and significant client attrition. As for myself, I have a new vinyl railing that doesn’t need to be painted, a neatly trimmed holly bush, and am revisiting the list of home repairs given to me by my wife a few years ago.

--Derek Schutz

Derek Schutz is the Director of Programs for the Business of Law team at Redwood/LexisNexis.

Strategic Leverage: Just as Important as Ever

Admin — Wed, 25 Feb 2009 20:54:00 GMT

It is part of my job to make sure I am up to speed on all the economic movements of firms here and abroad as this economic downturn has not trickled down but headed full- fledged into the legal industry. Each day I read article after article about associate and staff layoffs at firms of various sizes and peer status. In addition I attend conferences and listen to Managing Partners, CFOs, and other C-level staff address how to combat this downturn through various actions used to cut costs. At most conferences there has been an inevitable line of presentations on reducing overhead along with addressing the headcounts of staff and salaried timekeepers. If I have to hear about controlling space planning and technology expenditures anymore I think my head might spin.

I speak with CFOs all the time and the prevailing theme is that budgets have been cut so much recently that the line is very thin on providing appropriate support to the primary operations of the firm. I am not saying that these measures of analyzing overhead aren’t important. In fact I agree they are and should be done on a consistent basis, not just when there is an economic downturn.

Most consultants I have spoken with all agree, if you had no strategic plan in place before the recession you are probably too late. Since many firms fall into that category they have fallen into an immediate cost cutting tactical strategy that almost completely focuses on the easiest things to cut (staff, associates, technology, etc.) In some cases the staff and associate cuts are valid in that the recession has produced a prime opportunity to do what was probably overdue in eliminating poor performers. For other cases it is the perceived method of addressing what aims to be a possible rough year or two. Unfortunately I feel that this method of reducing costs is shortsighted and evasive of one of the key detriments to firm performance within an economic downturn, underperforming partners.

Let’s address the shortsighted nature first. In the early 90s the legal industry felt the effects of a recession that lead to mass layoffs of associates and staff. As time passed and the economy improved those firms found difficulty in re-staffing properly for the growing legal work they were receiving. Gone were the associates who were already trained and ready to be the next leaders of the firm leaving a re-tooling effort that could have been avoided. By purging large numbers of associates it mortgages the future of the law firm, leaving a void to fill when the economy turns. This, despite the fact that when it comes to strategic leverage, a well levered firm can be much more profitable.

Strategic Leverage

Below is an extremely simplified view of the effects of leverage. Assuming 100% utilization and 1800 budgeted hours the impact of a shift in the non-partner to partner ratio of 1:1 to 3:1 clearly would reduce revenue, a point that is often used to counter the initiative of leverage, but the key statistic for the legal industry, Profits per Partner, increases. This is generally due to the higher percentage return that associates bring in. Another component that is not even captured in the model is a likely reduction in overhead. This sort of analysis should be done by firms on a consistent basis regardless of economy to find the right mix. You obviously need partners for reasons that anyone reading this blog should be aware of but leveraging is a true way to improve firm profitability. That fact reinforces the shortsighted nature of the removal of staff and associates for cost cutting purposes. You just cannot cut and cut all the way down into profitability.

Addressing the Economic Slowdown through Underperforming Partners

This leads into the other concerning trend I have seen. The legal industry is not focusing enough effort on underperforming partners. As mentioned by my colleague Bo in his forward looking view of leverage last week, smart firms are the ones who will take this opportunity to deal with underperforming partners as well as associates. But we’re just not seeing it here in the US.

I have often wondered why that is the case, but from many discussions with managing partners, the prevailing theme seems to be a feeling that by disturbing the “glue” it would show weakness and perhaps cause unrest among the other Partners. At face value I can understand, but the examples are before us where turning a blind eye to underperforming partners have contributed to successful partners actually leaving firms and causing those firms to fall into decline. I think the point is that subjectively most partnerships have a general idea on who is performing and who is not within the ranks. Technology and consulting can bring data to back those beliefs, but if nothing is done about the underperformers, the over performers may develop resentment as their pocketbooks get hit.

Within recent weeks we have seen several firms release partners in the UK. Linklaters just announced a reduction in their partnership as has Addleshaw Goddard. The Times Online recently spoke with Nigel Boardman one of the UK law firm Slaughter and May’s top partners. He had several great quotes that illustrate this need to address underperforming partners, “I don’t think it follows that a downturn in work means that you cut your associates…If you have to cut, cut your partner profits and even your partners…good lawyers are hard to find.” Mr. Boardman is addressing that thinning the junior ranks will leave firms without qualified talent as the years go by and that is not a good long term strategy.

Profitability of law firm is driven by several factors, but the seemingly elephant in the room (cutting underperforming partners) seems to be a factor that firms have difficulty addressing. It could date to years gone by when partners were considered untouchable. Yet the recessions of the past have changed that as has the changing model of the law firm. This recession is weighing on the legal industry and those firms that finally address partners and practice areas that have not been performing to firm standards and make the move to strategically shift their firm for the long term are going to come out ahead when the economy turns the corner.

--Russ Haskin

Russ Haskin is Director of Consulting for Redwood Analytics/Lexis Nexis.

A Different 2011 Scenario: Leverage Expands

Admin — Sat, 21 Feb 2009 01:01:00 GMT

Over at the AmLawDaily, Paul Lippe recently caught our attention here at Redwood Analytics with his sensational headline, ("Welcome to the Future: The 2011 Scenario and the End of Leverage,") but we're having trouble connecting the dots to get to Mr. Lippe's vision for the future of the legal industry.

Mr. Lippe's assertion: Leverage will be less prevalent, because the market value of associate work will be less than it is today. While partner contribution may be essentially the same as today, the declining value of the work of non-partners and other fee earners will reduce overall revenue for work between today and two years hence by as much as 20 percent.

We're not convinced that firms will devalue leverage for two reasons:

Mr. Lippe's hypothesis assumes that the legal work of 2011 will be identical to the legal work of 2008. We disagree.
What is described as the "end of leverage" is in actuality an extension of leverage. The current supply/demand dynamic between purchasers and providers of legal services does not mean the end of leverage. If anything, an expectation of reduced pricing power argues for more efficient planning and staffing of matters and a closer look at the structure of practice groups and law firms.

The Work of the Future

Whether Mr. Lippe is correct about the relative value of a piece of work today and in three years is largely irrelevant. For starters, today's premium work is tomorrow's commodity work. This is the case in most industries, and we don't believe the legal industry is an exception. While partners will appropriately be compensated for their "deep expertise, and judgment about the client, the law and best practices....." pricing power is as much about the type of law as the lawyer. This is at least in part a function of supply and demand, and will impact associate pricing right along with the partners for whom they are working.

We're hard pressed to believe that the nature of legal work will be static over the next three years, and that there won't be new types of work, new areas in which there will be an opportunity to become an expert, and areas of law in which the demand for expertise will return pricing power to the lawyer and the law firm.

Leverage Continues to be the Answer

Mr. Lippe points to four places that dollars will go instead of into the pockets of law firms:

1. "Clients will just flat-out spend less, drive harder bargains and get more for their money."

Clients driving harder bargains will force law firms to produce efficient work. That means good work at the lowest cost. Alternative pricing and deep discounting does not argue for a de-emphasis of leverage as a driver of profitability. While most firms are cutting headcount through associates and staff, we believe that the smarter firms are the ones who are taking this opportunity to deal with underperforming partners as well.

2. "Some work will go to outsourcers, whether onshore or off."

How is this not leverage? This form of leverage will continue to expand, and we acknowledge that there is work currently done by large full service firms that will be handled much more efficiently by other providers. We refer again to the fact that legal work is not static in nature. There is certainly work that is handled today by paralegals that was handled by associates 10 or 20 years ago.

3. "More work will go to contract lawyers or proto-associates not on any kind of partnership track."

This form of leverage too will continue to expand.

4. "Some associate time will get replaced by technology."

Nothing new here. No question, legal work will continue to evolve and technology will help firms become more efficient. This is the ultimate form of leverage.

Mr. Lippe asserts that "associate time is a pricing mechanism, not an indicator of value." While we don't disagree, it seems fairly clear that all fee earner time is a pricing mechanism within an hourly billing system, and that the market itself is the indicator of value. For Mr. Lippe and other proponents of the argument that law firms are on the brink of "the end of leverage" we're very interested to learn how firms will maintain, or grow, profitability without the use of leverage. While there may be a small decline in overall leverage ratios of large firms over the next year or two, we believe this will be the result of firms being slow to make hard decisions about partners. This, surely, must be temporary. At Redwood, we've studied the drivers of profitability across hundreds of firms, and found that leverage is far and away the second biggest driver of firm profitability (behind revenue per lawyer). We just don't see leverage diminishing in importance, regardless of economic factors or advances in technology. These things aren't new.

As for the current demand imbalance between law firms and clients: as a wise man once said, "this too shall pass."

--Bo Yancey

Bo Yancey is the Director of Professional Services at Redwood Analytics. He leads a team of consultants who provide practical advice to law firm leaders interested in using analytics to manage the business of law.

Merit Based Systems?

Admin — Fri, 20 Feb 2009 00:37:00 GMT

The recent NYT article, “Chill of Salary Freezes Reaches Top Law Firms”, once again highlights that the recession is causing many firms to rethink their compensation structure. In the short term that means freezing salaries. “There is this sense that firms didn’t act prudently during the boom and now they are getting religion, and that it’s better late than never…Many associates we have spoken to think the freeze probably saved jobs.” In addition, many firms are also taking the long term approach of moving to a more merit-based compensation and advancement system. David Lat, founding editor of AboveTheLaw.com, suggests “I think some breakdown in the lock-step mentality might actual stick. Firms are recognizing that on a certain level, it makes sense to pay people in a way that reflects their performance”

But can merit based systems become a reality in a profession steeped with tradition and typically averse to change? For Henry Bunsow, a partner at Howrey, the answer is yes. Bunsow states, “I would say the leaders of Howrey are very concerned about client perception and the cost of legal services and justifying the cost of legal services… And the idea that the compensation levels are arbitrarily set, when those compensation levels in turn result in hourly billing rates, makes no sense from a business standpoint – no business in this country would run themselves that way.” Howrey introduced a merit-based system in 2007.

Still, many will argue that a move towards a system without billable hour requirements or mathematical formulas will result in fewer billable hours. There are two answers to this argument. First, for many law firms, culture dictates lawyers work long hours, so a minimum billable hour requirement is unnecessary. Second, focusing on the quality of hours and not the quantity can have a greater impact to firm profitability than any negligible impact on hours. The key is to make the hours count. As Bunsow also notes, “Our goal is to attract and keep the best people, to compensate them for what they’re worth and to justify their cost to the clients, because we think clients are willing to pay for high quality legal services.”

To implement such a system, law firm managers should begin with full disclosure for the reasons for changing to a new system. Next, evaluation criteria should be discussed. If the goal is improving quality of work, special consideration should be given client satisfaction. Recently, the Association of Corporate Counsel began working on a “Value Challenge Index”. Criteria for the value proposition can be easily applied to a merit based evaluation and includes:

1. Understands goals and expectations

2. Legal expertise

3. Efficiency/process management

4. Responsiveness

5. Innovation/Flexibility

6. Results delivered

7. Values: Pro Bono/diversity/green/professionalism

The merit based decisions and budgets for salary increases should be put in the hands of practice group leaders. “In this fashion, the firm can control its budget and the percent of associate salary expense relative to revenue and total expenses. Also, since these partners are most knowledgeable about associate performance, they are the most appropriate persons to award merit increases.” Lastly, increased monitoring and management of individual margins and rate spreads is essential to improving profitability in a merit based system. But you were doing that already, right?

--Rick Rawls

Rick Rawls is a Senior Business of Law Consultant for Redwood Analytics/Lexis Nexis

Watch This Space

Admin — Fri, 20 Feb 2009 00:35:00 GMT

Keep watching MorePartnerIncome.net, now sponsored by Redwood Analytics as part of LexixNexis, as we bring you more of the thoughtful content you've come to expect on the financial management of the law firm. We welcome your comments and ideas, and look forward to offering insightful financial management techniques and business practices for law firms.

The Corporate Management Structure: Viable in the Legal industry?

Admin — Tue, 25 Nov 2008 20:34:00 GMT

In a former career I consulted within the corporate world. There, the majority of companies used a management approach where levels of managers would have direct reports that would scale upwards to higher levels- essentially a vertical corporate structure. Although there has been a shift within many organizations to a “matrix” or “flat” horizontal platform, the structure of boss and direct report still exists at the core. Since I have been consulting for the legal industry I have seen similarities to the corporate structure, but there are some fundamental differences, and it has always struck me that there could be a better organizational structure within the legal industry that would provide the desirable attributes of accountability and developmental planning.

Almost every firm has department chairs or practice group leaders who are responsible for the management of that portion of the firm. In addition, the mentoring of associates is a big priority for most firms. But is it truly a boss/employee relationship? Do law firms have “management teams.”?

The idea of management teams within the legal industry is not a new idea, but it is one that has been tough to implement. In an ideal setting you would have one partner managing several associates, with responsibility for their utilization, development, and discipline. This way when an associate is underperforming there would be one partner to talk with, who should know all the ins and outs of what is taking place. That is not what we are seeing today. Generally you have an associate working on a multitude of partners’ matters. This creates various issues, among them multiple levels of discounting by responsible attorney, personality differences, and having to request additional work from multiple attorneys to meet billable hour targets. The last of these is the most troubling.

The Redwood Think Tank did a study that indicated that those associates who eventually make partner start out making or surpassing their billable hours target and continues with this trend until they are promoted. Conversely those associates that end up leaving the firm or managed out within the first 5 years start and continue not making their billable hours goal from the beginning.

These facts are pretty powerful in addressing associate development, even after the first year. I am not sold that those associates who underperform are not getting the work solely because of a lack of effort or poor performance. Perhaps it is because they were not placed in the proper environment, and perhaps having the right mentor could be the key to success. A mentor might not only provide the needed billable hours to meet goals, but also the legal and organizational knowledge to propel an associate down the partner track. The opposite is true for those associates who don’t have a sufficient mentor. Are firms losing qualified associates simply because of a substandard organizational structure?

A potentially better structure would be to have one partner feeding work and being responsible for the development of a specific group of associates. This structure might not work with many law firms, as originations and responsible hours vary by group/partner, but it does not mean that you cannot have a boss/direct report relationship. A system that allows the associate to request more work from the mentor, and the mentor using that request to go to other partners for more work if he/she does not have it available could create a more cohesive and development-friendly atmosphere.

Having a structure like this provides the ability to analyze data by mentoring partner to identify development gaps and fill them when needed. I am not suggesting that underperformance is always due to a lack of mentoring, I am simply suggesting having accountability by associate and partner so there are two points of contact.

The question remains how to make this feasible and cause a shift to the suggested structure. The first suggestion is robust time-keeping software that can break out and measure the performance of mentoring time as well as other non-billable activities. The second, and more important suggestion, is that the performance of those associates whom a Partner is mentoring should be included within the partner compensation process. For most firms the focus for partner compensation continues to be billable hour generation and collections. The idea of assigning a portion of compensation has been quite subjective. If management teams are in place, and you truly measure the success of those teams, you end up assigning a number that can be benchmarked against other teams. Placing a quantitative value on mentoring and addressing it within partner compensation would be give this process the best chance to affect real change.

--Russ Haskin

Russ Haskin is Director of Consulting for Redwood Analytics/Lexis Nexis.

Alternatives to the Billable Hour

Admin — Tue, 18 Nov 2008 21:30:38 GMT

For years, there has been much talk, and decidedly less action, on “alternatives to the billable hour.” GC’s say they want this, and firms say they are willing to provide these options, but neither side tends to “walk the walk” in a way that matches up with their stated intentions. We think there are a couple of key reasons for this:

1. On the GC side, as much as companies are interested in reducing costs, there is little creativity or interest in crafting “win-win situations.” There is clarity in the billable hour, and with that model, less concern that firms will be leaving money on the table that ends up in law firms’ pockets.

2. On the law firm side, firms quite simply have trouble managing to a fixed price or blended rate. It takes people skilled at active management and estimation, which only comes with experience. Firms often always lose money the first few times they try these types of arrangements, making them “gun shy” about doing it again.

The result of the above two issues is that the billable hour continues to dominate, despite its’ being a disincentive to efficiency on the firm side, and an inexact way of predicting legal expenses for clients.

In these less-than-robust economic times, both sides should take a harder look at the pricing models that exist currently for legal services. The most obvious issue, implicit in both of the above-stated problems, is one of trust, which is borne out of relationships and experience. As we all know, trust is a key component in the long-term success of any client/law firm engagement, and especially on one using a pricing model other than the billable hour.

On the law firm side, the more firms can accurately understand the value to the client they are providing for various types of work, the better they can accurately assess the appropriate work effort and the price the company is willing to pay. Over time, the combination of these 2 things can be used to accurately price the work profitably, based on staffing needs and their associated cost.

On the client side, the client has to understand that the law firm is a business too, and requires a margin on its work for it to desire to continue the long-term relationship. The greater the clarity into what the client bottom line is--- whether total cost, expense predictability, outcome, or some combination—the better the firm can be at pricing the work in question.

There are many tools available to law firms (such as Redwood Analytics’ Matter Planning Tool) to help firms price out blended or hourly rates, with multiple scenarios and sensitivities. These are a key piece, from the firm side, of understanding how leverage and pricing affect profitability. However, it is the back-and-forth between the client and firm that ultimately has the biggest impact on alternative pricing arrangements. Firms must understand and respect clients’ priorities and their relative importance regarding legal services, and clients need visibility into firms’ bottom line as well. This give-and-take, and both sides’ commitment to long term success of the relationship, will be what make alternative arrangements succeed. Given rate pressures, clients’ general dissatisfaction with legal services, and a more challenging economic environment, firms would do well to begin to engage their clients in these conversations, if they haven’t already done so.

--Bo Yancey

Bo Yancey is Director of Professional Services for Redwood Analytics/Lexis Nexis.