Make More Rain : economic outlook, forecasting

Tax Reform Up For Grabs

Admin — Thu, 29 May 2008 07:00:45 GMT

With the tax cuts enabled during the Bush administration coming to an end soon, lobbyists and tax attorneys are lining up to offer their opinions on how the tax code should be reformed.

According to an article in the National Law Journal (Firms Gear Up For Critical Tax Polcy Changes), "[a]bout $4 trillion worth of tax revenue provisions are expiring, the most in the history of the U.S. tax system":

"The next president has some ticking time bombs to address," said Jim Miller, a tax attorney who last month moved to Winston & Strawn's Washington office from Hunton & Williams. "There's now the greatest potential for tax reform certainly since 1986".

How is this important to you? Consider this:

"Tax issues will be the key driver for political and economic activity for the next half-dozen years," Mike T. McNamara (a Sonnenschein Nath & Rosenthal partner) said. "All of our clients are trying to look at how tax policy will drive or hinder their business plans."

It isn't just your clients who need to watch the tax policy. Your firm needs to pay close attention to how tax policy is addressed so that you may draft your own business plan that take the new policies into consideration.

Alan J. Auerbach, Jason Furman, and William G. Gale wrote an essay on possible approaches to tax policy titled Facing the Music: The Fiscal Outlook at the End of the Bush Administration.

The tax foundation has a summary of each of the Presidential Candidates' tax plans that can be accessed by clicking here.

If you want to talk about "perfect storms", consider the effects on your business of expiring tax cuts and a struggling economy. How tax policy is approached in the coming year(s) will be telling on how well our economy rebounds from this (at least so far) minor contraction.

Partner Cost and Client Profitability (Part V)

Admin — Tue, 27 May 2008 07:00:00 GMT

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.

Over the last 4 weeks, we have been discussing in some detail the topic of partner compensation as a direct cost in profit modeling. Specifically we are answering the question: “How much of a partner’s compensation should the firm consider when calculating the cost rate allocated to each billable hour he/she works?” We have evaluated several methodologies that create unfavorable results and 2 that Redwood Analytics recommends. While we will discuss another methodology today (or variations of previous strategies), it is important to remember that there is not one right answer that will work for all firms. Instead, 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.

Sliding Scale (for minimum margin % or $):

The final methodology we will explore in this series is a variation on the previously recommended approaches. In this variation, firms have the flexibility to use different minimum margins for different partner “ranks”. We do not suggest moving to complete customization (where each partner has a different threshold) but we do recognize that the minimum margin for a senior partner may differ from that of a mid-level partner and a junior partner. In other words, it has been argued by several partners we know that the relative portion of compensation paid to a partner for performing billable work decreases with seniority. Since most firms have some form of partner ‘shares’ , ‘points’ or other credits, we recommend using this as the basis (see fig 1 below), but standard rate or tenure could work as well. In this example, we have split the partnership into 3 buckets to determine the minimum margin %, the firm is free to choose any number of buckets. It should be kept in mind that too many can unnecessarily increase complexity and open the door for disagreement for both start/end points for the ranges and the minimum thresholds

Minimum Shares	Maximum Shares	Minimum Margin %
1	50	40%
51	100	30%
101	150	20%

Figure 1

Alternatively, instead of using a handful, a firm could create a continuum to represent the changing minimum that would eliminate the abrupt change in partner profit that would be experienced as they progressed from one bucket to the next (see fig 2 below). In this example, a partner with 150 shares would have a 20% minimum margin while a partner with 100 shares would have a 30% minimum.

Figure 2

In the examples below, we see the three familiar partners from our previous blog entries with the minimum % applied from the table shown in figure one. Once again, the Jr. Partner is not affected by the minimum because his fully loaded margin exceeds the threshold. Unlike the minimum margin % methodology though, this approach differentiates the Rainmaker and the Dept. Manager (instead of both having 40%). Keep in mind that while we have illustrated this methodology using the minimum margin % approach, we can also apply this to the minimum margin $ approach.

Role	Comp	Std Rate	Shares	Minimum Margin %	Cost Rate*	Actual Margin
Rainmaker	$1MM	$250	125	20%	($200)	20%
Dept. Manager	$500M	$200	75	30%	($140)	30%
Jr. Partner	$150M	$150	25	40%	($83)	44%

* Assumes 1800 standard billable hours expectation

Advantages of the methodology:

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.

We have to address the weaknesses of this approach as well:

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.

While this series documents every methodology (some with slight variations) that we have come across in our years of working with firms, we do realize that it is not necessarily exhaustive. Have you used, seen, or thought about a methodology that we have missed? Do you have any other feedback? I’d love to hear from you: rpaquette@redwoodanalytics.com

Law Firm PEPP "Bubble" To Burst?

Admin — Fri, 09 May 2008 07:00:24 GMT

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.

Partner Cost and Client Profitability (Part II)

Admin — Tue, 06 May 2008 07:00:21 GMT

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

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

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

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

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

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

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

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

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

Alan Greenspan Versus The World - The Debate Matters To Law Firms

Admin — Fri, 11 Apr 2008 07:00:57 GMT

There are differences in opinion on regulation of financial markets. On the one hand, Alan Greenspan takes a mostly hands-off approach to financial markets, except when risks to the economy appear. Martin Wolf, among others, have criticised Mr. Greenspan for his policies that they believe contributed, even caused, the current credit crisis.

They both seem to enjoy sparring via the Financial Times. For a little background, read what Mr. Wolf wrote of Mr. Greenspan after he retired as Federal Reserve Chairman (requires registration to read). It was written about in the New Economist blog with a summary.

In March, Mr. Greenspan opined in the Financial Times that regulation won't create a "perfect model of risk". He concludes:

"Thus it is important, indeed crucial, that any reforms in, and adjustments to, the structure of markets and regulation not inhibit our most reliable and effective safeguards against cumulative economic failure: market flexibility and open competition."

Mr. Wolf responded in his forum with nine points in opposition to Mr. Greenspan (read through the comments to see Mr. Wolf's response). He and others criticised the former Chairman for keeping interest rates too low for too long after the brief recession of 2001. This, they maintain, led to the massive asset bubble fueled by great liquidity. Mr. Wolf also aludes in one of his points that far too little attention is still being given the "excessive savings outside of the United States". Some fear global inflation in excess of 5% will be the result.

Mr. Greenspan answered in the Economist's Form section of the Financial Times that was published in print April 7th in an Op/Ed piece. Again, Mr. Greenspan set the rules of the game as black and white:

"My view of the range of dispersion of outcomes has been shaken, but not my judgment that free competitive markets are by far the unrivaled way to organize economies. We have tried regulation ranging from heavy to central planning. None meaningfully worked. Do we wish to retest the evidence?"

Mr. Wolf responded on April 8th in an editorial titled, "Why Greenspan does not bear most of the blame". He grants many of Mr. Greenspan's arguments, but finishes:

"Regulation cannot be perfect. But the worse the outcomes now become, the more difficult it will be to defend free financial markets at all. Without a credible design for regulatory improvement, it will prove impossible."

The arguments on both sides are well worth the time spent reading and provide a better understanding of the likely debates to be held later this year contemplating additional regulation of the financial markets. The breadth of reach that resulting legislation will have affects just about every area of the legal market in some shape or form. The thought leaders are debating it right now. Take some time and read the opposing views. On whose side do you favor?

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

Business Development Opportunities For Law Firms In 2008

Admin — Mon, 07 Apr 2008 07:00:08 GMT

An article in the Tampa Tribune (hat tip: Estrin Report) reports that foreclosures are so high in some areas that firms are hiring as many as 200 additional staff to handle the workload. Foreclosures in Hillsborough County, Florida in February more than doubled the amount from February 2007 and is more than 5 times the foreclosures from February 2006. This reportedly is putting a strain on the "assembly line" approach firms here use to push these cases through the system.

This is an extremely worrying sign. Granted, the investment houses purchased in Florida may not be the primary residences of the owners. However, their investments were lost and many lost their savings in the process.

This is more evidence that the 2008 Client Advisory published by Hildebrandt and CitiBank is off the mark. There does appear to be offsetting legal work to be found. This is reassuring news to law firms, especially those who have expanded practice areas, that they may not suffer what the Client Advisory termed "the perfect storm" where all areas of practice trend downward with no offsetting surge of work.

However, it is likely that Congress will act to slow foreclosure activity on primary homes sometime this year. Though good news on the surface, Congress isn't very effective in softening the effect of a market correction.

Our economy is volatile. Opportunities for work will be everywhere but not necessarily in areas traditionally served by your firm. Firms need to prepare to be innovative in their business development approaches this year to take advantage of the continued fall out from the several market corrections that have happened and will happen in the coming months.

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

Law Firms Pass On Arbitration In Employment Disputes

Admin — Fri, 04 Apr 2008 07:00:36 GMT

In an article for the upcoming issue of the National Law Journal (NLJ) posted yesterday on their site, law firms are not taking their own advice when it comes to arbitration clauses in employment disputes.

Is this a case of what's good for the goose isn't good for the gander? Why would arbitration be a good idea for other businesses but not good for law firms? The answer brings into question the utility of arbitration.

The arguments for arbitration come from those who have been burned in litigation. Litigation can have you sitting in front of a jury that likely has no experience in the subject matter at hand and may in fact have motives other than the subject matter at hand to deliver a large award to a plaintiff. Arbitrators, on the other hand, are picked from within the industry from which the dispute arises and ostensibly provide a more fair, though equally binding, resolution at less cost than litigation. Where litigation can hinge on perception, arbitration decisions are meant to be grounded in experience-laden fact.

According to the NLJ story, however, only 10% of 200 law firm respondents to a 2003 survey had "mandatory arbitration in place". I assume this means that equity partners were bound by it through the partner agreement and that other employees were bound by it as a condition of employment, though it isn't specified in the article. One reason cited is that arbitration clauses may have a detrimental effect on the workplace. Said a partner with DLA Piper, "Your attorneys can perceive that you are materially changing their position vis-a-vis the firm and attempting to circumscribe the rights they might otherwise have."

I believe that statement holds true to any situation where arbitration exists, not just when applicable to law firms. Any other reason to not have them? The article paraphrased a partner in the New York office of Greenberg Traurig, writing "Arbitration [] no longer offers the benefits of a speedier, cheaper resolution, as proceedings have become bogged down in discovery and quasi-motion work that mirrors litigation."

If that is truly the case, then arbitration has a gloomy future indeed, and not just with law firms. I brought up the article to an attorney I know who defends clients in arbitration and he told me some of his concerns with it:

Arbitration has become very inefficient, with no control over evidence admission (ie, evidence can come in at any time);
The arbitrators do not have the same fear of appeal that judges do and thus are unafraid to ignore precedent;
The quality of arbitrators has declined.

This indicates some serious problems with the arbitation system for dispute resolution. As the attorney I spoke with said, "Our clients used arbitration to get away from runaway juries. Now they are going back to the courts to get away from runaway arbitrators".

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

Another Word Of Caution Regarding Inflation

Admin — Thu, 13 Mar 2008 07:00:05 GMT

This morning I am off to Chicago to attend the ABA Techshow. I am speaking on benchmarking and the results of the 2007 Law Firm Economic Survey Friday at 2:30pm central. If you are attending the conference I encourage you to drop by. I plan to do some blogging at the event as well, including recording some interviews.

In the meantime, I did a little more research on inflation yesterday and learned some interesting things. I'm no conspiracy buff, but I have to admit that connecting dots is a fun exercise.

First, the Federal Reserve just two years ago decided to stop tracking what is called M3 transactions.

http://www.federalreserve.gov/releases/h6/discm3.htm

According to the fed, it isn’t necessary. According to others, it means the fed is hiding something.

http://www.inflationdata.com/inflation/Inflation_Articles/M3_Money_supply.asp (Interesting analysis related to the Chinese buying back our debt that is being devalued daily just so we can continue to buy their exports.)
http://www.investmentu.com/IUEL/2005/20051208.html
http://www.discursivemonologue.com/2008/02/10/the-federal-reserve-m3-and-inflation/
http://www.moneyweek.com/file/5138/m3-0212.html

A House Bill was introduced shortly thereafter requiring the Fed to reinstate the policy (introduced by ex-Presidential candidate Ron Paul) - http://thomas.loc.gov/cgi-bin/query/z?c109:H.R.4892: - no legs sprouted from it.

Some are therefore calculating M3 themselves:

http://www.nowandfutures.com/key_stats.html
http://www.shadowstats.com/alternate_data

Another troubling sign is what the Fed has been doing lately to help weakened financial institutions increase their liquidity – ie, pumping money into the markets by buying up the possibly worthless mortgage notes so that banks continue to lend.

http://biz.yahoo.com/ap/080311/fed_credit_crisis.html?.v=6

The final worrying sign is the runaway bull market in oil. Oil is near $110 per barrel.

http://www.ft.com/cms/s/0/53123f5c-ef59-11dc-8a17-0000779fd2ac.html?nclick_check=1

How will this affect law firms? Well, as noted yesterday, you need to keep an eye on inflation and your margin. With high margins and low inflation, you are pretty well insulated to inflation's effects. If inflation spikes, though, all bets are off. Based on the above linked articles, however, are we (as Larry Bodine has stated several times) already in a recession? And is inflation already well above 4%?