Make More Rain : forecasting, blog

Why the Year End Collection Push is Not a Best Practice

Admin — Tue, 09 Sep 2008 16:38:57 GMT

It is that time of year again, at least for the early starters, when the legal industry begins its preparations for the year end collection push. The push has become an industry standard and buzz word over time. Each year countless hours are put into collecting massive amounts of receivables every December in order to meet targeted numbers. Although it is a foregone conclusion that there will be a year end push for most law firms, is this really a best practice?

The “ideal” approach with respect to legal industry inventory management is to have a continual billing and collections push year round, so everyone can enjoy the holiday season without worrying about making a budgeted target for collections. Although ideal, given the history of the industry, this is unfortunately a practice that will take time to implement. Even if that happens, the remains of the year end push might still have legs. For most firms both lawyers and, more importantly, their clients are used to and expect a year end push. It is a behavioral pattern that is established and therefore not going away anytime soon. That said there are negative ramifications to such a practice and a few firms have recognized this and smoothed out their collection pattern.

Client Behavior

The first obvious detriment to a year end collection push is the impact on client behavior. If clients expect a year end collection push then they are less apt to pay within a consistent, timely manner. Some clients even have said to relationship attorneys who have tried to smooth out the process, “Why pay now if I know you are just going to look for more in December.” In fairness to the client I would probably hold on until December as well. For example, if my mortgage company let me pay all of my mortgage payments in December, I would do so - which brings me to my next detriment of the push, the Time Value of Money impact.

Time Value of Money

A dollar today is worth more than a dollar tomorrow, so everyday a firm does not collect on a receivable they are foregoing the opportunity of re-investment. In my previous mortgage company example, I would take all of the money I owe the mortgage company invest it in some sort of portfolio that would give me a return on that money which would go straight to my pocket instead of the mortgage company. That is the same thing that occurs with the year end collection push within the legal industry: Investment income is left on the table as receivables age.

Aging Inventory

The next 2 problems are more internally focused within each firm. Not only can the collections push can have a negative impact on client behavior, it can as well with attorneys . A colleague of mine wrote a blog back in June on “Valuing your Firm’s Inventory” which I encourage everyone to read as it outlines how, as receivables age, the likelihood of realizing the original amount of those receivables diminishes. Since attorneys also exhibit the behavior of letting work age before it is billed, and billings age before they are collected, the probability of billing or collecting the original work/bill amount goes down.

Other obvious detriments include the ability to know where you are to your budgeted numbers as the year goes along, and how to budget for next year given a lack of information on your collections; a final drawback of the year end collection push is the impact on the age of your inventory. In the graph below, you can see three years worth of inventory pushes. There is a significant drop in balance each December (as depicted in the bar graph), but you can also see a spike in the age of inventory. Why does this occur?

I ask many of the firms I work with and they almost always point to the answer: At year end, with pressure to make budgeted goals, most of the collection effort is on receivables that firms know they can collect and are more recent in nature. Therefore, the older inventory that has been aging over the years continues to get older and may get to a point where it is completely uncollectable. This is an unfortunate side effect of the collection push and one that should be accounted for in any inventory management strategy.

Although I have gone over many reasons why the year end collection push is not a best practice, I am not blind to the fact that it is not easy to make a quick switch to a continual inventory management process. So given that the “ideal” practice is not a readily accessible current option, are there things firms can do to prepare and approach the year end billing and collection push to try to maximize its result while working on the before mentioned strategy shift ? The first suggestion is start billing early –nothing earth shattering. With most firms you see an upward trend in periodic billings in October and November. That trend should start in the 3^rd quarter, and those firms that have a more gradual collection slope in the last few months also have an increased slope in billings from August until November. The easy explanation to this is that billing is a more controllable portion of the inventory cycle than its counterpart. In the example below, you can see such steep a slope in each of the prior 2 year end pushes where as in the last year that billing was much more gradual and steady as the end of the year approached.

The natural benefit is that by getting the built up WIP out the door in a timely manner will give you the ability to focus on collections for a longer period.

The firms that I have worked with who have had the most success with respect to WIP management are those that have some stipulation on billing in a timely manner when it comes to their partner compensation. Knowing that many firms cannot simply switch their compensation system on a dime, this type of action is not widespread, but it is a proven method. Each firm has seen an improvement in inventory management when a portion of partner compensation has been tied to that driver. “Compensation” in this regard can be defined as a direct input into the partner compensation equation or, alternately, can equate to monetary “fines” for late billing and/or collections.

It may be inevitable within current industry conditions that December will be the month with the most collections. Again, it is in the best interest of the firm to change the status quo and begin collecting earlier and in a timely manner. Not only will you be able to have a better idea of where you will stand to budget sooner, but it will set your firm up for budgeting the next year. Still, if focus can be put on opportunity balances (those that have aged past an expected pay time) early in the process it may help avoid the side effect of the ever aging inventory. Those older balances can have the focus early on and perhaps generate collections while in December the focus can shift to the more readily available receivables.

I certainly hope that as time goes along the year end collection push will lose its luster as a buzz word and be replaced with continual inventory management. At the end of the year the firms that take this to heart just may see increased realizations, additional investment income, and perhaps most importantly a little more piece of mind that you are on target and can enjoy the holiday season.

- Posted by Russ Haskin

Associate Salary Increases & Firm Margins

Admin — Thu, 04 Sep 2008 17:20:23 GMT

It should come as no surprise to anyone that the most recent wave of associate salary increases have helped to erode law firm profit margins. Whether the wave begins in west coast technology firms, or east coast financial capital firms, its effects are felt beyond big law in the mid-size and regional firms headquartered in the mid-west and southeast. And, with 80% of law firm expense tied up in compensation and occupancy, the impact can be devastating. What is more surprising is the response of law firm leaders in this new economic environment. Reactions run the gamut from slash and burn tactics to taking it on the chin and silently watching margins erode. Formulating a balanced strategy and resisting the urge for an emotional response is critical. Consider the following.

First, is increasing associate salaries is an appropriate response to increased competition for the best talent in your market or just a follow the leader reaction? Associate salary increases typically begin in markets where competition is fierce for not only attracting the best talent, but also keeping that talent as the reality of billable hours requirements hits home. Increasingly, associates are not willing to trade work life balance for a big paycheck. This attitude is not pigeonholed in the bottom half of the law school classes, but pervades throughout. Are there other work life benefits your firm can offer to entice top talent?

Secondly, recent surveys suggest the demand for legal services have declined in the first two quarters of 2008, and making sure your lawyers are properly utilized is essential to maintaining profitability. As margins become slimmer, there is no room for unproductive associates taking up space. But are associates really the problem? Most associates have little control over the projects they are assigned and virtually no ability to generate new business. They, like everyone else in the firm, rely on the rainmakers to generate enough billable hours to support the business. Before taking a defensive posture and eliminating positions, look for ways to improve your business development efforts. Are you effectively cross-selling your services to existing clients? Do you place enough emphasis on developing new business and in the right sectors?

Lastly, in today’s competitive marketplace, passing increased costs on to your clients is rarely an option. Even in big law, where clients were thought to be less price sensitive, general counsels are scoffing at increased rates as a result of higher associate salaries. Can you blame them? That doesn’t mean you have lost the ability to control your average rates. The next time someone asks you for an alternative billing arrangement, consider the request an opportunity to control your own destiny. Look for ways to strengthen the value proposition, improve practice management at the matter level, and increase leverage.

Can you avoid the impact of associate salary increases? Not likely. But focusing on the positive economic aspects of your business, rather than going on the defensive, may help you roll through the downturn and leave you prepared for the eventual upswing.

- Rick Rawls

Management Report Do's and Don'ts

Admin — Mon, 01 Sep 2008 17:21:00 GMT

I was recently asked to speak at a conference on the topic of management reports and how firms are using them to help run their businesses. It is a topic that I have been fortunate enough to gain a lot of insight into over the years. Often I am handed a stack of reports and asked to help the firm automate them or to come up with a package of reports to use as their “reporting package”. Most firms spend a lot of time and resources building their reports to look a certain way but spend little thought into the way that they are used and the actions they expect them to drive.

Any firm can generate data, but to be able to use this data to help model, analyze, and improve their business the firm must approach reporting with a more consistent process. Currently, I see many firms looking at information that could be best described as “interesting”. Interesting information is not the same as useful information. In order to take full advantage of the information available to them a firm must:

• Understand the business drivers of a law firm
• Identify what is controllable
• Establish reasonable goals and relevant metrics

Once the proper mindset has been established and goals have been set, the law firm can move forward with building a set of reports that identifies the best opportunities to reach these targets. The most important part of developing these reports is to keep them focused on the specific drivers of the goals and not get lost in the “noise” of the data. A common misconception is that having more data available improves the management process. In fact, the danger of information overload is just as great (or greater) of a problem as not having enough data or the wrong data. As Jack Trout says in his book Trout on Strategy, “Knowledge is power only if you can separate the important from the billions of data swirling around you”.

In the end, reports need to be catalysts for action. Reports by themselves do not make any difference in performance of a firm, rather they should serve to initiate improvement. By setting up a plan from the outset and then setting up reports to manage towards that plan the firm will become more efficient and consistent in their approach. Reports do not need to be complex to be useful, but they do need to speak directly to the questions being asked, providing clear direction quickly and succinctly.

- by Derek Schutz

Managing Partner Advocate Summer Issue In The Mail

Admin — Mon, 30 Jun 2008 23:30:57 GMT

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

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

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

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

Valuing Your Firm's Inventory

Admin — Fri, 27 Jun 2008 17:16:24 GMT

Most law firms understand intuitively that the value of inventory (both WIP and A/R) degrades over time, but by how much and how quickly? The ability to understand and answer these two questions is the first step in preparing a realistic, forward looking valuation model; one that can identify opportunities and drive action, rather than simply report on past performance.

To begin to answer the question of the future value of current inventory, it is important to realize there are two different forces diminishing a firm’s return on work performed, and both have the same basis: time. In essence the old adage “Time is Money” is true; as time passes, your inventory becomes less valuable.

The first and most basic of the two forces is widely known and easily calculated. For our purposes, we will call it the Time Value of Money effect, or TVM. A dollar today is worth more than a dollar tomorrow. Anyone who has ever used a credit card, carried a mortgage, or borrowed or lent money in any fashion, understands this concept. However, many law firms simply disregard this as a cost against their inventory, or use such a low discount rate, as to make it negligible. When considering a firm’s discount rate, too often factors such as reasonable market expectations of returns and inflation are swept aside. In the model below we use a simple method (with two different Discount Rates) to determine the cost of time on a firm’s inventory: Amount X Daily Discount Rate X Open Days; where the Daily Discount Rate = Yearly Discount Rate/365 days.

The second, and in most cases much larger charge to your inventory, is what we will call the risk of default (this refers to both defaulting on receivables and not billing work in progress). This is the risk that a firm will not realize a portion, or the entirety, of the value of work performed. In most cases it is instinctively understood that receivables a year old are far less likely to be realized than those just billed. The same can be said for WIP. But how do we measure this concept? One possible way (and there are many) is to use available historical billing and payment patterns to develop a forward expectation curve. We can then apply this curve to our current inventory to determine the amount that is realistically likely to bill or collect. This method can be made more complex or simple depending on various assumptions and the level at which the expectation curve is developed to (i.e. practice group, type of work, client, etc) but the concept remains the same -- past performance is an indication of future performance.

In the example below, such a curve is constructed for a client based on a set period of time and then applied to four matters with outstanding A/R (a similar model can be built for the WIP side). A total of $200,000 has been billed over the life of this client, with $175,000 eventually being realized (or 87.5% seen at day 0). As might be expected, the majority of the collections (> 50%) have historically taken place within the first 90 days. The Fwd A/R Expectation Curve helps quantify the expectation of collection (or non-collection) as current A/R ages based on prior practices (i.e. at 240 days, $50,000 has been available to collect, but only $25,000 has been collected, giving us a historical realization expectation of 50%; therefore, if current A/R now ages to 240 days, we would expect to realize 50% and lose 50%). Of course, like any forecast, our model will not be 100% correct at each level of granularity, but it does provide a logical, and historically proven, method to value inventory, particularly at the firm level.

While simplified, the models above allow us a better understanding of a) how much of the work we have currently performed we expect to realize and b) the actual value of that work once we do realize it. Any questions, concerns, or comments on the above can be directed to Dschutz@redwoodanalytics.com.

Associate Attrition Skyrockets By Year 5

Admin — Wed, 18 Jun 2008 07:00:18 GMT

The Association For Legal Career Professionals recently released an Update On Associate Attrition covering the 2007 calendar year. The numbers are striking:

Overall percentage of associate attrition was 18% for 2007;
24% of these associates had been on the job for two years or less;
74% of 2007 departing associates left the firm within 5 or fewer years of their arrival.

The most cited reason for entry-level associate attrition was "pursuit of specific practice interests".

The reason for entry-level associate attrition leads me to believe that the survey is large-firm heavy. Large firms provide entry-level attorneys with high salaries and intense work schedules. Within 3 to 5 years, prudent associates should have their law school loans paid off and can now seek to practice in their own desirable area of law. In fact, the median size of the firms in this survey was 220 attorneys. Only a fifth of respondents were firms with 100 or less attorneys.

Looking at just the 100 and less category, the percentage of associate attrition was at 17%, 15% had left the firm within 2 years of being hired and 69% left the firm within 5 years of hiring year. It is too bad the survey did not track the reasons for attrition based on firm size, because I suspect that the main reason for attrition for smaller firms wasn't to pursue specific practice interests, but may be closer to the main reason cited by departing laterals: "unmet work quality standards".

There is little doubt that associate attrition is prevalent in law firms of all sizes. It is possible that the high attrition rates are reflective of the common culture. Where once a ball player would stay with the same team for their entire career, free agency now reins. Where someone would work at the same company for the greater portion of their life, now employee loyalty is considered a thing of the past. Neither sports nor businesses in general have made employee attrition a pressing issue to be resolved. When it comes to business realities (i.e., pensions) some businesses specifically don't want employees to retire with them. Why should it be a concern to law firms?

Whether or not associate attrition is important to your firm may depend on the area of law practiced. For example, a defense litigation firm that is well organized and has developed processes that manage their recurring tasks may not be too bothered by attrition, particularly if they have a mechanism for quickly training new associates. On the other hand, an estate practice that relies on many years of expertise can't afford high associate attrition.

Firms would do well to track associate attrition and determine the reasons for their departures. Although it may be in the interest of some firms to encourage attrition, in the long run firm sustenance is reliant upon the retention of quality talent.

Forecasting Collections and Inventory Management

Admin — Thu, 12 Jun 2008 07:00:51 GMT

In today’s unstable environment, driven by outside economic forces, higher associate salaries, and increased competition, law firm leaders are faced with the tough job of forecasting cash collections. Many existing forecast methodologies focus on production and collection realization. However, these models often fall short because they ignore the other drivers of collections, and do not provide any information about collections beyond the forecast period. A better model:

1) Forecasts bills and collections as they relate to inventory levels thus allowing analysis into the impact of the next period’s collection funnel,

2) Drives the forecast according to the speed of the billing and collection cycle,

3) Isolates the quality of inventory separate from collection timing by analyzing realizations at the time of collection.

A key aspect to understanding collections is to think of the process as an inventory funnel. Each month production is added to the funnel, increasing inventory available to bill and collect. At the same time, bills and collections, as well as write downs and write offs drain the funnel, thus reducing inventory levels available next period. By analyzing this inventory turnover, modelers can focus on the drivers of collections: beginning inventory, production, inventory turnover, and realizations. Consider the following example:

	Last Year		Forecast
Beginning Inventory	$50,000		$60,000
Production	$150,000		$170,000
Total Available for Collection	$200,000		$230,000
Written down/off	$10,000		$11,000
Cash Collected	$130,000		$150,000	(3)
Inventory Turnover	$140,000		$161,000	(4)
Ending Inventory	$60,000		$69,000

Inventory Turnover %	70%	(1)
Realization %	93%	(2)

1) Inventory Turnover/Total Available for Collection

2) Cash Collected/Inventory Turnover

3) Total Available for Collection * Last Year’s Inventory Turnover %

4) Inventory Turnover * Last Year’s Realization %

In this model, the total available for collection is beginning inventory plus production. By comparing the amount available for collection and the ending inventory, the modeler may derive the inventory turnover. Also, by looking at the type of turnover, collected vs. written down or off, the modeler can calculate realization. Applying Inventory Turnover % and Realization % to future inventory, produces a cash collected forecast based on all of the cash drivers mentioned above and provides a starting point for the next period.

Redwood Analytics has helped law firms forecast collections using this and other methodologies since its inception. Our Business of Law Consultants are prepared to help law firm leaders take their forecasting to the next level by sharing best practices forecasting techniques, separating inventory turnover for billing and collection cycles, and capturing the seasonality of collections. In addition, our business intelligence solution is uniquely positioned to help law firms not only improve their forecast, but also their actual results.

Blawg Review # 163

Admin — Mon, 09 Jun 2008 07:00:16 GMT

Now that it is finally the turn of More Partner Income to host Blawg Review, it is tempting to stray from our mission. For those who may expect this, I'd like you to join me for a moment of digression, as I whisk you away to a remote vineyard in southern France, placing you at a hilltop overlooking hectares of ripe grapes as a cool breeze gently flows through your hair. It is dusk, and the reddish glow of the horizon creates in you a moment of reflection, something you haven't done in years. A sommelier suddenly appears: a vinucator who will ruin the moment by lamenting the perils of the homogenization of wine.

Ok, that should sufficiently shatter the tranquility of the moment, so let's move on to the theme of this entry: Law firm survival in economic hard times.

You know that when the price of a gallon of gas increases, it is because of evil oil companies. That is a given, right? Well, sure, if you don't know what goes into the price of oil. Similarly, without knowing the costs associated with performing a service, law firms might be tempted to not increase their own rates, considering the implications it may give to clients (gasp! we are affected by economic conditions, just like you!).

Reid Trautz argues in his blog Reid My Blog! that firms should increase rates now, mid-year, based on perceptions of our economy. If firms haven't already increased rates this year, now is about the time they should consider it. Inflation isn't waiting for you. Though some argue that law firms can be recession-proof, Ed Poll argues that law is subject to economics just as any other business.

Judge Posner in the Becker-Posner blog writes of the cost of the deterioration of infrastructure. More money will be needed to finance upgrades. From where will it come? Tax increases? Tax cuts? How about taxing wheels?

The Estrin Report discusses more layoffs for associates and staff - regardless of whether the economy improves or not. Even partners aren't immune. Jim Cotterman of Altman Weil suggests that the likelihood of becoming partner is being affected by the economy:

Generally law firms are best situated if they promote to ownership only those who can maintain, refresh and expand the business opportunities of the firm. Without this one attribute, no firm can remain competitive or viable for very long.

What can a law firm do? For one, it can avoid being stupid, as Jordan Furlong of Law21 writes. What does he mean by stupid?

Partnerships that don't enforce rules against uncooperative or alienating partners who happen to bring in a lot of revenue;
Senior lawyers who consistently hoard the best work and the most client contact, to the detriment of junior lawyers;
Firms that allow women lawyers to leave because of partnership tracks that are tailored for men;
Firms that prioritize short-term profits over long-term interests.

Speaking of women, Matt Homann in his blog the [non]billable hour writes of the five things you need to know about women and word of mouth. One of the things appears to be costly: Instead of offering a 15% discount for referrals, offer a 15% discount to everyone a woman refers! Considering this blog's disdain for discounting fees, I would prefer that "kirtsy" discount be placed on a timer.

I'm more inclined to attract women [clients] who misbehave.

Another thing firms can do is communicate better with clients. Status reports are often an underutilized medium of communication that can mean the difference between a happy client and a lost client.

Tom Kane's Legal Marketing Blog discusses 6 steps to improving client service:

Agree upon and commit to a defined set of client service standards.
Turn fluffy, high-level strategic statements into real, definable, measurable action steps.
Provide training and ongoing reminders focused on what it takes to meet and exceed a client's expectations.
Include client service as a significant factor in compensation.
Give leaders the power to enforce standards (carrot and stick).
Provide role models, teach the skills, give opportunities to practice and supply meaningful feedback. One great rehearsal hall is within your own firm, where lawyers can deliver exceptional service to each other.

Being a role model is a tall order in today's firm, where partners appear to work twice as much as associates. However, in a great post from the Harvard Business Review "Editor's Blog" titled A Boss Who Changed My Life, Steve Prokesch writes of the means that his boss employed that helped "turn us individually and collectively into winners":

Set the bar high and then push your team to raise it higher;
Make excelling a team activity;
Promote your team in the organization;
Remember that management is personal;
Champion your people.

The above is a lesson that can be learned by all in business.

There are other blogs that were emailed to me which are also worthy of mention:

Mark Herrmann, author of one of my personal favorite books, "The Curmudgeon's Guide To Practicing Law", co-authors a blog called Drug and Device Law. His June 5th post is titled Users Guide To Defence Amicus Briefs - Wyeth v. Levine.
Victoria Pynchon, author of the blog Settle It Now Negotiation Blog, wrote a series of moving articles on the familial issues surrounding the last days of her father's life and the possibility of suing her father's physician; the first titled Negotiating Life's End.
Biker Law Blog host Norman Gregory Fernandez writes of California's new law banning cell phone use (when not using hands free) and whether the law serves its purpose of reducing distractions to drivers.
Eric Turkewitz of the New York Personal Injury Law Blog writes of a purported obscene filing in a Texas court (which is later shown to be a practical joke played on a partner - who said lawyers had no sense of humor?).
There must be something in the air in Texas: The Wall Street Journal Law Blog writes of a Texas Federal Judge in the case Waggoner v. Wal-Mart issuing an Order that was as ridiculous as it was funny (as if the SouthWest Conference was ever in the same category as the SouthEastern Conference!).
Lowering the Bar has a post discussing a Colorado store owner who was ordered to stop taking shoes from people he catches shoplifting in his store.
Brett Trout discusses in his blog, BlawgIT, the patent application of Microsoft's device manner's policy.
Every law student finds an obsession to take their mind off the stress of law school (I dropped over $10k on building a 110 gallon reef aquarium), but Chris Colin from the San Francisco Chronicle writes of an old friend who developed a passion for crafting dinner plates based on legal themes.

Jesse Hines (a guest author on Write to Done) argues that a single-idea post often works better than list posts. Though I didn't follow that particular advice in writing this entry, I look to that blog as a source of writing guidance.

Thanks to all who emailed suggestions this past week. Blawg Review has information about next week's host, cearta.ie, and instructions how to get your blawg posts reviewed in upcoming issues.

RainToday Report: 76% of Law Firms Discount Fees

Admin — Fri, 06 Jun 2008 07:00:32 GMT

Pricing has been a frequent topic at More Partner Income. Some past topics include the science behind pricing, the ill effects of inflation on pricing, pricing management, and discounting.

RainToday has recently released the Fees & Pricing Benchmark Report: Law Firm & Legal Services Industry 2008. David Maister wrote a blog post on a similar report released by RainToday focused on the consulting industry on April 28th. There were some striking similarities between the two reports:

65% of consulting firms reported they discounted fees. 76% of law firms reported discounting fees;
Average discount of responding consulting firms was 11.7%. Average discount of responding law firms was 9.9%.

Of the two pre-bill adjustments (mark downs and discounts), discounting is the most difficult to change. Both show weakness in the firm, but discounting creates a feeling of entitlement from clients. How?

Marking down time tells your client one of several things (the below is not exhaustive):

I spent more time than I can reasonably charge you for the service provided: ie, I am not efficiently working the matter;
My associates spent more time that I can reasonably charge you for the service provided: ie, my firm has less competent attorneys working on your case or I have inefficient staff working on your case;
Even though I spent an adequate amount of time on this, it "seems" too high to me: ie, I am unclear on the value of my service.

All of the above are correctable. They are entry-specific adjustments that can be seen as temporary.

On the other hand, discounts are typically applied to the entire bill. This gives rise to expectations of entitilement. They can tell your clients one very negative thing: I am overcharging you up front and adjusting it on the back-end.

Just as discussed on this site in the post Discounting At Law Firms, the RainToday report suggests that there may be valid reasons to discount, but only when the discount is intentional, strategic, and, ultimately, mutually beneficial to you and your client.

Some reasons to discount given in the report include well-funded start-up clients (in expectation of long-term payoffs) and absorbing the cost of training new associates. It is also something to consider when trying to win RFPs, in exchange for quick payment of invoices or in return for a threshold amount of work that the client will provide to the firm.

The important part of discounting is that it is mutually beneficial to you and your client - there needs to be consideration for the discount. It needs to be binding so that if the client does not perform on their end, the discount doesn't get applied. If there isn't quid pro quo, you are giving a clear message to your client that you overcharge up front - and that your rates are open to negotiation.

Hosting Blawg Review # 163 Next Week

Admin — Thu, 05 Jun 2008 19:25:40 GMT

More Partner Income will be the guest "blawg" on BlawgReview next week. If you would like to submit a blog to be reviewed, please refer to the submission guidelines that can be found here.

Partner Cost and Client Profitability (Part VI)

Admin — Tue, 03 Jun 2008 07:00:03 GMT

This is the last in a 6-part series on partner compensation and client profitability written by Ron Paquette, consultant with Redwood Analytics, now part of LexisNexis. The first article, titled Client Profitability: What Is The Cost Of Partner Time?, was an introduction to the concept of allocating partner cost in calculating client profitability. The second article, titled Partner Cost And Client Profitability, (Part II), is focused on pitfalls of some firms' methodology in allocating costs to partners. The third article, titled Partner Cost And Client Profitability, (Part III), is focused on basing a partner's direct cost on a "minimum margin percentage". The fourth article, titled Partner Cost and Client Profitability (Part IV), is focused on basing a partner's direct cost on a "minimum margin dollar amount". The fifth article, titled Partner Cost and Client Profitability (Part V), is focused on allocating a partner's direct cost using a variation of both the "minimum margin percentage" and "minimum margin dollar amount" based on different partner "ranks" using a sliding scale. This final article compares the different methodologies to help a firm decide which one to utilize in their environment.

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

The first step Redwood took as we set out to answer this question was to determine what we were trying to accomplish with an allocation methodology. From there, we developed a list of five criteria to evaluate each methodology against. As I wrote about in the prior blog entries, the advantages and weaknesses are all based on this list:

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

In our journey through this process, we gathered various approaches from our clients and from industry experts. The list of criteria above is a solid place to begin evaluation to determine if the resulting model is providing the desired outcome. In the figure below, you will see the six methodologies that we evaluated and the degree to which they meet the criteria above (solid circle indicating criteria met, half circle indication partial, and blank indicating criteria not met). As you can see, the three methodologies that we recommend to our clients, Minimum Margin %, Minimum Margin $ and Sliding Scale, meet almost all six of the criteria we have laid out here.

If you use or know of another methodology, we would be interested to hear about it and may be able to provide some guidance on its performance against the list of criteria. Please send an email to rpaquette@redwoodanalytics.com with any suggestions, questions, or additional methodologies that we have not yet seen.

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

Does A Cult Of Personality Dictate Your Firm Strategy?

Admin — Fri, 23 May 2008 07:00:53 GMT

David Maister wrote an article in 2007 related to the conditions that confront firms who face strategic changes (Are We In This Together? The Preconditions For Strategy). In it he wrote of four types of personalities:

Type 1 is the solo operator who values independence, wants to make little investment in the future, but is willing to bet on his (or her) ability to catch fresh meat each and every day. I call this the Mountain Lion approach. “Pay me for what I do today (or this year.)”
Type 2 is the individual who prefers to act in coordination with others, but doesn’t like to invest (or defer gratification) too much. I call these people (collectively) the Wolf-Pack. “If we act together we can kill bigger animals, but it had better pay off soon or I’m joining another Pack!”
Type 3 is the individual who wants to be independent, but is interested in building for the future by investing time and resources to get somewhere new. Such people remind me of Beavers building dams to provide a home for their (own) family.
Type 4 are individuals who want to be part of something bigger than they can accomplish alone, and have the patience, the ambition and the will to help the collective organization invest in that future (He references humankind, Ants and Bees as possible personifiers - I'll stick with Ants).

One of the things that draws me to this article is that I can identify people in the firm in which I worked in all the above types. The Mountain Lions were the highest producers and top originators; the Wolf-Pack were those who lived off the fat of the Lion's spoils and could churn out work; the Beavers were those who just did the work and quietly practiced law; the Ants were those who just went along with what was decided and never had much input or care into the direction of the firm.

The dynamics led Lions and wolves to form alliances and complain of the ants. In spite of the work ethic of the ants, they lost clients, had poor billing practices, and always ended up being the worst performers in the firm.

Thus, most initiatives failed in our firm. When decisions needed to be made, lions and wolves teamed up against ants. The lack of unified purpose left a conference room thick with self-preservation and under-the-breath animosity. Maister summed it up nicely:

It is hard to identify and create buy-in for what “we” (i.e., the firm) should do if there is no strong sense of “we” — a mutual commitment and sense of group loyalty and cohesiveness. Similarly, it can be meaningless if the members of the firm are not committed to go on a journey together into the future.

Problems result when a cult of personality forms around some in the firm (typically the lions). Left unchecked, the lions gain an air of invincibility and management becomes practically impossible. On the other hand, poor performers are a drag on the firm and lack of accountability can tear apart a firm. The only impetus to change can end up being a a dip in profits and/or a lion or wolf going to another firm. Both of these events are bad times to begin a discussion of change.

It would be unwise to deny that changes need to be made to adapt to the changing economy. There is little reason to expect the economic down cycle to end soon. The real estate boom is being replaced by the volatile commodities boom (energy and food). Globally, businesses are transitioning into "defense mode"; ie, shrinking investment, laying off employees not directly related to long-term strategic goals, hoarding money. Law firm cash flows lag, on average, 160 days. You may not feel it today, but soon your cash flow will be affected.

How will your firm adapt? There are many blogs talking marketing and business development ideas. This month alone there are several who have discussed marketing and client development:

Bruce Marcus, May 17th: NO PAIN, NO GAIN (Is The Marketing Return Worth The Risk?)
Kevin O'Keefe, May 22nd: Effective presence marketing via blogs and social media
Bruce MacEwen, May 12th: Who's On Your "Red Team?"
Tom Kane, May 20th: Full-Time Client Feedback Person - The Next Trend?

Though counterintuitive to some, maintaining or even increasing spending on business development during market downturns can lead to more profitability (RVs, Bananas and Recession-Proofing the Law Firm, Marketing Advice for Lawyers During Economic Down Cycles). One thing should be certain: maintaining the status quo should be off the table.

Anthony Cerminaro (BizzBangBuzz) wrote of a top ten list of obstacles to making changes in his post Overcoming Resistance To Change:

Procrastination;
Well-meaning naysayers and apologists;
Fear of failure (defeatism);
Impatience;
Waiting for the whole plan to be in place;
Lack of self-confidence or cultural intimidation;
Inflexibility or lack of adaptability;
Trying to do it all yourself;
Lack of forethought or concentration;
Lack of necessary skills or talents.

His post also provides suggestions to overcome the above.

To effectively create positive change in your firm, you must first determine what changes need to be made. This requires a thorough understanding of your current position and requires some forethought into what should be your firms strengths and weaknesses going into the next few years. Then a plan needs to be devised that will address the weaknesses and take advantage of the strengths based on the opportunities showing up in the marketplace. Measurable performance indicators need to be established that further your plan. Then the difficult part: gaining consensus.

The dynamics of your firm will dictate the direction you go and the ability to form a consensus to act. The degree of success in getting the lions and wolves on board will determine whether the plan will ever gain favor. The degree of accountability placed upon everyone may end up being the deciding factor.

Partner Cost And Client Profitability, (Part IV)

Admin — Tue, 20 May 2008 07:00:39 GMT

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.

Thus far, we have evaluated a number of methods of allocating partner direct costs (compensation) to a client. Since firms have differing long and short term goals, levels of partner compensation, and thought processes about client profitability, we have concluded that there is not one perfect solution for this question, but instead a handful of recommended options.

Minimum Margin $ (or fixed margin $ for firms with closed compensation):

Very similar to the Minimum Margin %, this methodology differs only in that the threshold is set as a dollar value instead of a % of standard rate. Some firms we interviewed think about partner profitability in dollars, stating as an example that each partner should have an annual margin (standard revenue less direct costs) of $100M on their bRate MinimumMargin Minimumillable time (hourly margin is an option as well).

In the example, again we have the same partners but now each is given a minimum annual margin of $100M (or $56 per hour based on 1800 std hours). Since the Rainmaker and the Dept. Manager have fully loaded margins much less than this amount, they are set to the minimum while the Jr. Partner remains at his full compensation level. Notice that with this methodology, while both the Rainmaker and the Dept. Manager are at the minimum threshold, they have different Direct Margin %. While the dollar margin is the same, the higher rate timekeeper has a lower margin %, thus encouraging a billing attorney to use the more junior (or lower cost lawyers) on their matters.

Role	Comp	Std Rate	Minimum Yearly Margin	Minimum Hourly Margin*	Cost Rate*	Direct Margin
Rainmaker	$1MM	$250	$100M	$56	($194)	22%
Dept. Manager	$500M	$200	$100M	$56	($144)	28%
Jr. Partner	$150M	$150	$100M	$56	($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 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.

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

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.