Make More Rain : forecasting, compensation

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

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.

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.

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

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.

Managing Partner Forum Attendees: Business Development Most Effective Way To Improve Profitability

Admin — Fri, 16 May 2008 07:00:54 GMT

This past week, The Remsen Group held the Southeast Managing Partner Forum in Atlanta. Fifty-eight participants attended representing thirty-nine firms in the Southeastern region. According to 23% the participants, marketing and business development was the most effective way to improve long-term profitability. This eclipsed raising rates, which was rated as the most effective way to improve long-term profitability by 21% of respondents.

According to the 2007 Law Firm Economic Survey from LexisNexis, marketing and business development was second only to rates as the most effective way to improve profitability. Yet only 3% linked compensation to marketing and business development activity. It is apparent that firms consider marketing and business development as important keys to improving profitability.

In our 2008 Survey (currently accepting submissions - please click here if you would like to participate), we dedicate 19 questions on business development. We hope to be able to flesh out what works for firms and what isn't working to improve profitability.

In a year where the majority of economic news points to an economic downturn, how a firm invests now will determine what opportunities open for it after the economy recovers. It's worth reviewing some past posts that help firm's manage down cycles and prepare for the eventual upswing:

Another interesting statistic that follows earlier surveys is that over 2/3rds of the attendees of the Managing Partner Forum in Atlanta did not follow a firm-wide strategic plan. John Remsen, along with John Smock and Thomas Grella, Esq., have teamed up to provide a web seminar on Law Firm Strategic Planning. John Remsen is the owner of The Remsen Group, a marketing consulting firm that is focused on the law firm market. John Smock is a management consultant and partner with Smock Sterling strategic management consultants. Mr .Grella is the Managing Partner of McGuire Wood & Bissette, PA and co-authored the book The Lawyer's Guide to Strategic Planning published by the American Bar Association. The webinar is scheduled for June 10th at noon eastern. To register, click here.

Partner Cost And Client Profitability, (Part III)

Admin — Tue, 13 May 2008 07:00:29 GMT

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

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

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

In this methodology, margins (Std Rate less Direct Cost Rate as a % of Std Rate) are kept at or above a minimum threshold (or equal to the threshold for firms with closed compensation cultures). In the example below, we have the same three timekeepers from previous examples, with the Rainmaker and Dept. Manager having compensation that exceeds their billable hours revenue. With the minimum margin % methodology, these two timekeepers’ direct costs are set so that the margin % is 40% (this variable is set by the firm) while the Jr. Partner maintains the 44% margin occurring ‘naturally.’

Role

Compensation

Std

Rate*

Cost

Rate*

Direct

Margin

%

Rainmaker

$1MM

$250

($150)

40%

Dept. Manager

$500M

$200

($120)

40%

Jr. Partner

$150M

$150

($83)

44%

*Assumes 1800 standard billable hours expectation

Advantages of this 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.

There are some weaknesses to this approach:

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

Overall, the strengths of this methodology far outweigh its drawbacks. With this method, client profitability can be evaluated objectively with minimal explanation about the handling of partner compensation. In subsequent entries we will be evaluating additional methodologies vetted by Redwood Analytics and providing a checklist of criteria that your firm can use to select a methodology.

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.

Survey Targets Business Development In Law Firms

Admin — Fri, 02 May 2008 07:00:07 GMT

ALM Research recently released the 2008 Law Firm Business Development Practices Survey, which targets two "tiers" of law firms: those listed in the AmLaw 200, The Global 100, and the NLJ 250 (Tier 1) and those not listed (Tier 2). Though the survey is mostly focused on large firms, the average number of attorneys for Tier 2 firms was 85, within the higher range of the mid-market.

Business development is difficult to assess in mid-size firms simply because many don't track it. However, firms do see the importance. In the 2007 Law Firm Economic Survey by LexisNexis, 25% of respondents claimed business development was the best strategy to improving profitability, second only to increasing rates. Likewise business development is one of the 5 highest rated factors for financial growth in the ALM survey. The extent to which these activities are tracked and measured will determine the extent to which firms can gauge the effectiveness of their methods.

Some other key findings:

More firms are dedicating resources to business development that are separated from a marketing role;
Budgets for business development have increased over the past year;
Around 50% of respondents employ client interviews and surveys (the highest rated business development activity among respondents);
Just under 50% employ "client service teams" focused on clients who generate the most revenue;
Over 50% receive some sort of sales training;
Nearly a third of Tier 2 firms reported that they were "not sure" if revenues increased, decreased or remained flat in the past year.

The last finding listed is surprising. If your firm is not tracking revenues, there is no way of knowing whether your firm is in trouble financially or not. Further, you can't accurately forecast if you don't benchmark. The importance of measuring performance can't be emphasized enough.

The above is just part of the findings of the survey. To purchase the survey, visit the ALM Research site by clicking here.

Client Profitability: What Is The Cost Of Partner Time?

Admin — Tue, 29 Apr 2008 07:00:26 GMT

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

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

Partners are compensated for a number of contributions to their firm. Some include:

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

Since no firm (that we have encountered) determines a partner’s compensation by measuring each contribution and summing them, our goal with every firm is to come up with a proxy that is reasonable and creates a means of evaluating client/matter profitability that is truly usable.

You might be wondering why this is such a big deal. After all, you know how much a partner is compensated – why not allocate all of that compensation across his/her clients? It’s important to distinguish between a partner’s profitability and his/her clients’ profitability to the firm. Should a client or matter look less profitable solely because a highly compensated partner performed some of the work? What if most of his/her compensation was a reflection of his value to the firm as a rainmaker? What if there were two partners with similar legal skills and similar billing rates, but Partner A is a heavy originator while Partner B is primarily a service partner? Should the client appear less profitable simply because Partner A was staffed to the matter instead of Partner B?

If, as we’ve seen some firms do, you choose to include all partner compensation in this hourly cost rate, clients could end up being allocated costs like in the figure below.

Role	Compensation	Std Rate	Cost Rate	Profit Margin
Rainmaker	$1MM	$250	($556)	-122%
Dept. Manager	$500M	$200	($278)	-39%
Jr. Partner	$150M	$150	($83)	44%

In this example, the Rainmaker and the Dept. Manager are both compensated more than their billable hours alone would bring in as revenue (calculations assume 1800 standard or budgeted hours). For every one hour the Rainmaker works on a matter, it would take 4.5 hours of Jr. Partner time for the client to have a 0% profit margin (and all this without considering overhead). Therefore, EVERY HOUR for which the Rainmaker or Dept. Manager billed time would appear unprofitable. Granted, it may be desirable that the firm should be leveraging a more junior person to the matter, and the Rainmaker and Dept. Manager should have a relatively lower profit margin for their work, it makes no sense that their contribution to a matter is unprofitable.

We’ve discussed the concept of the cost of partner time with many leaders of law firms over the years. What we know for sure is that there is not a one size fits all solution. What has become clearer, however, is that there are key criteria that every solution should strive to meet. Over the course of a series of entries, we’ll be exploring the pros and cons of various options. We welcome your feedback and reactions.

Measuring Your Law Firm's Billing Cycle

Admin — Fri, 25 Apr 2008 07:00:14 GMT

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

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

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

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

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

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

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

The Science Behind Pricing

Admin — Tue, 22 Apr 2008 07:00:25 GMT

The April 2008 Scientific American contains an article titled Why Things Cost $19.95: What Are The Psychological "Rules" Of Bartering? (hat tip: Matthew Homann, in his blog the [non]billable hour). The article explains the effects that initial pricing has on a potential buyer based on a series of tests. The results found:

people appear to create mental measuring sticks that run in increments away from any opening bid, and the size of the increments depends on the opening bid. That is, if we see a $20 toaster, we might wonder whether it is worth $19 or $18 or $21; we are thinking in round numbers. But if the starting point is $19.95, the mental measuring stick would look different. We might still think it is wrongly priced, but in our minds we are thinking about nickels and dimes instead of dollars, so a fair comeback might be $19.75 or $19.50.

The authors of the tests then looked at five years of real estate sales in Florida to see the difference between the list price of real estate and the actual sales price.

They found that sellers who listed their homes more precisely—say $494,500 as opposed to $500,000—consistently got closer to their asking price. Put another way, buyers were less likely to negotiate the price down as far when they encountered a precise asking price. Furthermore, houses listed in round numbers lost more value if they sat on the market for a couple of months. So, bottom line: one way to deal with a buyer’s market may be to pick an exact list price to begin with.

Homann, in his post on the subject, took it a step further: Why not charge $297 per hour rather than $300 per hour? Then if a client wanted to negotiate, ostensibly the negotiations would be in single dollars rather than tens of dollars.

In the case of firms who are competing with other firms for business, this tactic may work well to secure a deal.

It may not work as well when clients are asking for a discount. Many times when it comes to discounting rates, clients look at percentage discounts of the whole bill rather than dollar discounts. Therefore taking a few dollars off the charge per hour may end up costing you a lot more than anticipated. Where it may work better is in flat fee or value-bill situations, where you are adjusting only the final price of the service.

So, if you have priced a certain task at $1,500, try advertising a price of $1,497.96. On top of making the client look at penny increments, it also makes it look like you have calculated the exact value of the service. Before making wholesale changes to your pricing, try on a specific area that may have a higher average of discounts (or lost potential clients due to pricing) than other areas. Track whether the change in pricing has an effect. If so, please feel free to post your results here.

How To Compensate A Rainmaking/Investor "Muted" Partner?

Admin — Tue, 15 Apr 2008 07:00:49 GMT

A reader emailed me with a question related to the compensation of a non-practicing equity partner whose responsibilities include only the investment of capital in the firm and bringing in new clients. The firm has a niche practice and is looking to expand. Their plans require more capital than the existing partnership can manage. They are in a position to bring in another partner who will be responsible for infusing additional capital in the firm. The partner will also do some rainmaking. The new partner will not be responsible for any management or production and will not be expected to manage any of the clients in which he brings.

Because of the rainmaking responsibilities, I wouldn't classify the partner as a "silent partner". However, since the partner won't participate in the day to day management of the firm nor will be responsible for any production, it may be better to classify him as "muted".

I asked several attorneys I knew and didn't get very good answers. Thus I am taking the question to More Partner Income readers. What ways would you suggest this firm compensate an equity partner whose responsibilities are only investment in the firm and rainmaking?

The American Airlines Fiasco And Customer Service

Admin — Mon, 14 Apr 2008 07:00:04 GMT

As I sat in a terminal in Chicago O'Hare after a week of ridiculous delays and cancellations, I finally believed I was almost home. Instead it was dripping water for the forehead, dirty carpet for a bed.

This week was a long travel week for me, as I had presentations to give in Chicago, Dallas and Minneapolis, respectively. Getting to Chicago was pain-free, but then the news broke of FAA inspections of MD80 planes, of which American Airlines owns 300. My colleagues and I knew we were going to have our flight cancelled. As luck would have it, our flight was the only one going to Dallas that wasn't cancelled. However, we suffered the "chinese water torture" of delays. As the time neared to board, another delay. First the flight was to leave at 6:15pm, then 7:45, then 8:00, then 9:00, then 9:39 (which we all thought was odd), then 10:00, then 10:30, then 11:00, then 12:00am, then 12:30, then 1:00.

Finally, at 1:24am, we boarded the plan, under the sound of the gate attendant stating to "hurry up and get seated or else the flight would get cancelled" - yes, the group of passengers that were being seriously inconvenienced by the airlines were being threatened by cancellation if we didn't rush to board. There was mild pandemonium on board as people rushed to get their seats and not be the person who caused the cancellation. However, after working up a sweat to get in our seats quickly, the pilot, in his soothing and assured voice, came over the loud speaker, "well folks, we are just about ready to get going - just need to get the luggage to get loaded. We should be on our way in a few minutes." We sat at the gate for another half an hour as cargo was being loaded (it was referred to as "luggage", but the windows gave clear view of large palletes of cargo being loaded).

Finally we left Chicago and made it to Dallas around 4:30am. However, since no ground crew were at our assigned gate, we had to go to another gate and didn't get off the plane until after 5am. By the time we made it to our hotel, it was almost 6am. The presentation was at noon, so the best of us only received about 3 hours of sleep before heading to the luncheon around 11am.

Before I even started my presentation, we learned that our flight to Minneapolis was cancelled. We felt pretty lucky to learn of this early enough to rebook on a flight that left at 5:30 am Thursday.

After finishing the last presenation of the week on Thursday, we hoped for the best. I was skeptical: after all, we had to go through Chicago to get back to Nashville. The delay from Minneapolis was minor - about 1 hour. Once at Chicago O'Hare, however, the water torture started again. Delay from 7:45pm, to 8:15, then 8:30, then 9:15, then 9:45, then 10:00, then 10:30, then 10:55. Amazingly, we boarded around 11pm. As we sat on the tarmac, the pilot addressed us to let us know that due to storms just south of us, we had to change the flight pattern, which would just take a few minutes. I was half unconscious by this point, lured to sleep by the familiar hum of the jet engines. At what appeared to be 10 minutes later, the pilot came back on with the bad news: since there were still a few jets ahead of us, it looked like they wouldn't be able to make it to Nashville before their limit of 16 hours expired. We had to return to the gate. Grumbles abounded.

Personally, I wasn't surprised. I was already prepared for a cancellation - it is O'Hare and we had a double dose of bad signs: the problem of 300 planes and a weather system that was already dumping snow in Minneapolis and thunderstorms just south of Chicago. As we were about to get off the plane, though, the crew asked us to stay on board as they attempted to get another crew. A gentleman in front of me lamented that the pilots purposefully delayed takeoff because they knew their 16 hours were coming up. I have to admit the thought crossed my mind as well. Why not alert us to this possibility earlier, like the kind gate attendant did a few days before?

Needless to say, no crew was available. We were led out and told that they were not cancelling the flight, just delaying it until 6:20 am. This allowed them to provide us a hotel and food vouchers, but nothing else. I was offered a room at a Holiday Inn 30 minutes away. Considering it was after midnight and the flight was to leave at 6am, I didn't find this acceptable. I wasn't offered a voucher either - instead being told to ask for one when I got to the gate in the morning. I was then booked on a separate flight, not the same one. This happened to several others as well - the passengers walked aimlessly around in confusion. Were we delayed or cancelled? Were we to get rebooked on another flight or the same one?

Finally we were able to find an attendant who gave us boarding passes to the same flight, except the date showed April 10 at 6:20am to leave, then below it said boarding started at 7:45pm. Most of the passengers opted not to take the hotel voucher. Those that did described to us later the difficulty in getting through security with their confusing boarding passes. We were all upset that at the very meager accomodations and compensation for this inconvenience.

I stuck it out at the airport and meandered around the airport until submitting to my exhaustion around 3am for a few hours' nap on the unfresh-smelling carpet in the gate area. Once the sun rose (and it was as beautiful as the sunset just a few hours before), the familiar drip, drip, drip started its maddening splatter on the forehead again. 6:20am . . . no, 6:30am . . .no, 6:50am . . . no, 7:05am . . . finally, we board and after sitting on the tarmac for 30 minutes, we lift off to applause and land in Nashville just after 9am.

My experience is probably not the worst that has happened to people over the past week. However, it does expose major issues facing American Airlines - and I am not talking just about FAA compliance. The experience reeked of crisis mismanagement and flaws in customer service. Many of the attendants were rude and condescending, such as one that was rebooking customers on a different flight who ignored everyone who advised that we were supposed to be given a new boarding pass for the same flight. He just repeated that there was no other flight and that this is the flight you are going to take.

American Airlines will lose tens of millions of dollars from this fiasco. Not only are they having to pay customers for their inconvenience (even if some of their offers are paltry), they are losing the trust of tens of thousands of travelers. There were several who said "I won't be flying American Airlines again." Though I doubt that will be the case for most - I know the powerful tonic of time - it will take a while before confidence will be restored. I don't think there could be a worse time for this to have happened, for more than my own personal reasons.

As with most crises, there are stories of hope. In this case, there was a friendly American Airlines attendant who stayed with those of us camping at the gate and finding blankets for people and advising of areas where cots were available. She also helped others who needed to get rebooked, regardless of whether they were at her gate or not. She had tremendous patience and was generous with her time even though there were many who demanded it.

Although I can understand the frustrations of attendants having to answer to unhappy travelers (which wasn't confined to American Airlines - we found rudeness in other airlines' staff who were absorbing the displaced passengers), it was good to know that there are some (unfortunately few) who commiserate and go out of their way to provide customer service. Without any management in sight, will this woman attendant get the recognition she deserves? From me, yes. Her name is Ramina Zomaya, based in Chicago.

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.

Role	Compensation	Std Rate*	Cost Rate*	Direct Margin %
Rainmaker	$1MM	$250	($150)	40%
Dept. Manager	$500M	$200	($120)	40%
Jr. Partner	$150M	$150	($83)	44%