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Smart Growth: How to Increase Profits Per Partner
Michael Moore
Moores Law
Lawyers can make more profits even in this challenging economic climate. Unfortunately, law firms frequently cut what is required to get the kind of clients and work that would improve profits. A 2009 Altman Weil survey of law firms found that 46% had reduced support staff; 33% cut paralegals; 32% thinned their associate ranks, and 24% cut non-equity partners. Lawyers also absorb administrative and management tasks they could inexpensively outsource. This takes them away from billing time and getting clients, two activities that increase profitability. Many firms also eliminate training programs and hold back on key technology investments. These actions only create a temporary windfall and fail to address the real issues contributing to lower profits.
Measuring Profitability
The starting point to improvement is always measurement. The standard formula for measuring law firm profitability was created by David Maister, noted expert on law firm management, where Net Income Per Partner = (1 + Leverage) x (Blended Hourly Rate) x (Utilization) x (Realization) x (Margin). These factors, expressed as ratios, are interdependent, meaning one of them cannot be changed without affecting the others. For example, if you doubled your billing rate, profitability would also double, by definition. Of course, if you doubled your billing rate, realization would suffer as clients objected to the higher cost by not paying bills timely and utilization would suffer as clients switched to cheaper competitors. Therefore, understanding each factor is key to executing the right steps to increase profitability.
Leverage
Leverage is the ratio of non-equity fee earners to equity partners. The most profitable firms in a 2007 LexisNexis survey had the highest billable hour leverage. The goal is to increase leverage once partners reach or exceed the target billable hour threshold. Since there are only so many hours an individual can work, once the threshold is reached, it is imperative that work be passed to another fee earner if you want to increase profitability. Delegation is one lawyer behavior that needs to be rewarded by compensation committees.
Blended Hourly Rate
Blended Hourly Rate is the ratio of total fees earned divided by the total hours charged. In the Altman Weil survey, no firms planned on reducing their billing rates in 2009. Instead, most firms made “smaller than normal” increases. While it is important to increase billing rates annually to avoid devaluing your rates due to inflation, the real secret to beating inflation actually isn't rate –it’s productivity. High productivity creates the gap (margin) between cost (which includes inflation) and revenue. The higher your margin, the less inflation hurts you.
Utilization
Utilization is the percentage of available capacity that is chargeable. For a law firm to be highly profitable, all fee earners must be fully utilized. Increasing the headcount of non-equity fee earners to handle accretive work (as opposed to absorbing work that could be handled by others) increases partner income. Attaining maximum productivity means getting the most output from your fee earners. The top performing firms had both associates and paralegals with productivity numbers closer to their partners. The best way to increase productivity is through incentives to partners to share work with associates.
Realization
Realization is the percentage of chargeable time actually billed and not written-off. How efficient are you at converting your work to cash? Each percentage point lost represents money out of the pocket of the firm. If you can get control over pre-bill adjustments, your revenue will increase. Your work product is your inventory, and it loses value every day that it sits on your desk. Send out bills in a timely fashion. Stay on top of receivables. Be efficient in how you work, how you bill and how you collect. Tracking realization at every step in the process will help your firm become more efficient and, thus, more profitable.
Margin
Margin is the firm’s net income, expressed as a percentage. It is the partners’ profits divided by firm revenues. A common mistake is to assume that better profits come simply by reducing costs, increasing hourly rates and increasing billable hours. Often, these tactics fail to achieve the desired results, while resulting in client dissatisfaction and problems with lawyer and staff morale. Increasing revenue, while maintaining the same expense structure, is the most direct approach to improving the firm’s bottom line.
Get the right people on the bus
Many lawyers make less money because they either don't have the right people or they don’t help them maximize their potential. They struggle with frequent turnover and spend time hiring, supervising, training and, eventually, firing people who just aren't the right fit. Getting a new hire through the door is only the beginning. Substantive training also provides a powerful incentive for people to stay with the firm. Firms where people learn to work together effectively and develop complimentary skills have an advantage over their competitors.
Do the Math
Managing, recruiting, hiring and training both staff and other lawyers is called “lost time.” A lawyer with an average hourly rate of $200 who loses 1 hour each day, 5 days per week, 50 weeks per year loses $50,000 annually. If a committee of 5 lawyers gets involved, their firm loses not only $250,000 each year, but 1,250 hours when they could have been billing time and getting more clients. In addition, the failure to outsource effective recruiting and development creates turnover, which can cost a firm in excess of $100,000 per occurrence. Lawyers make money by doing what they do best – practicing law. They should turn to other professionals to do what they do best, thereby maximizing available resources.
Lawyers can make more profits even in a recessionary economy. This goal requires leadership from partners and a willingness to invest in people and technology. In many firms, the majority of the lost profit potential lies in the high level of reinvention among the lawyers. Lawyers should strive to increase their firm's collective knowledge base, leverage their time, and strategically move beyond temporary solutions.
As Will Rogers correctly observed, “Even if you’re on the right track, you’ll get run over if you just sit there.” ¨
Michael Moore, J.D., is a professional coach for lawyers and the founder of Moore’s Law, Milwaukee. He specializes in marketing, client development and leadership coaching for attorneys at all levels of experience.
Moore also advises law firms on growth initiatives, strategic planning and resource optimization. He has more than 25 years’ experience in private practice as a general counsel, in law firm management and in legal recruiting.
Reprinted with permission from “Class Action,” the newsletter published by the Wisconsin Chapter of the Association of Legal Administrators, Fall 2011. |
