Profitability Levers: The Lore and Lure of the RULES

The importance of profitability levers is compelling, but readers who sense some haziness about the subject should note that different authors conceptualize the levers differently.

In just this edition of A&FP, the Altonji-Chow article alludes to “the five key levers of profitability.” The Steinberg article posits and describes five “underlying factors that affect profitability.” They're not the same five levers, though. Both lists include realization, utilization and leverage. Altonji and Chow list price (rates) and cost structure as their fourth and fifth levers. Steinberg approximately combines those two into a lever he calls production, and adds speed (of collection) as his fifth lever.

Readers of the PriceWaterhouse-authored text Law Firm Accounting and Financial Management (published by our very own Law Journal Press) will likely recall the similar “RULES” factors defined in LFAFM '9.04. RULES stands for realization of billing rates, utilization of attorneys, leverage of lawyers, expense control, and speed of billing and collection.

Curiously, in LFAFM's overview of profitability per se ('8.05), the contributing factors are organized under only three headings: revenues, expenses and leverage of lawyers. LFAFM actually discusses RULES in a management-reporting context, as performance factors for which operating statistics should be maintained. In any event, calling these factors profitability levers also makes sense, and it's impressive that they're serviceable both in the broad strategic focus of the Altonji-Chow article and for Steinberg's tighter focus on the profitability of new work.

Without presuming to judge the relative merits of these formulations, I'll conclude with a comment on their most obvious difference: The LFAFM set is presented with an acronym and the others are not. One contributor to this newsletter recalls hearing back in his PriceWaterhouse days that Bob Arndt and Raven Horst came up with the RULES acronym over lunch one day. I haven't inquired if their scribbled-on napkin is framed somewhere at PWC.

While bracing myself for a torrent of e-mails aimed at setting me straight on the genesis of RULES (send them to [email protected]), I'll note that I actually have some serious reservations about acronymized factor lists.

The RULES acronym makes it far easier to remember the LFAFM list, and that's a strong plus. But acronyms for such a list invariably make me wonder if any factors were added, deleted, merged, split or substituted to get the acronym to work. It's tempting to twiddle when you're one letter away from a snappy acronym! In the case of RULES, though, my guess is that the composers actually said what they meant.

Unfortunately, the very structure of any acronym can distort our thinking in three much less obvious ways. Using one letter for each word subtly suggests that the factors are 1) equally important and 2) independent. At the same time, the self-contained completeness of an acronym strongly suggests that the list is 3) comprehensive. The problem is that all three of these implications are usually inaccurate!

To their credit, the authors of the LFAFM text (John P. Quinn; Joseph A. Bailey, Jr.; and David E. Gaulin) present the RULES list circumspectly, especially with regard to interdependence of the factors. For example, they astutely warn a firm that monitors billing realization to monitor speed of billings as well. “When a firm only monitors billing realizations,” they explain, “there is a disincentive to prompt billing because slow billing delays the recognition of under realizations.” Similarly, with regard to profitability overall, they stress that they have sought to “demonstrate the interrelation among the revenue and cost factors and the effect of leverage.”

Subscribers to A&FP since 2002 may also wish to leaf back to that year's October article by Gary B. Fiebert on the particular value of attending to all the RULES factors in a fluctuating economy. Then COO of New York's Rosenman & Colin LLP, Fiebert is now the Executive Director of Schulte Roth & Zabel LLP. Like the LFAFM authors, Fiebert stresses and illustrates the interdependence of the RULES factors. He also emphasizes the need to operationalize these general concepts into locally defined measures that suit each firm's unique characteristics: its size, ownership, practice areas, clients, environment, structure, geography, degree of community involvement, etc.

Like these prior authors, our current authors put the notion of profitability levers to good use. We just need to remember to treat all such conceptual schemes as useful guideposts rather than as complete maps to the territory.

' Joe Danowsky

The publisher of this newsletter is not engaged in rendering legal, accounting, financial, investment advisory or other professional services, and this publication is not meant to constitute legal, accounting, financial, investment advisory or other professional advice. If legal, financial, investment advisory or other professional assistance is required, the services of a competent professional person should be sought.

The importance of profitability levers is compelling, but readers who sense some haziness about the subject should note that different authors conceptualize the levers differently.

In just this edition of A&FP, the Altonji-Chow article alludes to “the five key levers of profitability.” The Steinberg article posits and describes five “underlying factors that affect profitability.” They're not the same five levers, though. Both lists include realization, utilization and leverage. Altonji and Chow list price (rates) and cost structure as their fourth and fifth levers. Steinberg approximately combines those two into a lever he calls production, and adds speed (of collection) as his fifth lever.

Readers of the PriceWaterhouse-authored text Law Firm Accounting and Financial Management (published by our very own Law Journal Press) will likely recall the similar “RULES” factors defined in LFAFM '9.04. RULES stands for realization of billing rates, utilization of attorneys, leverage of lawyers, expense control, and speed of billing and collection.

Curiously, in LFAFM's overview of profitability per se ('8.05), the contributing factors are organized under only three headings: revenues, expenses and leverage of lawyers. LFAFM actually discusses RULES in a management-reporting context, as performance factors for which operating statistics should be maintained. In any event, calling these factors profitability levers also makes sense, and it's impressive that they're serviceable both in the broad strategic focus of the Altonji-Chow article and for Steinberg's tighter focus on the profitability of new work.

Without presuming to judge the relative merits of these formulations, I'll conclude with a comment on their most obvious difference: The LFAFM set is presented with an acronym and the others are not. One contributor to this newsletter recalls hearing back in his PriceWaterhouse days that Bob Arndt and Raven Horst came up with the RULES acronym over lunch one day. I haven't inquired if their scribbled-on napkin is framed somewhere at PWC.

While bracing myself for a torrent of e-mails aimed at setting me straight on the genesis of RULES (send them to [email protected]), I'll note that I actually have some serious reservations about acronymized factor lists.

The RULES acronym makes it far easier to remember the LFAFM list, and that's a strong plus. But acronyms for such a list invariably make me wonder if any factors were added, deleted, merged, split or substituted to get the acronym to work. It's tempting to twiddle when you're one letter away from a snappy acronym! In the case of RULES, though, my guess is that the composers actually said what they meant.

Unfortunately, the very structure of any acronym can distort our thinking in three much less obvious ways. Using one letter for each word subtly suggests that the factors are 1) equally important and 2) independent. At the same time, the self-contained completeness of an acronym strongly suggests that the list is 3) comprehensive. The problem is that all three of these implications are usually inaccurate!

To their credit, the authors of the LFAFM text (John P. Quinn; Joseph A. Bailey, Jr.; and David E. Gaulin) present the RULES list circumspectly, especially with regard to interdependence of the factors. For example, they astutely warn a firm that monitors billing realization to monitor speed of billings as well. “When a firm only monitors billing realizations,” they explain, “there is a disincentive to prompt billing because slow billing delays the recognition of under realizations.” Similarly, with regard to profitability overall, they stress that they have sought to “demonstrate the interrelation among the revenue and cost factors and the effect of leverage.”

Subscribers to A&FP since 2002 may also wish to leaf back to that year's October article by Gary B. Fiebert on the particular value of attending to all the RULES factors in a fluctuating economy. Then COO of New York's Rosenman & Colin LLP, Fiebert is now the Executive Director of Schulte Roth & Zabel LLP. Like the LFAFM authors, Fiebert stresses and illustrates the interdependence of the RULES factors. He also emphasizes the need to operationalize these general concepts into locally defined measures that suit each firm's unique characteristics: its size, ownership, practice areas, clients, environment, structure, geography, degree of community involvement, etc.

Like these prior authors, our current authors put the notion of profitability levers to good use. We just need to remember to treat all such conceptual schemes as useful guideposts rather than as complete maps to the territory.

' Joe Danowsky

The publisher of this newsletter is not engaged in rendering legal, accounting, financial, investment advisory or other professional services, and this publication is not meant to constitute legal, accounting, financial, investment advisory or other professional advice. If legal, financial, investment advisory or other professional assistance is required, the services of a competent professional person should be sought.