Educating Marketing Professionals on Key Financial Metrics and Measurements

Today, marketing and business development professionals need to understand law firm finance and economics. Likewise, law firm chief financial officers need a better understanding and appreciation of marketing strategies. The success of your firm will depend on how well these two disciplines work together. Marketing decisions affect whether the firm will obtain new business or increase business from existing clients. Profit needs to be returned to the firm as a result of these activities. Accordingly, the test of marketing decisions ultimately comes from its financial results. This article discusses two strategic but basic tenets of law firm finance and economics 'matter profitability and return on investment (ROI) ' and how marketing and finance professionals can work together to link marketing and financial strategies.

With concerns about the current economy and dire predictions of a recession that has staying power, it is probably a good time for law firms to rethink how their marketing dollars are being invested. Yes, invested. As a believer that marketing delivers profits over time, I am also a believer that marketing can be a major misspent category in most firms. Similar businesses face the same challenge. For example, consider this statement attributed to Macy's founder, John Wanamaker, when weighing the contribution of marketing expenditures: 'Half the money I spend on advertising is wasted; the trouble is I don't know which half.'

Client/Matter Profitability

Today, considerable emphasis is being placed on law firm profitability. An income statement can tell you if the firm, as a whole, is profitable; but it does not tell you if the work performed in a certain area of law, by a specific timekeeper or for a specific client, is profitable.

Performing regular profitability studies at the timekeeper and time-entry levels enables the firm to make more knowledgeable decisions regarding hiring and staffing, overhead expenditures, work assignments, target marketing, billing and collections, billing rate evaluations, and performance reviews. Why should determining the profitability of client matters be important information for the marketing professional? Because ultimately, this is the most important metric in determining the success of your firm. This analysis also provides the foundation for determining practice group or industry segment profitability. Armed with such knowledge, law firm leaders have useful information for:

• Strategic planning purposes;
• Investment decisions, including the allocation of limited firm resources;
• Improving profitability of existing clients or areas by:
• Increasing knowledge levels in order to reject unprofitable work;
• Understanding the impact on matter staffing patterns;
• Making pricing decisions;
• Profitability increases through alternative pricing;
• Careful use of discounts; and
• Holding attorneys accountable for matter management

As this list suggests, law firms are using profitability analysis as a management tool. Determining the cost of services sold is an absolute necessity, so do not be swayed by some partners who argue that only the traditional determining factors of hours, billings and collections are the correct measure of overall profitability.

Cost Allocations: Art vs. Science?

Businesses in this country are expected to abide by generally accepted accounting principles (GAAP). However, some firms have their own principles, which are referred to as PCAP (politically correct accounting principles). What this means is that there is no one correct way to determine cost allocations, and this is why some art is needed in determining the methodology for cost allocations. Any method will be subject to debate, so the key is to obtain the approval of firm management on the assumptions and then proceed.

For purposes of determining matter profitability, all or most costs must be allocated, and such costs are normally tracked by the hours invested in the matter. The end result of the allocation is that each fee earner will have a cost number associated with his or her billable hours. These costs are further defined as 'direct' (such as fee earner salaries and benefits) and 'indirect' (overhead). Marketing professionals do not need a mastery of numbers to get through this exercise, as the firm's CFO can easily walk them through the process.

Ongoing Review and Reporting

One thing to keep in mind is that ultimate matter profitability is not determined until the matter is closed. However, monthly or periodic reporting will assist management by keeping track of the financial progress of each matter. For example, on fixed-fee engagements, management can monitor the investment of billable time compared with the fixed fee, in addition to monitoring costs on the file. Sophisticated financial systems incorporate 'push reporting' to signal certain financial events, such as fee budget warnings.

The timing and frequency of these reports will depend on the ability of the firm's financial system and the CFO's team to generate the reports. Some firms will be able to use data warehouses to generate reports with relative ease, and some firms may be able to utilize executive inquiry systems. Executive inquiry systems are available from your desktop with easy-to-follow screen inquiries.

Last, beware of the potential divisiveness that may result from this analysis. If partners in Practice Group 1 were to learn how much more profitable they really are compared with another practice group, they may begin putting tremendous pressure on decision-makers as to compensation and other issues. There could be pressure to drive to expel the unprofitable practice group from the firm. Worse, Practice Group 1 may look to join another firm where they will be more appreciated.

Welcome to Marketing: Two-Drink Minimum

Scott Adams, creator of 'Dilbert,' penned a cartoon where the pointy-haired boss announces that he is placing Dilbert on a rotational assignment to the Marketing Department. As Dilbert nears the entrance to the marketing department, he notices the sign above the door that reads: Welcome to Marketing: Two Drink Minimum.

Over the years, I have compared marketing expenditures for many firms. I was astonished and mildly amused to see the six-figure amounts one firm spent on tickets to sporting events. Given the precious commodity of time, I wonder how many client decision-makers attended these events. I suspect that the return on this investment is considerably low or may run to the negative.

Return on Investment

You are probably already aware of the concept and some practical applications of ROI based on personal experience. Some examples include the amount of equity buildup in your home as a percentage of original cost and the returns (or lack thereof) from your personal savings and investments in the stock market. Businesses can use ROI as a very broad measure, such as dividing the company's annual net income by the company's total assets on the balance sheet. On a more micro level, CFOs and management will use ROI to judge specific requests for capital outlays, marketing and technology initiatives and the like.

In the real world, requests are normally approved for those projects offering the highest returns. Some law firms may have difficulty in assessing ROI data since the results of many marketing strategies and activities do not find their way onto new matter intake forms. Firms cannot begin to accurately measure ROI related to marketing activities if sources and reasons are not tracked at the intake stage. Examples of source activity include:

• Seminars;
• Advertising in the legal or trade press;
• Legal and other directories;
• Referrals;
• Personal relationships;
• The 'me' factor;
• Information from the firm's Web site;
• Client newsletters or other news articles;
• Press releases; and
• Corporate department golf tournaments

Forecasting ROI

The use of ROI in determining actual results from marketing campaigns is relatively clear based on historical information. However, ROI should also be used to forecast returns on future activities. Forecasting requires that we have good historical information or judgment on activities that have resulted in new clients or new matters from existing clients. For example, assume you want to sponsor a seminar related to nanotechnology, and you want to demonstrate the return to the CFO and firm management. To do so, you would need the following data from historical information (or professional judgment):

• How many responses will we receive from the invitation;
• How many will actually attend the seminar;
• The number of attendees that will become 'leads'; and
• The number of leads that will result in new business

Determining the Investment And the Return

What should be included as costs in the investment determination? Some of that depends on the firm's tracking systems. It would be easy to track the costs for the Labor and Employment seminar (printing, facility, catering, etc.). Should you include other expenses, such as an allocation of marketing department salaries, for this activity? How about the time invested by the firm's attorneys in preparing for and attending the event? I would suggest that you include this information only if the data is readily available. We don't want to have everyone suffer from analysis paralysis. Start from some meaningful point.

The return is normally the profit that the marketing campaign or initiative provided ' not simply the fee revenue that was derived. Most non-financial managers miss this point. Earlier, we explored matter profitability, so it is possible for you to determine or make a conservative estimate on resulting profits.

Last, how do we interpret the results? What is an acceptable ROI ' 10%, 20%, 50%? The main purpose of the measurement is to interpret the result relative to the ROI of other investment opportunities. For example, if you determined that the ROI from the Labor and Employment seminar was 35% and that the ROI from the Subprime Finance Golf Tournament was 2%, you would hopefully focus your future resources on similar seminars or events. Time also plays an important role since you need to allow the marketing initiative to run its course for an acceptable period ' the amount of time it takes to generate a new client or matter from a lead that originated from the event.

Benchmarking is another use of ROI. If the seminar yielded 35% in year one, our minimum results expectation for a similar seminar in year two should be 35% or higher. If you have no basis for comparison, you are left to judge each set of results on its own merits.

Considerations in Trying to Determine ROI

Lack of buy-in from firm leaders. Your time is important and you need partner interest in various technology and marketing initiatives. Accordingly, you seek their support in developing the business case before you spend considerable time creating the analysis.

Little in the way of in-depth analysis. I would advise against taking a mediocre approach at the ROI analysis. You need to address the significant concerns and questions of those partners who may pick apart your assumptions and case point.

Articulating the benefits. Document your ideas on where the greatest benefits will occur for various initiatives whether they are marketing- or technology-focused. Partners are looking for specifics on what costs can be reduced or avoided or how much revenues will increase.

Lack of follow-through after the analysis. The firm's initiatives are much more likely to realize the expected benefits when they are closely monitored and measured. Identify and highlight the critical metrics on an ongoing basis to validate the model and investment decisions.

Moving Forward

ROI is a powerful tool, and measuring ROI for marketing activities is a must. Marketing professionals have the ability to effect positive contributions to the revenue cycle and, ultimately, the bottom line. To accomplish this, you need to understand the concepts and measurements of ROI and matter profitability. Armed with this information, you can help your firm identify specific clients and types of matters that are more profitable than others. Matter profitability is the beginning point for reviewing the profitability of clients, a book of business, practice groups, industry segments and ultimately, the success of the firm.

Stephen M. (Pete) Peterson is the CEO of the accounting and business advisory firm Maxfield Peterson Richards and is the Managing Director of the firm's specialty practice, the Law Firm Business Institute.

Today, marketing and business development professionals need to understand law firm finance and economics. Likewise, law firm chief financial officers need a better understanding and appreciation of marketing strategies. The success of your firm will depend on how well these two disciplines work together. Marketing decisions affect whether the firm will obtain new business or increase business from existing clients. Profit needs to be returned to the firm as a result of these activities. Accordingly, the test of marketing decisions ultimately comes from its financial results. This article discusses two strategic but basic tenets of law firm finance and economics 'matter profitability and return on investment (ROI) ' and how marketing and finance professionals can work together to link marketing and financial strategies.

With concerns about the current economy and dire predictions of a recession that has staying power, it is probably a good time for law firms to rethink how their marketing dollars are being invested. Yes, invested. As a believer that marketing delivers profits over time, I am also a believer that marketing can be a major misspent category in most firms. Similar businesses face the same challenge. For example, consider this statement attributed to Macy's founder, John Wanamaker, when weighing the contribution of marketing expenditures: 'Half the money I spend on advertising is wasted; the trouble is I don't know which half.'

Client/Matter Profitability

Today, considerable emphasis is being placed on law firm profitability. An income statement can tell you if the firm, as a whole, is profitable; but it does not tell you if the work performed in a certain area of law, by a specific timekeeper or for a specific client, is profitable.

Performing regular profitability studies at the timekeeper and time-entry levels enables the firm to make more knowledgeable decisions regarding hiring and staffing, overhead expenditures, work assignments, target marketing, billing and collections, billing rate evaluations, and performance reviews. Why should determining the profitability of client matters be important information for the marketing professional? Because ultimately, this is the most important metric in determining the success of your firm. This analysis also provides the foundation for determining practice group or industry segment profitability. Armed with such knowledge, law firm leaders have useful information for:

• Strategic planning purposes;
• Investment decisions, including the allocation of limited firm resources;
• Improving profitability of existing clients or areas by:
• Increasing knowledge levels in order to reject unprofitable work;
• Understanding the impact on matter staffing patterns;
• Making pricing decisions;
• Profitability increases through alternative pricing;
• Careful use of discounts; and
• Holding attorneys accountable for matter management

As this list suggests, law firms are using profitability analysis as a management tool. Determining the cost of services sold is an absolute necessity, so do not be swayed by some partners who argue that only the traditional determining factors of hours, billings and collections are the correct measure of overall profitability.

Cost Allocations: Art vs. Science?

Businesses in this country are expected to abide by generally accepted accounting principles (GAAP). However, some firms have their own principles, which are referred to as PCAP (politically correct accounting principles). What this means is that there is no one correct way to determine cost allocations, and this is why some art is needed in determining the methodology for cost allocations. Any method will be subject to debate, so the key is to obtain the approval of firm management on the assumptions and then proceed.

For purposes of determining matter profitability, all or most costs must be allocated, and such costs are normally tracked by the hours invested in the matter. The end result of the allocation is that each fee earner will have a cost number associated with his or her billable hours. These costs are further defined as 'direct' (such as fee earner salaries and benefits) and 'indirect' (overhead). Marketing professionals do not need a mastery of numbers to get through this exercise, as the firm's CFO can easily walk them through the process.

Ongoing Review and Reporting

One thing to keep in mind is that ultimate matter profitability is not determined until the matter is closed. However, monthly or periodic reporting will assist management by keeping track of the financial progress of each matter. For example, on fixed-fee engagements, management can monitor the investment of billable time compared with the fixed fee, in addition to monitoring costs on the file. Sophisticated financial systems incorporate 'push reporting' to signal certain financial events, such as fee budget warnings.

The timing and frequency of these reports will depend on the ability of the firm's financial system and the CFO's team to generate the reports. Some firms will be able to use data warehouses to generate reports with relative ease, and some firms may be able to utilize executive inquiry systems. Executive inquiry systems are available from your desktop with easy-to-follow screen inquiries.

Last, beware of the potential divisiveness that may result from this analysis. If partners in Practice Group 1 were to learn how much more profitable they really are compared with another practice group, they may begin putting tremendous pressure on decision-makers as to compensation and other issues. There could be pressure to drive to expel the unprofitable practice group from the firm. Worse, Practice Group 1 may look to join another firm where they will be more appreciated.

Welcome to Marketing: Two-Drink Minimum

Scott Adams, creator of 'Dilbert,' penned a cartoon where the pointy-haired boss announces that he is placing Dilbert on a rotational assignment to the Marketing Department. As Dilbert nears the entrance to the marketing department, he notices the sign above the door that reads: Welcome to Marketing: Two Drink Minimum.

Over the years, I have compared marketing expenditures for many firms. I was astonished and mildly amused to see the six-figure amounts one firm spent on tickets to sporting events. Given the precious commodity of time, I wonder how many client decision-makers attended these events. I suspect that the return on this investment is considerably low or may run to the negative.

Return on Investment

You are probably already aware of the concept and some practical applications of ROI based on personal experience. Some examples include the amount of equity buildup in your home as a percentage of original cost and the returns (or lack thereof) from your personal savings and investments in the stock market. Businesses can use ROI as a very broad measure, such as dividing the company's annual net income by the company's total assets on the balance sheet. On a more micro level, CFOs and management will use ROI to judge specific requests for capital outlays, marketing and technology initiatives and the like.

In the real world, requests are normally approved for those projects offering the highest returns. Some law firms may have difficulty in assessing ROI data since the results of many marketing strategies and activities do not find their way onto new matter intake forms. Firms cannot begin to accurately measure ROI related to marketing activities if sources and reasons are not tracked at the intake stage. Examples of source activity include:

• Seminars;
• Advertising in the legal or trade press;
• Legal and other directories;
• Referrals;
• Personal relationships;
• The 'me' factor;
• Information from the firm's Web site;
• Client newsletters or other news articles;
• Press releases; and
• Corporate department golf tournaments

Forecasting ROI

The use of ROI in determining actual results from marketing campaigns is relatively clear based on historical information. However, ROI should also be used to forecast returns on future activities. Forecasting requires that we have good historical information or judgment on activities that have resulted in new clients or new matters from existing clients. For example, assume you want to sponsor a seminar related to nanotechnology, and you want to demonstrate the return to the CFO and firm management. To do so, you would need the following data from historical information (or professional judgment):

• How many responses will we receive from the invitation;
• How many will actually attend the seminar;
• The number of attendees that will become 'leads'; and
• The number of leads that will result in new business

Determining the Investment And the Return

What should be included as costs in the investment determination? Some of that depends on the firm's tracking systems. It would be easy to track the costs for the Labor and Employment seminar (printing, facility, catering, etc.). Should you include other expenses, such as an allocation of marketing department salaries, for this activity? How about the time invested by the firm's attorneys in preparing for and attending the event? I would suggest that you include this information only if the data is readily available. We don't want to have everyone suffer from analysis paralysis. Start from some meaningful point.

The return is normally the profit that the marketing campaign or initiative provided ' not simply the fee revenue that was derived. Most non-financial managers miss this point. Earlier, we explored matter profitability, so it is possible for you to determine or make a conservative estimate on resulting profits.

Last, how do we interpret the results? What is an acceptable ROI ' 10%, 20%, 50%? The main purpose of the measurement is to interpret the result relative to the ROI of other investment opportunities. For example, if you determined that the ROI from the Labor and Employment seminar was 35% and that the ROI from the Subprime Finance Golf Tournament was 2%, you would hopefully focus your future resources on similar seminars or events. Time also plays an important role since you need to allow the marketing initiative to run its course for an acceptable period ' the amount of time it takes to generate a new client or matter from a lead that originated from the event.

Benchmarking is another use of ROI. If the seminar yielded 35% in year one, our minimum results expectation for a similar seminar in year two should be 35% or higher. If you have no basis for comparison, you are left to judge each set of results on its own merits.

Considerations in Trying to Determine ROI

Lack of buy-in from firm leaders. Your time is important and you need partner interest in various technology and marketing initiatives. Accordingly, you seek their support in developing the business case before you spend considerable time creating the analysis.

Little in the way of in-depth analysis. I would advise against taking a mediocre approach at the ROI analysis. You need to address the significant concerns and questions of those partners who may pick apart your assumptions and case point.

Articulating the benefits. Document your ideas on where the greatest benefits will occur for various initiatives whether they are marketing- or technology-focused. Partners are looking for specifics on what costs can be reduced or avoided or how much revenues will increase.

Lack of follow-through after the analysis. The firm's initiatives are much more likely to realize the expected benefits when they are closely monitored and measured. Identify and highlight the critical metrics on an ongoing basis to validate the model and investment decisions.

Moving Forward

ROI is a powerful tool, and measuring ROI for marketing activities is a must. Marketing professionals have the ability to effect positive contributions to the revenue cycle and, ultimately, the bottom line. To accomplish this, you need to understand the concepts and measurements of ROI and matter profitability. Armed with this information, you can help your firm identify specific clients and types of matters that are more profitable than others. Matter profitability is the beginning point for reviewing the profitability of clients, a book of business, practice groups, industry segments and ultimately, the success of the firm.

Stephen M. (Pete) Peterson is the CEO of the accounting and business advisory firm Maxfield Peterson Richards and is the Managing Director of the firm's specialty practice, the Law Firm Business Institute.