Measuring Realization to Improve Firm Profits

Last month, we reviewed how to tailor a scorecard to your individual firm's goals. This month we review a very important financial metric. In creating a partner scorecard and setting individual partner goals, Realization should be at the top of the list.

What Is Your Realization?

When consulting with a client, if the law firm cannot respond immediately to the question, “What is your realization?” then I am confident that over the next several months of working with the firm, I can help to improve its realization by an average of 5%. The reason is that if a lawyer does not understand the importance of realization enough to track it and know it off the top of his head, then he is not spending enough time making sure it is trending at a respectable level.

How Do You Measure Realization?

It is important to define each goal on the partner scorecard clearly. When I ask, “How do you calculate realization?” I often get a mix of answers ' even from members of the same firm. I calculate realization, sometimes referred to as billing realization, as follows:

Realization = Net Fee Billings divided by Standard Value of Time Recorded

When I drill into how a law firm is actually calculating realization, I often find a deviation from the above definition, so I am going to break down this seemingly simple definition to make it clearer.

Net Fee Billings for a period of time are calculated as follows:

Billings mailed to actual clients (include only “real” bills and “real” clients),

Less any costs included in those billings mailed (include only “fees”),

Less any write offs of previous billings mailed (adjust to “net”).

Standard Value of Time Recorded is calculated as follows:

Sum of standard rates, multiplied by actual hours worked.

Standard rates can be interpreted in different ways, but it is best to have one standard rate for each individual timekeeper. Any deviation from that standard rate should be considered a discount (an agreed-upon rate that is less than the standard rate).

Actual hours worked should be interpreted as the hours recorded initially by the timekeeper before any “write-downs” by a billing partner.

Common Errors in Calculating Realization

Some common errors, intentional and unintentional, in calculating realization are as follows:

• Including clients who are prospects, or mixing in non-client projects instead of using real clients with whom the firm has a signed fee agreement;
• Not adjusting for write-offs of previous billings;
• Calculating with actual rates, but routinely giving client discounts and not factoring it in;
• Adjusting “time recorded” before measuring realization;
• Including costs billed instead of just fees; and
• Recording bills in the system that will never be mailed ' contingent or speculative work.

I have seen all of the above errors over the years, and not surprisingly, they inflate realization. I have yet to come across a deviation in the calculation that actually makes realization appear less than it would if it were calculated properly.

Many time and billing systems give the users the option of creating reports that calculate realization using actual rates or standard rates. It is often useful to track realization using both methods for trending purposes. The difference is the result of how many different billing rates an individual has for different types of services or how often the firm grants client “discounts” using agreed upon rates or even blended rates for everyone involved in the engagement. However, realization based on standard rates should be the key benchmark.

Developing a Target Realization

After the firm has calculated its overall realization and the billing partner's individual realization, it is time to set expectations for what is acceptable. Overall, a law firm should strive to reach 95% realization; i.e., bills are actually mailed for the value of 95% of the work expended. This should be both the firm-wide and the individual partner goal. However, a firm may set interim goals if there are a lot of behavioral changes necessary to implement before a 95% target is an achievable goal. Setting a realization target of 95% for a partner who has historically achieved 80% is unrealistic in the short-term. However, if that partner is coached one-on-one by a peak-performing partner and feels accountable to change his behavior to improve his realization, he may be able to reach an interim goal of 85% to 90%.

Publishing Monthly Results

When a firm publishes the monthly results of realization for all the partners, it should also publish the average as well as the target goal as benchmarks in order to communicate what the actual results mean overall. I also prefer that clients publish what it means in terms of profits if the average was met by the partner who is trending below the average and what it means in terms of profits if the target was met by the partner who is trending below the target.

Partner's Scorecard Excerpt

The following is an example of how realization metrics may be reported on an individual partner's scorecard

Month of August            | Year to Date

Fee Billings                   | $200,000 $1,600,000

Realization Actual          | 90% 89%

Firm Average                | 92% 92%

Firm Target                  | 95% 95%

Deviation from Average  | $4,444 $53,932

Deviation from Target    | $11,111 $107,865

Follow Up and Provide Feedback

It is important to provide feedback to partners on their performance in order to revisit expectations and to be able to effect changes in behavior, if warranted. Many times, expectations are set but there is no mechanism or appropriate follow-up system in place to compare actual performance on an individual personal basis. If a partner “score” does not meet expectations, then an individual or committee in the firm should be responsible for reviewing and discussing potential causes with that partner. In this way, the firm is reinforcing the importance of the goals and their impact on the success of the firm.

Feedback may include acknowledging that the expectations are not being met, discussing why, and brainstorming on specific reasons. Less than desirable realization could be the result any of the following:

• Intake procedures
• Pricing and budgeting projects
• Negotiation of billing rates
• Timely billing practices
• Lack of expertise
• Lack of confidence to bill for work performed
• Poor time-entry explanations
• Project efficiency
• Poor communications with client
• Poor supervision of staff
• Overservicing a client on a fixed-fee agreement
• A demanding client whose need for service exceeds his tolerance for fees

Conclusion

Realization is a key metric to track because improvements in realization translate directly into firm profits. There is no additional investment in staff needed to improve realization, but changes in behavior may be required. It is important to drill down to realization by client to brainstorm what changes can be made at the client or staffing level to improve realization for an overall book of business. If a partner can improve the realization on one client from 70% to 90%, then the partner's average realization will also increase. If a partner is confident that the bill represents the value-added to the client, then he will feel more comfortable billing all the time expended. If a partner is able to replace a client with poor realization with one with respectable realization without working more hours, then profitability will increase. Next month we will review some more “must-have” financial goals for individual partners.

Last month, we reviewed how to tailor a scorecard to your individual firm's goals. This month we review a very important financial metric. In creating a partner scorecard and setting individual partner goals, Realization should be at the top of the list.

What Is Your Realization?

When consulting with a client, if the law firm cannot respond immediately to the question, “What is your realization?” then I am confident that over the next several months of working with the firm, I can help to improve its realization by an average of 5%. The reason is that if a lawyer does not understand the importance of realization enough to track it and know it off the top of his head, then he is not spending enough time making sure it is trending at a respectable level.

How Do You Measure Realization?

It is important to define each goal on the partner scorecard clearly. When I ask, “How do you calculate realization?” I often get a mix of answers ' even from members of the same firm. I calculate realization, sometimes referred to as billing realization, as follows:

Realization = Net Fee Billings divided by Standard Value of Time Recorded

When I drill into how a law firm is actually calculating realization, I often find a deviation from the above definition, so I am going to break down this seemingly simple definition to make it clearer.

Net Fee Billings for a period of time are calculated as follows:

Billings mailed to actual clients (include only “real” bills and “real” clients),

Less any costs included in those billings mailed (include only “fees”),

Less any write offs of previous billings mailed (adjust to “net”).

Standard Value of Time Recorded is calculated as follows:

Sum of standard rates, multiplied by actual hours worked.

Standard rates can be interpreted in different ways, but it is best to have one standard rate for each individual timekeeper. Any deviation from that standard rate should be considered a discount (an agreed-upon rate that is less than the standard rate).

Actual hours worked should be interpreted as the hours recorded initially by the timekeeper before any “write-downs” by a billing partner.

Common Errors in Calculating Realization

Some common errors, intentional and unintentional, in calculating realization are as follows:

• Including clients who are prospects, or mixing in non-client projects instead of using real clients with whom the firm has a signed fee agreement;
• Not adjusting for write-offs of previous billings;
• Calculating with actual rates, but routinely giving client discounts and not factoring it in;
• Adjusting “time recorded” before measuring realization;
• Including costs billed instead of just fees; and
• Recording bills in the system that will never be mailed ' contingent or speculative work.

I have seen all of the above errors over the years, and not surprisingly, they inflate realization. I have yet to come across a deviation in the calculation that actually makes realization appear less than it would if it were calculated properly.

Many time and billing systems give the users the option of creating reports that calculate realization using actual rates or standard rates. It is often useful to track realization using both methods for trending purposes. The difference is the result of how many different billing rates an individual has for different types of services or how often the firm grants client “discounts” using agreed upon rates or even blended rates for everyone involved in the engagement. However, realization based on standard rates should be the key benchmark.

Developing a Target Realization

After the firm has calculated its overall realization and the billing partner's individual realization, it is time to set expectations for what is acceptable. Overall, a law firm should strive to reach 95% realization; i.e., bills are actually mailed for the value of 95% of the work expended. This should be both the firm-wide and the individual partner goal. However, a firm may set interim goals if there are a lot of behavioral changes necessary to implement before a 95% target is an achievable goal. Setting a realization target of 95% for a partner who has historically achieved 80% is unrealistic in the short-term. However, if that partner is coached one-on-one by a peak-performing partner and feels accountable to change his behavior to improve his realization, he may be able to reach an interim goal of 85% to 90%.

Publishing Monthly Results

When a firm publishes the monthly results of realization for all the partners, it should also publish the average as well as the target goal as benchmarks in order to communicate what the actual results mean overall. I also prefer that clients publish what it means in terms of profits if the average was met by the partner who is trending below the average and what it means in terms of profits if the target was met by the partner who is trending below the target.

Partner's Scorecard Excerpt

The following is an example of how realization metrics may be reported on an individual partner's scorecard

Month of August            | Year to Date

Fee Billings                   | $200,000 $1,600,000

Realization Actual          | 90% 89%

Firm Average                | 92% 92%

Firm Target                  | 95% 95%

Deviation from Average  | $4,444 $53,932

Deviation from Target    | $11,111 $107,865

Follow Up and Provide Feedback

It is important to provide feedback to partners on their performance in order to revisit expectations and to be able to effect changes in behavior, if warranted. Many times, expectations are set but there is no mechanism or appropriate follow-up system in place to compare actual performance on an individual personal basis. If a partner “score” does not meet expectations, then an individual or committee in the firm should be responsible for reviewing and discussing potential causes with that partner. In this way, the firm is reinforcing the importance of the goals and their impact on the success of the firm.

Feedback may include acknowledging that the expectations are not being met, discussing why, and brainstorming on specific reasons. Less than desirable realization could be the result any of the following:

• Intake procedures
• Pricing and budgeting projects
• Negotiation of billing rates
• Timely billing practices
• Lack of expertise
• Lack of confidence to bill for work performed
• Poor time-entry explanations
• Project efficiency
• Poor communications with client
• Poor supervision of staff
• Overservicing a client on a fixed-fee agreement
• A demanding client whose need for service exceeds his tolerance for fees

Conclusion

Realization is a key metric to track because improvements in realization translate directly into firm profits. There is no additional investment in staff needed to improve realization, but changes in behavior may be required. It is important to drill down to realization by client to brainstorm what changes can be made at the client or staffing level to improve realization for an overall book of business. If a partner can improve the realization on one client from 70% to 90%, then the partner's average realization will also increase. If a partner is confident that the bill represents the value-added to the client, then he will feel more comfortable billing all the time expended. If a partner is able to replace a client with poor realization with one with respectable realization without working more hours, then profitability will increase. Next month we will review some more “must-have” financial goals for individual partners.