Law Firms' Top Three Factors for Operational Success

Every year, The American Lawyer publishes a major survey regarding U.S. law firms. Of particular note to the industry is the section discussing profits per partner. The outcome of this survey can be a source of pride (and PR marketing) for firms that rise in the rankings, or a cause for chagrin as they fall. For partners specifically, benchmarking their compensation in relation to others is an intriguing concept. Surveys of this nature provide a barometer of success to those partners who are evaluating their worth in the industry.

Partners want to work for a firm that runs its operations well and gives them the best opportunity to be well compensated. Law firms want to attract and keep partners who will allow them to continue to grow. Understanding the factors driving profits to a law firm and eventually to the partner's pockets becomes imperative to this process. There are many specific traits that can be debated, but there are three inherent operational difference makers that every law firm can control: business development, pricing controls, and controlling overhead costs.

Business Development

Lawyers who command the highest compensation in the legal industry are those with the biggest, most diverse books of business. Having a large book of business brings in the most dollars both directly (more clients and hours equates to more dollars) and indirectly (greater opportunity for cross selling to different parts of the firm). Expertise is a hallmark of a great lawyer. However, when it comes to profits per partner, what you know is less important than being able to use that knowledge for a client's benefit. There are many expert lawyers who are not as financially successful as their peers, and the reason is simple. Some partners are simply better at selling themselves, and therefore provide more value to the firm they are a part of.

Make no mistake, by being a practicing lawyer and generating revenue, you are part of a business. Large, successful, professional service industries have a lot of competition and high expectations. For this reason, simply practicing law is not enough to be highly compensated compared with others. Partners need to drive revenue to their firms to reap the benefits, and that means selling. The concept of being in a sales organization is often distasteful to those in the profession of law. It conjures up the caricature of a used car salesman or an ambulance chasing lawyer. However, selling legal services to potential clients is not only necessary for a successful business, but is also beneficial for the client. There is a need for legal services, a need that must be fulfilled for clients to be successful in their own ventures.

For a law firm, helping attorneys sell themselves should be number one on their priority list. Not only should the resources be made available for training, but also action plans for existing associates and partners alike must be at the forefront of every business development plan. As an associate starting out, the path to partnership must incorporate multiple skills that will contribute to the overall return for the firm. Selling, managing and cross selling services are crucial components of that skill set. Without those skills being ingrained into each attorney, firms are setting themselves up for a lack of future revenue generation, improper succession planning, and even losing key contributors.

Pricing Controls

Pricing control refers to the process a firm sets up in order to ensure that dollars do not escape the bottom line through leakage. All too often, law firms compensate based on hours, but do little to ensure those hours make the journey to the bottom line. Time is the valuable resource firms must grasp, and the concept of opportunity cost is of utmost importance when evaluating this resource. Allowing hours to become free or heavily discounted unexpectedly severely limits the earning potential of a firm.

Most firms understand this concept and have implemented pricing committees or czars to monitor discounts and ensure that excessive discounts are, at the very least, explained and not repeated. However, with the increase of alternative fee arrangements, this process has become more cumbersome and difficult.

With new arrangements and pricing pressure, law firms need to become more advanced. Looking at each lawyer, determining a total dollar-based working output for each, and then monitoring the total expected dollars of their efforts throughout the year allows the firm to get a handle on how time is being utilized. Note that this is a different concept than utilization, which simply looks at the total amount of hours. Looking at pure hour generation will not do. The expected value of a lawyer is not simply hours or effective hourly rates, but the combination of both. Compensating on this principle will generate the behavior that leads to greater profits per partner and greater retention. Doing the opposite and focusing primarily on hours will lead to divisive behavior that leads to scrutiny on compensation and possible attrition of key performers.

Controlling Overhead Costs

Nothing erodes profit faster than runaway overhead costs. These types of costs are difficult to manage, particularly in the short term, and in many cases require hard decisions to bring under control. Fortunately, thanks to the recent downturn, most firms have already made many of these tough decisions. However, law firms historically have short memories with similar mistakes being repeated in the future. Firms need to always be mindful for an escalation of overhead in good times and bad. Unfortunately, the metrics used to manage this concept are faulty. For example, many firms look to their overhead as a percentage of revenue in order to maintain control over it. As revenue goes up, it appears that there is more room for costs to rise. It is much easier to raise overhead costs than to cut them, and so when revenue stops increasing, what is left are high percentages of overhead that once again need to, painfully, be brought under control. Better metrics, such as tying overhead to counts of employees or partners, help stem some of the problems. Or better yet, using funding mechanisms in which long-term costs must be offset with future cash flows (although this too can lead to problems). In the end, overhead is the least controllable issue at an individual level, but still plays a large part in the overall profitability of the individual partner. Closely managing this aspect of a law firm's budget will minimize future risks.

Operational excellence is not a new term within the business community, but it can be revolutionary within the legal community. Every firm has room to improve, even those at the top of The American Lawyer's survey. Focusing on the three differentiators of business development, pricing control, and overhead cost can lead a firm to greater profitability and propel it forward past competition. A law firm's operational success and a partner's financial success are inextricably tied. Partners are well served by overseeing how well their firms are operating.

Derek Schutz, a member of this newsletter's Board of Editors, is the Director of Programs/Services for the Business of Law Group at Redwood/LexisNexis. He can be reached at [email protected]. As Director of Consulting and Business of Law Services at LexisNexis' Redwood Analytics Division, Russ Haskin has worked with more than 150 law firms across the globe. He leads a team that consults with firm leadership on Redwood tools and methodology, business analysis, and process improvement, and additionally plays a lead role in designing and implementing training and consulting programs. Haskin is a primary contributor to the MorePartnerIncome.com blog.

Every year, The American Lawyer publishes a major survey regarding U.S. law firms. Of particular note to the industry is the section discussing profits per partner. The outcome of this survey can be a source of pride (and PR marketing) for firms that rise in the rankings, or a cause for chagrin as they fall. For partners specifically, benchmarking their compensation in relation to others is an intriguing concept. Surveys of this nature provide a barometer of success to those partners who are evaluating their worth in the industry.

Partners want to work for a firm that runs its operations well and gives them the best opportunity to be well compensated. Law firms want to attract and keep partners who will allow them to continue to grow. Understanding the factors driving profits to a law firm and eventually to the partner's pockets becomes imperative to this process. There are many specific traits that can be debated, but there are three inherent operational difference makers that every law firm can control: business development, pricing controls, and controlling overhead costs.

Business Development

Lawyers who command the highest compensation in the legal industry are those with the biggest, most diverse books of business. Having a large book of business brings in the most dollars both directly (more clients and hours equates to more dollars) and indirectly (greater opportunity for cross selling to different parts of the firm). Expertise is a hallmark of a great lawyer. However, when it comes to profits per partner, what you know is less important than being able to use that knowledge for a client's benefit. There are many expert lawyers who are not as financially successful as their peers, and the reason is simple. Some partners are simply better at selling themselves, and therefore provide more value to the firm they are a part of.

Make no mistake, by being a practicing lawyer and generating revenue, you are part of a business. Large, successful, professional service industries have a lot of competition and high expectations. For this reason, simply practicing law is not enough to be highly compensated compared with others. Partners need to drive revenue to their firms to reap the benefits, and that means selling. The concept of being in a sales organization is often distasteful to those in the profession of law. It conjures up the caricature of a used car salesman or an ambulance chasing lawyer. However, selling legal services to potential clients is not only necessary for a successful business, but is also beneficial for the client. There is a need for legal services, a need that must be fulfilled for clients to be successful in their own ventures.

For a law firm, helping attorneys sell themselves should be number one on their priority list. Not only should the resources be made available for training, but also action plans for existing associates and partners alike must be at the forefront of every business development plan. As an associate starting out, the path to partnership must incorporate multiple skills that will contribute to the overall return for the firm. Selling, managing and cross selling services are crucial components of that skill set. Without those skills being ingrained into each attorney, firms are setting themselves up for a lack of future revenue generation, improper succession planning, and even losing key contributors.

Pricing Controls

Pricing control refers to the process a firm sets up in order to ensure that dollars do not escape the bottom line through leakage. All too often, law firms compensate based on hours, but do little to ensure those hours make the journey to the bottom line. Time is the valuable resource firms must grasp, and the concept of opportunity cost is of utmost importance when evaluating this resource. Allowing hours to become free or heavily discounted unexpectedly severely limits the earning potential of a firm.

Most firms understand this concept and have implemented pricing committees or czars to monitor discounts and ensure that excessive discounts are, at the very least, explained and not repeated. However, with the increase of alternative fee arrangements, this process has become more cumbersome and difficult.

With new arrangements and pricing pressure, law firms need to become more advanced. Looking at each lawyer, determining a total dollar-based working output for each, and then monitoring the total expected dollars of their efforts throughout the year allows the firm to get a handle on how time is being utilized. Note that this is a different concept than utilization, which simply looks at the total amount of hours. Looking at pure hour generation will not do. The expected value of a lawyer is not simply hours or effective hourly rates, but the combination of both. Compensating on this principle will generate the behavior that leads to greater profits per partner and greater retention. Doing the opposite and focusing primarily on hours will lead to divisive behavior that leads to scrutiny on compensation and possible attrition of key performers.

Controlling Overhead Costs

Nothing erodes profit faster than runaway overhead costs. These types of costs are difficult to manage, particularly in the short term, and in many cases require hard decisions to bring under control. Fortunately, thanks to the recent downturn, most firms have already made many of these tough decisions. However, law firms historically have short memories with similar mistakes being repeated in the future. Firms need to always be mindful for an escalation of overhead in good times and bad. Unfortunately, the metrics used to manage this concept are faulty. For example, many firms look to their overhead as a percentage of revenue in order to maintain control over it. As revenue goes up, it appears that there is more room for costs to rise. It is much easier to raise overhead costs than to cut them, and so when revenue stops increasing, what is left are high percentages of overhead that once again need to, painfully, be brought under control. Better metrics, such as tying overhead to counts of employees or partners, help stem some of the problems. Or better yet, using funding mechanisms in which long-term costs must be offset with future cash flows (although this too can lead to problems). In the end, overhead is the least controllable issue at an individual level, but still plays a large part in the overall profitability of the individual partner. Closely managing this aspect of a law firm's budget will minimize future risks.

Operational excellence is not a new term within the business community, but it can be revolutionary within the legal community. Every firm has room to improve, even those at the top of The American Lawyer's survey. Focusing on the three differentiators of business development, pricing control, and overhead cost can lead a firm to greater profitability and propel it forward past competition. A law firm's operational success and a partner's financial success are inextricably tied. Partners are well served by overseeing how well their firms are operating.

Derek Schutz, a member of this newsletter's Board of Editors, is the Director of Programs/Services for the Business of Law Group at Redwood/LexisNexis. He can be reached at [email protected]. As Director of Consulting and Business of Law Services at LexisNexis' Redwood Analytics Division, Russ Haskin has worked with more than 150 law firms across the globe. He leads a team that consults with firm leadership on Redwood tools and methodology, business analysis, and process improvement, and additionally plays a lead role in designing and implementing training and consulting programs. Haskin is a primary contributor to the MorePartnerIncome.com blog.