Profitability and the Legal Marketing Professional

Increasingly, legal marketing professionals are being looked upon to assist their firms in improving profitability. The demand that legal marketing professionals assist the attorneys in their respective law firms with soliciting new business or responding to proposal requests is not new, although the number and complexity of the pursuits and dollar value of the RFPs is surely greater than ever before. What is new is that the results of these pursuits are far more critical to the success of the law firm than they ever were in the past.

The reasons for this sea change in looking at the value of marketing efforts are many and include fallout from the continuing economic slowdown that began in 2008, increased competition for high'value-added (and more profitable) legal work and the demands of corporate counsel for increased efficiency, reduced rates and levels of service in the delivery of their legal products and business solutions. Whatever the reason, the demands are there and legal marketing professionals must respond.

At a conference in Washington, I had the opportunity to speak with many legal marketing professionals and found a wide range of understanding among them as to how law firms measured client and attorney profitability and how the marketing function could impact a firm's profitability. There was also a good deal of confusion over how law firms measure, utilize internally, and report their “profitability.”

This article first provides for the legal marketing professional a guide to the basics of law firm economics, then includes sample metrics and ideas as to how to improve the contributions of the marketing department to the bottom line of your law firm.

Casey Stengel used to say about baseball and the early New York Mets, “Can't anybody play this here game right?” And indeed, at the highest level, profitability in a law firm, and playing a child's game, should be quite easy. After all, we charge $375 or more for an hour of attorney time and pay that attorney less than $125 for that same hour. Why can't we make money (a lot of money!) in this “game”? But as Casey and the Mets learned, there is more to “this here game” than meets the eye.

And the Metrics Are?

Any discussion of metrics, or measurement of an attorney's performance, must begin with the law firm's business strategy. As we all know, that which is measured is performed. Therefore, before we develop metrics we need to understand what a firm's strategic objectives are and then devise ways of measuring progress against those objectives. The clearer the strategy of a law firm, the easier it will be to identify meaningful metrics, calibrate those metrics to evaluate and motivate individual and group performance, and ultimately drive the firm's strategy to success.

At our firm, SB2 Consultants, we utilize eight basic metrics to evaluate an individual attorney's performance or a client's billings and collections, and therefore, the overall profitability of the law firm. They are:

1. Utilization;
2. Realization;
3. Cash Collection Cycle;
4. A/R and WIP Aging;
5. Partner Sales Efficiency;
6. Partner Matter Leverage;
7. New Fees per Hour; and
8. Fully Loaded Client Profitability.

These metrics can be developed for individual attorneys, groups of attorneys or the entire firm. The descriptions of the calculations outlined below are all aimed at developing the metric for an individual attorney, but the logic and methodology for developing them would hold true for larger aggregations.

Utilization

Utilization is the percentage of time an attorney bills against a “theoretical” work week or target number of hours. The target number of hours for associates in national law firms is between 1900 and 2200. Therefore, if an associate records 1820 hours and the target number of hours at the firm was 2000 hours, the utilization percent for that individual would be 91%. Similarly, if another associate in the same firm recorded 2100 hours, that individual's utilization would be 105%. In most firms there are different hourly objectives for partners and associates. In some firms, there also are different hourly targets for each class of associates.

Realization

Realization is the difference between the hours recorded by an individual on a specific matter and the number of hours that are ultimately billed to a client. As an example, if an associate records 100 hours on a matter and the partner bills 86 hours (and writes-off the rest) then the individual attorney realization percent for that matter will be 86%. It is possible for realization to be more than 100% when a partner bills more time than has been recorded. This event is commonly referred to as a “premium bill” and generally reflects exceptional value (when contrasted to the amount of time invested) delivered to a client.

Cash Collection Cycle

Cash Collection Cycle, or the “Docket to Pocket” metric, is the length of time, in days, between when work is performed by an attorney and when the law firm receives the payment for those services. If work was recorded on April 2, invoiced on May 5 and the client check received on June 21, then the total cash cycle for that matter would be 80 days. If we divide that number (80 days) into the 365 days in a year the resultant number (4.56) represents the number of times that a law firm collects its complete accounts receivable.

A/R and WIP Aging

These metrics indicate the length of time that WIP (Work in Process) remains unbilled and then, once billed (Accounts Receivable), remains unpaid. Commonly, unbilled time and uncollected receivables are reported in 30/60-day increments such as: 0-30, 31-60, 61-90, 91-120 and 121-180 and 181 or more.

Partner Sales Efficiency

Partner Sales Efficiency is a ratio between the billing value of the time that a partner, and other members of a client pursuit team, invest in securing a matter and the resulting value of the matter. It is calculated by extending the number of hours invested in developing the matter times the individual's full hourly rate divided into the total amount billed to the client. Therefore, if a partner spent 10 hours developing a matter and the partner bill rate was $500 and the matter billed $100,000 the ratio would be 20:1 or for every dollar of time invested $20 of work was produced.

Partner Matter Leverage

Partner Matter Leverage is a ratio between the total number of hours that a partner charges to all matters and the total numbers of hours others (partners, associates and paralegals) charged to those matters. It can be expressed as a ratio or in terms of FTAs (full-time equivalent attorneys). As a ratio, if a partner charged 1650 hours to all matters and other attorneys charged 23,100 then the ratio of managed hours is 14 to 1 (23,100/1650). In terms of managed FTAs, it would be the total number of hours charged divided by the targeted number of billable hours for an associate. If in our example that number was 2000 hours, then the span of control for the partner would be 11.55. Or the partner was managing 11.55 attorneys' time throughout the year.

Net Fees per Hour

Net Fees per Hour is the average value of an hour billed by a partner on a matter. It is calculated by dividing the total number of hours charged to a matter by the total amount of fees collected on the matter. So if 200 hours were recorded to a matter with a value of $50,000 and the client was billed (and paid) $40,000, the net fee per hour (“NFH”) would be $200.

Fully Loaded Client Profitability

Fully Loaded Client Profitability is the most complex of our metric calculations and involves the attribution of a law firm's expenses into three groups. They are: direct attorney, identifiable client/matter and block overhead. The objective is to be able to calculate the firm's cost of providing the client's legal services and contrast it with the revenue generated from the client. Identifiable client/matter expenses (court reporter fees, expert witness fees, and direct out-of-pocket expenses, etc.) are first attributed to their proper matter. Then all direct attorney expenses (compensation, benefits, rent, etc.) are calculated for the attorneys. Some firms do this on an individual basis and others on a class year basis. However it is done, the resulting number is divided by the total number of collected hours the attorney worked in a given year. The resultant number is the first component of the attorneys' per hour cost. The second component is the result of dividing the block overhead amount (all expenses that could not be directly attributed to an attorney) by the total number of collected hours for the firm. That amount, plus the amount calculated as the direct attorney expense, is the cost on an hourly basis of providing one hour of a specific attorney's time.

That cost (for all attorneys who charged time to a matter) multiplied by the associated number of hours for each attorney aggregated with the direct client expenses, is the cost of providing the service to the client. When you subtract that number from the total fees received from a client you have determined the client's relative profitability. Some firms vary the calculation a little by excluding partner compensation and bonuses from the cost of partner time. The result is a higher theoretical profit number, but the methodology still holds true.

As noted, fully loaded client profitability is the most complex of all the metrics.

What Do All These Numbers Really Mean?

The metrics that we have just reviewed and the numbers that result will tell you a lot about the financial health of your firm and also enable you to track the results of marketing initiatives.

Low utilization (as an example) points to poor business generation skills among the partners and/or an inappropriate skill mix within the associates. High utilization but low realization might point to either quality of skill set issues or scarcity of client matters upon which the firm is working. It could also identify partner timidity.

Cash collection cycles should be short and, in general, the shorter the better. Likewise A/R and WIP aging should reflect robust billing and collection efforts. Large amounts of unbilled time and uncollected receivables are not a “nest egg” for the partners, but an investment (they, after all, have paid the associates, staff and the vendors) that is decreasing in value and likelihood of collection.

Partner sales efficiency ratios are valuable to compare the relative ability of partners to sell work to their clients, either through marketing, prior service experience or established relationships. They allow you to identify those attorneys who should be encouraged to market and those attorneys whose efforts are better spent in client service. After all, not all attorneys, or other professionals, are necessarily good marketers.

Partner matter leverage and net fees per hour are both strong measures of a partner's management skills and ability to deliver services to a client in an efficient manner.

The final metric, client/matter profitability, is the ultimate indicator of the success of your firm. It can help your firm identify specific practices, partners and clients that are more profitable than others. This information is useful when the firm makes investment decisions (new partners, more associates and branch offices) and where these investments might best be made.

Marketing departments and legal marketing professionals have the ability to positively impact each of these metrics if they understand them and their importance to the law firm, and if they utilize the metrics in their marketing efforts. It will not be easy to gain that option in your firm, but armed with the right information, you can play this game.

J. Mark Santiago is a member of this newsletter's Board of Editors and a certified management consultant. He is the managing partner of SB2 Consultants headquartered in New York City. Santiago has consulted to the legal profession for more than 25 years in the areas of financial performance improvement, compensation systems, merger/acquisition due diligence and integration, and administrative support outsourcing. While a partner at Deloitte & Touche he led the two largest law firm administrative outsourcing projects in the United States. Santiago is a frequent speaker and author and was the chairman of the Am Law CFO conferences for 11 years. He was also one of the three originators of LegalTech in 1981 and a member of its Advisory Board.

Increasingly, legal marketing professionals are being looked upon to assist their firms in improving profitability. The demand that legal marketing professionals assist the attorneys in their respective law firms with soliciting new business or responding to proposal requests is not new, although the number and complexity of the pursuits and dollar value of the RFPs is surely greater than ever before. What is new is that the results of these pursuits are far more critical to the success of the law firm than they ever were in the past.

The reasons for this sea change in looking at the value of marketing efforts are many and include fallout from the continuing economic slowdown that began in 2008, increased competition for high'value-added (and more profitable) legal work and the demands of corporate counsel for increased efficiency, reduced rates and levels of service in the delivery of their legal products and business solutions. Whatever the reason, the demands are there and legal marketing professionals must respond.

At a conference in Washington, I had the opportunity to speak with many legal marketing professionals and found a wide range of understanding among them as to how law firms measured client and attorney profitability and how the marketing function could impact a firm's profitability. There was also a good deal of confusion over how law firms measure, utilize internally, and report their “profitability.”

This article first provides for the legal marketing professional a guide to the basics of law firm economics, then includes sample metrics and ideas as to how to improve the contributions of the marketing department to the bottom line of your law firm.

Casey Stengel used to say about baseball and the early New York Mets, “Can't anybody play this here game right?” And indeed, at the highest level, profitability in a law firm, and playing a child's game, should be quite easy. After all, we charge $375 or more for an hour of attorney time and pay that attorney less than $125 for that same hour. Why can't we make money (a lot of money!) in this “game”? But as Casey and the Mets learned, there is more to “this here game” than meets the eye.

And the Metrics Are?

Any discussion of metrics, or measurement of an attorney's performance, must begin with the law firm's business strategy. As we all know, that which is measured is performed. Therefore, before we develop metrics we need to understand what a firm's strategic objectives are and then devise ways of measuring progress against those objectives. The clearer the strategy of a law firm, the easier it will be to identify meaningful metrics, calibrate those metrics to evaluate and motivate individual and group performance, and ultimately drive the firm's strategy to success.

At our firm, SB2 Consultants, we utilize eight basic metrics to evaluate an individual attorney's performance or a client's billings and collections, and therefore, the overall profitability of the law firm. They are:

1. Utilization;
2. Realization;
3. Cash Collection Cycle;
4. A/R and WIP Aging;
5. Partner Sales Efficiency;
6. Partner Matter Leverage;
7. New Fees per Hour; and
8. Fully Loaded Client Profitability.

These metrics can be developed for individual attorneys, groups of attorneys or the entire firm. The descriptions of the calculations outlined below are all aimed at developing the metric for an individual attorney, but the logic and methodology for developing them would hold true for larger aggregations.

Utilization

Utilization is the percentage of time an attorney bills against a “theoretical” work week or target number of hours. The target number of hours for associates in national law firms is between 1900 and 2200. Therefore, if an associate records 1820 hours and the target number of hours at the firm was 2000 hours, the utilization percent for that individual would be 91%. Similarly, if another associate in the same firm recorded 2100 hours, that individual's utilization would be 105%. In most firms there are different hourly objectives for partners and associates. In some firms, there also are different hourly targets for each class of associates.

Realization

Realization is the difference between the hours recorded by an individual on a specific matter and the number of hours that are ultimately billed to a client. As an example, if an associate records 100 hours on a matter and the partner bills 86 hours (and writes-off the rest) then the individual attorney realization percent for that matter will be 86%. It is possible for realization to be more than 100% when a partner bills more time than has been recorded. This event is commonly referred to as a “premium bill” and generally reflects exceptional value (when contrasted to the amount of time invested) delivered to a client.

Cash Collection Cycle

Cash Collection Cycle, or the “Docket to Pocket” metric, is the length of time, in days, between when work is performed by an attorney and when the law firm receives the payment for those services. If work was recorded on April 2, invoiced on May 5 and the client check received on June 21, then the total cash cycle for that matter would be 80 days. If we divide that number (80 days) into the 365 days in a year the resultant number (4.56) represents the number of times that a law firm collects its complete accounts receivable.

A/R and WIP Aging

These metrics indicate the length of time that WIP (Work in Process) remains unbilled and then, once billed (Accounts Receivable), remains unpaid. Commonly, unbilled time and uncollected receivables are reported in 30/60-day increments such as: 0-30, 31-60, 61-90, 91-120 and 121-180 and 181 or more.

Partner Sales Efficiency

Partner Sales Efficiency is a ratio between the billing value of the time that a partner, and other members of a client pursuit team, invest in securing a matter and the resulting value of the matter. It is calculated by extending the number of hours invested in developing the matter times the individual's full hourly rate divided into the total amount billed to the client. Therefore, if a partner spent 10 hours developing a matter and the partner bill rate was $500 and the matter billed $100,000 the ratio would be 20:1 or for every dollar of time invested $20 of work was produced.

Partner Matter Leverage

Partner Matter Leverage is a ratio between the total number of hours that a partner charges to all matters and the total numbers of hours others (partners, associates and paralegals) charged to those matters. It can be expressed as a ratio or in terms of FTAs (full-time equivalent attorneys). As a ratio, if a partner charged 1650 hours to all matters and other attorneys charged 23,100 then the ratio of managed hours is 14 to 1 (23,100/1650). In terms of managed FTAs, it would be the total number of hours charged divided by the targeted number of billable hours for an associate. If in our example that number was 2000 hours, then the span of control for the partner would be 11.55. Or the partner was managing 11.55 attorneys' time throughout the year.

Net Fees per Hour

Net Fees per Hour is the average value of an hour billed by a partner on a matter. It is calculated by dividing the total number of hours charged to a matter by the total amount of fees collected on the matter. So if 200 hours were recorded to a matter with a value of $50,000 and the client was billed (and paid) $40,000, the net fee per hour (“NFH”) would be $200.

Fully Loaded Client Profitability

Fully Loaded Client Profitability is the most complex of our metric calculations and involves the attribution of a law firm's expenses into three groups. They are: direct attorney, identifiable client/matter and block overhead. The objective is to be able to calculate the firm's cost of providing the client's legal services and contrast it with the revenue generated from the client. Identifiable client/matter expenses (court reporter fees, expert witness fees, and direct out-of-pocket expenses, etc.) are first attributed to their proper matter. Then all direct attorney expenses (compensation, benefits, rent, etc.) are calculated for the attorneys. Some firms do this on an individual basis and others on a class year basis. However it is done, the resulting number is divided by the total number of collected hours the attorney worked in a given year. The resultant number is the first component of the attorneys' per hour cost. The second component is the result of dividing the block overhead amount (all expenses that could not be directly attributed to an attorney) by the total number of collected hours for the firm. That amount, plus the amount calculated as the direct attorney expense, is the cost on an hourly basis of providing one hour of a specific attorney's time.

That cost (for all attorneys who charged time to a matter) multiplied by the associated number of hours for each attorney aggregated with the direct client expenses, is the cost of providing the service to the client. When you subtract that number from the total fees received from a client you have determined the client's relative profitability. Some firms vary the calculation a little by excluding partner compensation and bonuses from the cost of partner time. The result is a higher theoretical profit number, but the methodology still holds true.

As noted, fully loaded client profitability is the most complex of all the metrics.

What Do All These Numbers Really Mean?

The metrics that we have just reviewed and the numbers that result will tell you a lot about the financial health of your firm and also enable you to track the results of marketing initiatives.

Low utilization (as an example) points to poor business generation skills among the partners and/or an inappropriate skill mix within the associates. High utilization but low realization might point to either quality of skill set issues or scarcity of client matters upon which the firm is working. It could also identify partner timidity.

Cash collection cycles should be short and, in general, the shorter the better. Likewise A/R and WIP aging should reflect robust billing and collection efforts. Large amounts of unbilled time and uncollected receivables are not a “nest egg” for the partners, but an investment (they, after all, have paid the associates, staff and the vendors) that is decreasing in value and likelihood of collection.

Partner sales efficiency ratios are valuable to compare the relative ability of partners to sell work to their clients, either through marketing, prior service experience or established relationships. They allow you to identify those attorneys who should be encouraged to market and those attorneys whose efforts are better spent in client service. After all, not all attorneys, or other professionals, are necessarily good marketers.

Partner matter leverage and net fees per hour are both strong measures of a partner's management skills and ability to deliver services to a client in an efficient manner.

The final metric, client/matter profitability, is the ultimate indicator of the success of your firm. It can help your firm identify specific practices, partners and clients that are more profitable than others. This information is useful when the firm makes investment decisions (new partners, more associates and branch offices) and where these investments might best be made.

Marketing departments and legal marketing professionals have the ability to positively impact each of these metrics if they understand them and their importance to the law firm, and if they utilize the metrics in their marketing efforts. It will not be easy to gain that option in your firm, but armed with the right information, you can play this game.

J. Mark Santiago is a member of this newsletter's Board of Editors and a certified management consultant. He is the managing partner of SB2 Consultants headquartered in New York City. Santiago has consulted to the legal profession for more than 25 years in the areas of financial performance improvement, compensation systems, merger/acquisition due diligence and integration, and administrative support outsourcing. While a partner at Deloitte & Touche he led the two largest law firm administrative outsourcing projects in the United States. Santiago is a frequent speaker and author and was the chairman of the Am Law CFO conferences for 11 years. He was also one of the three originators of LegalTech in 1981 and a member of its Advisory Board.