Raising the Bridge v. Lowering the Water: Expense Management and Its Relation to Cost Recovery

This article focuses on the issue of expense management and its relation to cost recovery. Many firms over the past four years have been focusing on reducing expenses in an effort to ward off the effects of the recent economic downturn. This is commonly termed “lowering the water” and has evolved into a go-to strategy. Many times, for instance, as part of an introductory call with a potential client, firm management will ask the question: How much can you save me? This savings-focused or lowering-the-water strategy is only exacerbated by consultants in the industry who focus on savings as a basis for their payment ' a business model which, quite frankly, is not in anyone's best interest.

However, there is an alternative strategy: Firm management can choose to focus on the recovery of costs in addition to savings ' this is commonly termed “raising the bridge.” What many firms fail to take advantage of is the fact that, by focusing on the recovery of costs where applicable, they can accomplish more to help their bottom line than most cost reduction exercises.

Raising the Bridge

Before we explore the impact of cost recovery on your bottom line, I think it would be useful to dispel two of the cost recovery myths that you are hearing in the marketplace.

Myth #1: Clients are not paying for any of this stuff anymore.

As our Mattern & Associates 2012 Cost Recovery Study shows, clients will pay for justifiable, reasonable soft-cost recoveries. Moreover, it is not your clients that are your biggest problem; it is your own attorneys and your internal write-offs.

Myth #2: No one is charging for printing and scanning.

Based upon our 2012 survey, 48% of firms charge for prints and 37% charge for scanning.

The fact is that the traditional cost recovery model is still very much alive in the legal industry. It has shifted from a copy/fax to a print/scan based model, and the more intelligent firms are migrating in this direction.

The Relationship Between Costs and Recovery

Would you consider a project a success if you were able to lower your costs 10% without impacting your services? Most firms would say “yes.” How about 20%? If you could lower your costs by 20% without impacting service, your firm would probably name a conference room after you. However, consider this: By increasing your billable percentage by 15%, a very achievable goal, you can have a much bigger impact than either of the previous scenarios.

Taking a simplified example, if a hypothetical firm is paying $10 for an overnight package, is shipping 20,000 packages per year and billing 70% of those packages to a billable client matter number, its cost recovery revenue and overhead situation is as set forth in Table 1.

[IMGCAP(1)]

Let's say after a round of negotiations with the overnight vendor, this hypothetical firm succeeds in reducing the price to $9, a solid 10% decrease. The firm under this scenario realizes an overhead savings of $6,000 per year and is able to save its clients $14,000. Overall, this would be deemed a successful project. See Table 2.

[IMGCAP(2)]

However, suppose instead of focusing on price reduction, this hypothetical firm focused on increasing its billable percentage from 70% to 85% (Mattern Method Benchmark'). With price remaining constant at $10 from the first example, the results in this scenario would be as set forth in Table 3.

[IMGCAP(3)]

The net result here, when increasing billable percentage only, is a bottom line increase for the firm of $30,000. This result comes directly from increasing the firm's billable revenue which manifested in a significant decrease of $30,000 to the firm's overhead charges. This scenario, focusing only on increasing billable percentage, resulted in a remarkable 500% impact in comparison with only reducing the firm's price by 10%.

And Lowering the Water, Too

Let's say our hypothetical firm, having now been apprised of the impact of billable percentage, is able to both increase its billable percentage to 85% and decrease its costs by 10%. See Table 4.

[IMGCAP(4)]

This allows the firm to reduce its billable charges to clients by $17,000 and non-billable charges (overhead) by $3,000. This is a nice improvement, but we can now see the majority of the overhead savings can be attributed to the increase in billable revenue.

The above example shows in a very simplified way that pricing exercises are good, but cost recovery analysis and implementation of strategies to increase the billable percentage are better and will have a much greater impact on the bottom line.

How Do You Raise the Bridge?

Everyone can tell you how to lower the water. There are scores of books on purchasing, seminars on price negotiations, and sample RFPs that are available for you to use to create a competitive situation to improve pricing and terms. But how do you raise your billable percentages?

Depending on the areas you are targeting, some or all of these steps may apply:

1) Have a clearly defined, defensible cost-recovery policy.

How many fi-rms have a written cost-recovery policy that covers each area they recover and contains their pricing rationale, policies and procedures? About the same amount that have a records retention policy and actually implement it ' in other words, very, very few. A cost-recovery bible is critical to the success of your program and provides the basis to “selling” it to your biggest obstacle ' the billing attorneys.

2) Educate your biggest obstacle/opportunity ' the billing attorneys.

The largest percentage of write-offs occurring in your firm is happening internally. To shore up the defenses against this common practice, make sure the billing attorneys understand the policies, the pricing, the justification and basis for the pricing, as well as the impact when they write things off. In the past, write-offs were a non-issue. Nowadays, they make a difference, but the billing attorneys need to be integral to the conversation and impact of doing so in order to prevent it from occurring.

3) Educate the end-users.

It is also imperative that firms educate the end-users on the impact of charging non-billable overhead numbers when the services should be charged to a billable client matter number. Just as you educate the billing attorneys, the same should be done for the end-users. They may think they are extending a courtesy or doing the client a favor, whereas, in actuality they may be jeopardizing their jobs.

 4) Do not bring services in-house unless you are sure the client will pay for them.

This is especially prevalent in Litigation Support. Firms that send work off-site receive a hard-cost invoice to pass through to their clients. For a variety of reasons, some firms bring these services in-house and turn hard-cost charges into soft costs, which the clients will not pay. This leaves the firm in the unfortunate position of being left with an increase in overhead costs and suddenly no way to recover them.

5) Get the billable information upfront.

One of the simplest things firms can do to improve billable recoveries is to get the billing information upfront prior to the transaction and validate it. When you are chasing billing information you are just burning hours, increasing your overhead and impacting your billable percentages.

6) Police it.

As Peter Drucker said, “You can't manage it unless you measure it.” Have someone in your organization in charge of monitoring billable percentages, write-offs and realizations. The big brother effect is powerful, and this factor alone will increase billable percentages. Give this person the necessary authority to chargeback departments and make strategic changes.

In the end, in the matter of Raising the Bridge v. Lowering the Water, the numbers, while surprising to some are clear and speak for themselves: pricing exercises are good, improving billable percentages if applicable, is better.

Granted, running an RFP and negotiating a new contract may be easier, but the bigger impact to your bottom line will be from improving your billable cost recovery revenue.

Robert C. Mattern, a member of this newsletter's Board of Editors, is president and founder of Mattern & Associates LLC, a consultancy that decreases law firm overhead expenses through developing in-house and outsourcing strategies that streamline support services and increase net billable realization of soft-cost recoveries. Mattern publishes widely on the topic of law firm profitability and managerial decisions based upon cost recovery benchmarks, and is a frequent speaker at ALA Chapters across the country as well as the National ALA Conference and the Hildebrandt Institute's Annual COO-CFO Forum in New York City.

This article focuses on the issue of expense management and its relation to cost recovery. Many firms over the past four years have been focusing on reducing expenses in an effort to ward off the effects of the recent economic downturn. This is commonly termed “lowering the water” and has evolved into a go-to strategy. Many times, for instance, as part of an introductory call with a potential client, firm management will ask the question: How much can you save me? This savings-focused or lowering-the-water strategy is only exacerbated by consultants in the industry who focus on savings as a basis for their payment ' a business model which, quite frankly, is not in anyone's best interest.

However, there is an alternative strategy: Firm management can choose to focus on the recovery of costs in addition to savings ' this is commonly termed “raising the bridge.” What many firms fail to take advantage of is the fact that, by focusing on the recovery of costs where applicable, they can accomplish more to help their bottom line than most cost reduction exercises.

Raising the Bridge

Before we explore the impact of cost recovery on your bottom line, I think it would be useful to dispel two of the cost recovery myths that you are hearing in the marketplace.

Myth #1: Clients are not paying for any of this stuff anymore.

As our Mattern & Associates 2012 Cost Recovery Study shows, clients will pay for justifiable, reasonable soft-cost recoveries. Moreover, it is not your clients that are your biggest problem; it is your own attorneys and your internal write-offs.

Myth #2: No one is charging for printing and scanning.

Based upon our 2012 survey, 48% of firms charge for prints and 37% charge for scanning.

The fact is that the traditional cost recovery model is still very much alive in the legal industry. It has shifted from a copy/fax to a print/scan based model, and the more intelligent firms are migrating in this direction.

The Relationship Between Costs and Recovery

Would you consider a project a success if you were able to lower your costs 10% without impacting your services? Most firms would say “yes.” How about 20%? If you could lower your costs by 20% without impacting service, your firm would probably name a conference room after you. However, consider this: By increasing your billable percentage by 15%, a very achievable goal, you can have a much bigger impact than either of the previous scenarios.

Taking a simplified example, if a hypothetical firm is paying $10 for an overnight package, is shipping 20,000 packages per year and billing 70% of those packages to a billable client matter number, its cost recovery revenue and overhead situation is as set forth in Table 1.

[IMGCAP(1)]

Let's say after a round of negotiations with the overnight vendor, this hypothetical firm succeeds in reducing the price to $9, a solid 10% decrease. The firm under this scenario realizes an overhead savings of $6,000 per year and is able to save its clients $14,000. Overall, this would be deemed a successful project. See Table 2.

[IMGCAP(2)]

However, suppose instead of focusing on price reduction, this hypothetical firm focused on increasing its billable percentage from 70% to 85% (Mattern Method Benchmark'). With price remaining constant at $10 from the first example, the results in this scenario would be as set forth in Table 3.

[IMGCAP(3)]

The net result here, when increasing billable percentage only, is a bottom line increase for the firm of $30,000. This result comes directly from increasing the firm's billable revenue which manifested in a significant decrease of $30,000 to the firm's overhead charges. This scenario, focusing only on increasing billable percentage, resulted in a remarkable 500% impact in comparison with only reducing the firm's price by 10%.

And Lowering the Water, Too

Let's say our hypothetical firm, having now been apprised of the impact of billable percentage, is able to both increase its billable percentage to 85% and decrease its costs by 10%. See Table 4.

[IMGCAP(4)]

This allows the firm to reduce its billable charges to clients by $17,000 and non-billable charges (overhead) by $3,000. This is a nice improvement, but we can now see the majority of the overhead savings can be attributed to the increase in billable revenue.

The above example shows in a very simplified way that pricing exercises are good, but cost recovery analysis and implementation of strategies to increase the billable percentage are better and will have a much greater impact on the bottom line.

How Do You Raise the Bridge?

Everyone can tell you how to lower the water. There are scores of books on purchasing, seminars on price negotiations, and sample RFPs that are available for you to use to create a competitive situation to improve pricing and terms. But how do you raise your billable percentages?

Depending on the areas you are targeting, some or all of these steps may apply:

1) Have a clearly defined, defensible cost-recovery policy.

How many fi-rms have a written cost-recovery policy that covers each area they recover and contains their pricing rationale, policies and procedures? About the same amount that have a records retention policy and actually implement it ' in other words, very, very few. A cost-recovery bible is critical to the success of your program and provides the basis to “selling” it to your biggest obstacle ' the billing attorneys.

2) Educate your biggest obstacle/opportunity ' the billing attorneys.

The largest percentage of write-offs occurring in your firm is happening internally. To shore up the defenses against this common practice, make sure the billing attorneys understand the policies, the pricing, the justification and basis for the pricing, as well as the impact when they write things off. In the past, write-offs were a non-issue. Nowadays, they make a difference, but the billing attorneys need to be integral to the conversation and impact of doing so in order to prevent it from occurring.

3) Educate the end-users.

It is also imperative that firms educate the end-users on the impact of charging non-billable overhead numbers when the services should be charged to a billable client matter number. Just as you educate the billing attorneys, the same should be done for the end-users. They may think they are extending a courtesy or doing the client a favor, whereas, in actuality they may be jeopardizing their jobs.

 4) Do not bring services in-house unless you are sure the client will pay for them.

This is especially prevalent in Litigation Support. Firms that send work off-site receive a hard-cost invoice to pass through to their clients. For a variety of reasons, some firms bring these services in-house and turn hard-cost charges into soft costs, which the clients will not pay. This leaves the firm in the unfortunate position of being left with an increase in overhead costs and suddenly no way to recover them.

5) Get the billable information upfront.

One of the simplest things firms can do to improve billable recoveries is to get the billing information upfront prior to the transaction and validate it. When you are chasing billing information you are just burning hours, increasing your overhead and impacting your billable percentages.

6) Police it.

As Peter Drucker said, “You can't manage it unless you measure it.” Have someone in your organization in charge of monitoring billable percentages, write-offs and realizations. The big brother effect is powerful, and this factor alone will increase billable percentages. Give this person the necessary authority to chargeback departments and make strategic changes.

In the end, in the matter of Raising the Bridge v. Lowering the Water, the numbers, while surprising to some are clear and speak for themselves: pricing exercises are good, improving billable percentages if applicable, is better.

Granted, running an RFP and negotiating a new contract may be easier, but the bigger impact to your bottom line will be from improving your billable cost recovery revenue.

Robert C. Mattern, a member of this newsletter's Board of Editors, is president and founder of Mattern & Associates LLC, a consultancy that decreases law firm overhead expenses through developing in-house and outsourcing strategies that streamline support services and increase net billable realization of soft-cost recoveries. Mattern publishes widely on the topic of law firm profitability and managerial decisions based upon cost recovery benchmarks, and is a frequent speaker at ALA Chapters across the country as well as the National ALA Conference and the Hildebrandt Institute's Annual COO-CFO Forum in New York City.