The Cost v. Recovery of Costs: Which Has the Greater Impact?

Which will emerge as the victor in the case of Cost v. Recovery of Costs? The answer lay in this surprising fact: By focusing on the recovery of costs where applicable, law firms can accomplish more to help their bottom line than most cost-reduction exercises; in some cases 500% more.

Beginning with the Numbers

If a hypothetical firm, paying $10.00 for an overnight package, is shipping 20,000 packages per year and billing 70% of those packages to a billable client matter number, their cost recovery revenue and overhead situation is as follows:

Cost at $10.00 per package;
70% Billable Percentage

Cost per Package $10.00
Packages per Year 20,000
Billable Percentage 70%
Billable Revenue $140,000
Overhead Costs $60,000

Let's say after a round of negotiations with the overnight vendor, this hypothetical firm succeeds in reducing the price to $9.00, 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.

Cost at $9.00 per package;
70% Billable Percentage

Cost per Package $9.00
Packages per Year 20,000
Billable Percentage 70%
Billable Revenue $126,000
Overhead Impact $54,000

However, suppose instead of focusing on price reduction, this hypothetical firm focused on increasing their billable percentage from 70% to 85%. With price remaining constant at $10.00 from the first example, the results in this scenario would be as follows:

Cost at $10.00 per package;
85% Billable Percentage

Cost per Package $10.00
Packages per Year 20,000
Billable Percentage 85%
Billable Revenue $170,000
Overhead Impact $30,000

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 manifests 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, compared with reducing the firm's price by 10%.

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%.

Cost at $9.00 per package;
85% Billable Percentage

Cost per Package $9.00
Packages per Year 20,000
Billable Percentage 85%
Billable Revenue $153,000
Overhead Impact $27,000

This allows the firm to reduce billable charges to its clients by $17,000 and its 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. But herein lays the big question: How do you raise your billable percentages? Let's start by dispelling two popular cost recovery myths.

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

As our Cost Recovery Survey 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.

A Case Study: The Traditional Model Done Well

According to our survey results, the traditional model of cost recovery is the method that the vast majority, i.e., approximately 99%, of firms still employs. This is where firms capture on-site costs through a cost recovery system with a pre-set charge for copies, facsimiles, etc. While a number of firms have given up on this method and many predict its demise, the vast majority of law firms employ it. Based on the results of our survey, however, only a few do it well. One of those firms is a top AmLaw firm based in the Midwest. I spoke with the firm to determine the five key reasons for its success.

1. Focus of Firm Management On the Recovery of Costs: From Engagement Letter through Collection

The biggest reason for this firm's success is the across the board mentality on the recovery of soft costs. It is reflected from the firm's engagement letters through its efforts to collect these costs. The firm monitors these costs through the use of dedicated resources and is not afraid to police abusers of the system; nor does it fear making changes to its overall strategy while embracing new technologies. The firm adheres to the principle that it is recovering justifiable costs, not “charging” its clients.

2. Clear Cut, Defensible Policy

As the person who is responsible for the financial aspect of the cost recovery strategy for this firm stated, “We want to promote transparency to our clients on costs.” If the cost a law firm is trying to recover is not transparent or justifiable, not only will the clients not pay for it, the billing attorneys will not bill it. A clear cut pricing strategy based on actual costs along with a solid basis for its recovery will lead to the highest net realization of internal soft costs.

In fact, firms that have the highest net realization are not the firms with recovery rates at the higher end, but instead almost universally have rates that are at the lower end of the range, reflecting sensitivity to the market and competitive in-house operations. In this particular situation this policy is supported by an annual focused analytical review of all aspects of cost recovery with deep data dives in areas where questions arise. This analysis then supports the annual partner review of the area and decision making process.

3. Attorney Buy-in

Attorney buy-in is critical to the success of the recovery of soft costs. One of the items that participants are most surprised by in the Mattern Survey is that internal write-offs (attorneys) are higher than external write-offs (clients) as a percentage of net realization. As with most initiatives, the key is getting the attorneys involved. This particular firm has a Reimbursable Cost Committee that is involved in determining the overall cost recovery strategy for the firm based upon recommendations by the financial management.

Another non-scientific reason for this attorney buy-in is the trickledown effect it has on the other firm's employees. If the attorneys have a recovery mentality, the secretaries will have it, along with the paralegals and the support staff. Consistency is critical for the success of your cost recovery program. As the CFO at the firm recommended: “You have to set the tone at the top ' and also maintain the involvement of senior practice group attorneys.”

4. Dedicated Resources

In this firm, there were resources dedicated to managing and overseeing the recovery of soft costs. It understood the policies, analyzed the data and understood the mechanics. It was also instrumental in the strategy and the decision making process. With regard to the financial feasibility of this position, this firm nets 19% more on average (48% vs. 67%) on black & white copies, prints and scans than other firms in our survey.

5. Technology Awareness

This firm was one of the early adoptees of recovering black and white and color print costs and recovering convenience scans. They are not afraid of adopting technology and recovering these costs from their clients. Almost universally, firms that have a high realization recover for prints and scans recover a significantly higher percentage than firms that don't. They have accepted the changes in workflow/technology, incorporated it into their strategy and are reaping the benefits.

In summary, even though this firm is using the traditional method in a down economy, the results are impressive, to say the least, and prove the method works if done well.

Case Study in an Alternative Methodology

If your firm does not want to make the necessary changes to improve the traditional soft cost recovery model as outlined above, then perhaps an alternative model may be the better approach.

An example of the use of an alternative method with reported success is the firm Atkinson, Andelson, Loya, Ruud & Romo, a 140 attorney regional labor law firm operating in seven offices throughout California. The firm participated in the Mattern Survey in 2012 for the first time. According to the Director of Finance, Patrick Stevens: “The industry is changing a lot and the firm had been experiencing declining revenues from things we traditionally charged for including facsimile and legal research.” The firm sought out an industry-wide view of cost recovery practices.

At the same time, about four years ago, an attorney joined Atkinson Andelson who had been charging an administrative fee in lieu of the traditional soft cost model at her previous firm. The firm allowed this new attorney to continue this practice for her portfolio of clients ' and this turned out to be not only efficient for the firm but was met with some success. To that end, the firm decided to roll out this administrative fee to its public sector clients while removing the soft cost charges. One of the salient benefits of this procedural shift is that the firm was previously in the position of having to provide substantial paperwork on the soft cost charges for its public sector clients, who in return were required to investigate each cost line by line. This burdensome process was eliminated for these clients with the implementation of the administrative fee.

The firm still maintains the traditional cost recovery system for its clients accustomed to that type of billing procedure; however, the firm predicts that the administrative fee will eventually become the preferred method for both firm and client and the traditional charges will be eliminated as time goes on.

Conclusion

In the end, the numbers speak for themselves: Pricing exercises are good, but improving billable percentages, if applicable, are better. Firms have choices when dealing with the current client push back and refusal to pay for the soft cost recoveries: They can either increase their management and change the culture of the traditional model, or they can migrate to an alternative method, such as the administrative fee model.

Based upon our research and surveys, however, the highest realization a firm will achieve is when it passes a hard cost through to the clients to be reimbursed. Typically, a firm will recover in excess of 95% of these costs compared to less than 50% for the average soft costs such as copies or prints. One method we use is a process where a law firm's on-site soft costs are converted to hard costs at a typically lower rate than current recovery rates. However, this “client-focused” system will allow a firm to get out of the cost recovery business, reduce its overhead exposure and actually increase their overall net realization.

As part of my introductory call with a potential client, law firm management will often begin by asking: How much can you save me? It is, of course, an intelligent question being asked by intelligent people, not to mention the core thesis for an entire publishing niche. There are scores of books on purchasing, seminars on price negotiations, and sample RFPs that are available in the market to create a competitive situation to improve pricing and terms in almost every vertical market.

In most cases, firm management would consider a project a success if the firm was able to lower their costs by 10% without impacting services. If the firm in question were able to lower costs by 20% without impacting service, there would probably be a conference room named after you at project's end.

There is an alternative strategy: firm management can choose to focus on the recovery of costs rather than savings. Since 2008, law firms have been under siege with regard to the recovery of soft costs, and the results of the fifth biannual Mattern & Associates Cost Recovery Survey affirm this. To address this issue, different firms have developed various methodologies to attack the issue. Despite the outcries otherwise, the traditional model of cost recovery can be effective ' if done well. At the same time, the 2012 Survey also shows the largest percentage ever of firms seeking out and implementing alternative methodologies.

Which will emerge as the victor in the case of Cost v. Recovery of Costs? The answer lay in this surprising fact: By focusing on the recovery of costs where applicable, law firms can accomplish more to help their bottom line than most cost-reduction exercises; in some cases 500% more.

Beginning with the Numbers

If a hypothetical firm, paying $10.00 for an overnight package, is shipping 20,000 packages per year and billing 70% of those packages to a billable client matter number, their cost recovery revenue and overhead situation is as follows:

Cost at $10.00 per package;
70% Billable Percentage

Cost per Package $10.00
Packages per Year 20,000
Billable Percentage 70%
Billable Revenue $140,000
Overhead Costs $60,000

Let's say after a round of negotiations with the overnight vendor, this hypothetical firm succeeds in reducing the price to $9.00, 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.

Cost at $9.00 per package;
70% Billable Percentage

Cost per Package $9.00
Packages per Year 20,000
Billable Percentage 70%
Billable Revenue $126,000
Overhead Impact $54,000

However, suppose instead of focusing on price reduction, this hypothetical firm focused on increasing their billable percentage from 70% to 85%. With price remaining constant at $10.00 from the first example, the results in this scenario would be as follows:

Cost at $10.00 per package;
85% Billable Percentage

Cost per Package $10.00
Packages per Year 20,000
Billable Percentage 85%
Billable Revenue $170,000
Overhead Impact $30,000

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 manifests 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, compared with reducing the firm's price by 10%.

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%.

Cost at $9.00 per package;
85% Billable Percentage

Cost per Package $9.00
Packages per Year 20,000
Billable Percentage 85%
Billable Revenue $153,000
Overhead Impact $27,000

This allows the firm to reduce billable charges to its clients by $17,000 and its 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. But herein lays the big question: How do you raise your billable percentages? Let's start by dispelling two popular cost recovery myths.

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

As our Cost Recovery Survey 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.

A Case Study: The Traditional Model Done Well

According to our survey results, the traditional model of cost recovery is the method that the vast majority, i.e., approximately 99%, of firms still employs. This is where firms capture on-site costs through a cost recovery system with a pre-set charge for copies, facsimiles, etc. While a number of firms have given up on this method and many predict its demise, the vast majority of law firms employ it. Based on the results of our survey, however, only a few do it well. One of those firms is a top AmLaw firm based in the Midwest. I spoke with the firm to determine the five key reasons for its success.

1. Focus of Firm Management On the Recovery of Costs: From Engagement Letter through Collection

The biggest reason for this firm's success is the across the board mentality on the recovery of soft costs. It is reflected from the firm's engagement letters through its efforts to collect these costs. The firm monitors these costs through the use of dedicated resources and is not afraid to police abusers of the system; nor does it fear making changes to its overall strategy while embracing new technologies. The firm adheres to the principle that it is recovering justifiable costs, not “charging” its clients.

2. Clear Cut, Defensible Policy

As the person who is responsible for the financial aspect of the cost recovery strategy for this firm stated, “We want to promote transparency to our clients on costs.” If the cost a law firm is trying to recover is not transparent or justifiable, not only will the clients not pay for it, the billing attorneys will not bill it. A clear cut pricing strategy based on actual costs along with a solid basis for its recovery will lead to the highest net realization of internal soft costs.

In fact, firms that have the highest net realization are not the firms with recovery rates at the higher end, but instead almost universally have rates that are at the lower end of the range, reflecting sensitivity to the market and competitive in-house operations. In this particular situation this policy is supported by an annual focused analytical review of all aspects of cost recovery with deep data dives in areas where questions arise. This analysis then supports the annual partner review of the area and decision making process.

3. Attorney Buy-in

Attorney buy-in is critical to the success of the recovery of soft costs. One of the items that participants are most surprised by in the Mattern Survey is that internal write-offs (attorneys) are higher than external write-offs (clients) as a percentage of net realization. As with most initiatives, the key is getting the attorneys involved. This particular firm has a Reimbursable Cost Committee that is involved in determining the overall cost recovery strategy for the firm based upon recommendations by the financial management.

Another non-scientific reason for this attorney buy-in is the trickledown effect it has on the other firm's employees. If the attorneys have a recovery mentality, the secretaries will have it, along with the paralegals and the support staff. Consistency is critical for the success of your cost recovery program. As the CFO at the firm recommended: “You have to set the tone at the top ' and also maintain the involvement of senior practice group attorneys.”

4. Dedicated Resources

In this firm, there were resources dedicated to managing and overseeing the recovery of soft costs. It understood the policies, analyzed the data and understood the mechanics. It was also instrumental in the strategy and the decision making process. With regard to the financial feasibility of this position, this firm nets 19% more on average (48% vs. 67%) on black & white copies, prints and scans than other firms in our survey.

5. Technology Awareness

This firm was one of the early adoptees of recovering black and white and color print costs and recovering convenience scans. They are not afraid of adopting technology and recovering these costs from their clients. Almost universally, firms that have a high realization recover for prints and scans recover a significantly higher percentage than firms that don't. They have accepted the changes in workflow/technology, incorporated it into their strategy and are reaping the benefits.

In summary, even though this firm is using the traditional method in a down economy, the results are impressive, to say the least, and prove the method works if done well.

Case Study in an Alternative Methodology

If your firm does not want to make the necessary changes to improve the traditional soft cost recovery model as outlined above, then perhaps an alternative model may be the better approach.

An example of the use of an alternative method with reported success is the firm Atkinson, Andelson, Loya, Ruud & Romo, a 140 attorney regional labor law firm operating in seven offices throughout California. The firm participated in the Mattern Survey in 2012 for the first time. According to the Director of Finance, Patrick Stevens: “The industry is changing a lot and the firm had been experiencing declining revenues from things we traditionally charged for including facsimile and legal research.” The firm sought out an industry-wide view of cost recovery practices.

At the same time, about four years ago, an attorney joined Atkinson Andelson who had been charging an administrative fee in lieu of the traditional soft cost model at her previous firm. The firm allowed this new attorney to continue this practice for her portfolio of clients ' and this turned out to be not only efficient for the firm but was met with some success. To that end, the firm decided to roll out this administrative fee to its public sector clients while removing the soft cost charges. One of the salient benefits of this procedural shift is that the firm was previously in the position of having to provide substantial paperwork on the soft cost charges for its public sector clients, who in return were required to investigate each cost line by line. This burdensome process was eliminated for these clients with the implementation of the administrative fee.

The firm still maintains the traditional cost recovery system for its clients accustomed to that type of billing procedure; however, the firm predicts that the administrative fee will eventually become the preferred method for both firm and client and the traditional charges will be eliminated as time goes on.

Conclusion

In the end, the numbers speak for themselves: Pricing exercises are good, but improving billable percentages, if applicable, are better. Firms have choices when dealing with the current client push back and refusal to pay for the soft cost recoveries: They can either increase their management and change the culture of the traditional model, or they can migrate to an alternative method, such as the administrative fee model.

Based upon our research and surveys, however, the highest realization a firm will achieve is when it passes a hard cost through to the clients to be reimbursed. Typically, a firm will recover in excess of 95% of these costs compared to less than 50% for the average soft costs such as copies or prints. One method we use is a process where a law firm's on-site soft costs are converted to hard costs at a typically lower rate than current recovery rates. However, this “client-focused” system will allow a firm to get out of the cost recovery business, reduce its overhead exposure and actually increase their overall net realization.