Hildebrandt/ Citi Client Advisory: Slow Growth For Law Firms in 2010

Considering the contraction in 2009, this isn’t as newsworthy as it might appear. In fact, there is little evidence 2010 will be much better than 2009 according to the Advisory:

“However, while the profession is no longer in crisis mode, we recognize that firms will remain under intense pressure to create new models for pricing and delivery of legal services,” DiPietro said in a news release. “The report addresses these issues as well as the industry’s response to the current market environment.”

I suppose this will lead to another in depth discussion of alternative fee arrangements.  How novel.

Some highlights:

• Realization continues to drop in spite of efforts to raise rates to offset drops in demand;
• Pressure for discounting, fee caps, multi-year rate schedules and alternative pricing increases;
• Increases in “negotiated” rates are being offset by drops in “collected rates”, leading to the lower realization;
• Firms chose to cut expenses, especially compensation costs, to offset losses (a typical reaction);
• Biglaw firms fared better than smaller firms, mostly due to dramatic purging of staff and cost controls;
• Significant improvements seen in 2009 in demand for Mergers and Acquisitions, general corporate, tax, capital markets, and real estate practices;
• Expect further cost cutting measures in 2010 (ie, not likely to be a boom year for technology vendors seeking to encourage firm investment in technology).

A look at the effects on key profit drivers:

• Productivity still in negative growth “driven to some extent by associate pushback on the unsustainable billable hour requirements in many firms”;
• Leverage is increasing to make up for declining productivity (which makes no sense as this drives up costs without adding value);
• Realization, as earlier stated, is in steady decline;
• Expenses had been a source of continual growth until 2009;
• Growth prior to 2009 was consistently driven by rate increases between 6 to 8 per cent annually;
• Expectations for future rate increases are low due to increased client resistance.

The Advisory mentions something that I have touted for years:  the need for improved efficiency to maximize profitability.  During the boom years, it enhanced an already profitable model.  Now, it will be a necessity to offset rate stagnation.

Legal Current has more on the advisory.  To read their take and download a copy of the Advisory, click here.

Survey Your Clients To Improve Performance

When talking about improving performance, we talk about measurement.  Measuring productivity, rate, realization, margin and leverage.  But what about measuring the satisfaction of your clients?  After all, without their satisfaction, all of your numbers decrease.

Internal “upward reviews” are good to determine how well management is doing internally.  Client satisfaction reviews are good to determine how well your attorneys are doing in providing excellent service to the firm’s clients.

Tom Collins wrote a good sample client survey form that posted on More Partner Income in 2005.  It’s freely distributable, so I have posted a copy of it that you can download by clicking here.

Tracking Billing Cycle Metrics

The law firm business model is based on the measurement of 5 key profit drivers:  Rate, Realization, Utilization, Leverage, and Margin.  I would add another metric:  Cash flow.  You can really see a return on your investment in time and effort if you have a lot of time in WIP (work in process) and AR (accounts receivable).

The critical metrics that affect cash flow are the average days to bill, average days to collect (and by extension the sum of both to create the total billing cycle) and the average days in AR. Using a rolling 12 month period will give you an annual baseline, but you can also track it monthly. 

In the graph below, The variables are the total fees unbilled, total fees billed, and total fees collected over a 12 month period.  Knowing these numbers, you can calculate the total receivables outstanding during this time span, the average monthly and daily fees unbilled, billed and paid and your average days to bill, collect and days outstanding.

These metrics are critical for measuring your efficiency both at billing your work and collecting your fees.  If these numbers are high, then a review of your processes is due. Click on the graphic above to download and test with your own numbers.

Simplifying the Law Firm Business Model

The law firm business model, as defined by David Maister, is made up of the following equation:

1. Leverage
2. Rate
3. Productivity (Utilization)
4. Realization
5. Margin

If you are not tracking these profit drivers, it doesn’t matter how many reports you are thumbing through – they won’t measure the keys to per-partner profits and are thus, as far as profitability is concerned, irrelevant. The good news is that it doesn’t take much to track these drivers.  You can derive a simplified financial statement by just plugging in your numbers.  The below graph shows how tracking these key indicators can help you see exactly what drives your firm’s profits.  To download and plug in your own numbers, click on the graph.

 

I will be going over each of the drivers in more detail over the next several weeks.