Law Firm Profitability in the New World

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1 May 22-25, 2016 Los Angeles Convention Center Los Angeles, California Law Firm Profitability in the New World Presented by Toby Brown FM13 5/23/2016 1:45 PM - 2:45 PM The handouts and presentations attached are copyright and trademark protected and provided for individual use only.

thinking about submitting a rate increase for 2009... don't.

2 ALA 2016 Annual Conference Law Firm Profitability in the New World May 23, 2016 Toby Brown Chief Practice Management Officer Perkins Coie LLP Why You Should Care Late GC letter to outside counsel: "If you are thinking about submitting a rate increase for don't. If you have already requested and been approved for a rate increase... we changed our minds." Early 2016 Eight Outside Counsel Guidelines Received in Two Days 2 1

3 Foundation: Define Profit FIRM PROFIT: Annual Cash Basis Revenue Minus Cost = Profit All Revenue is the same Cost focus is on Administration and Overhead Challenge Revenue Trails Billing Billing Trails Work So Revenue not connected to its Cost of Generation CLIENT PROFIT: Revenue = Collected Dollars Cost = Cost of Hours that Generated the Revenue Challenge Partner Income Cost or Profit? 3 Profit Methodologies We are Assuming Cost s Most Litigated Aspect of Law Firm Profit Minor Impact Agree and Move On #1 Contribution All Partner Comp Treated as Cost #2 Gross All Partner Comp Treated as Profit AmLaw Stats Variation PPP #3 Split Partner Comp into Cost and Profit Components 4 2

4 What Drives Profit? Obviously - the Difference Between Revenue and Cost Drivers: s Realization s minus Discounts, Write Downs and Write Offs Productivity Hours billed and collected per Timekeeper Leverage Ratio of non-partner Hours to Partner Hours Not head count 5 Profit Drivers Profit Driver #1: s Higher = Better $900 per hour versus $600 per hour Obvious but s have a significant impact on profit In the example that follows: 5% change in s results in approximately 12% change in Profitability 6 3

5 Profit Driver #2: Realization Realization is the percentage of revenue collected against the value of time at standard rates The Math: s times Hours minus Discounts, Write-downs and Write-offs Discounts: Where we give a discount off of standard rates. Write-downs: When we remove time from a draft bill, before it goes to the client. Indicates we do not see value in effort could be training time or just too much time. Write-offs: When we remove time from a bill after the client sees it, usually at the client s request as they did not find value in certain effort, or feel the fee does not match the value of the overall work. 7 Profit Driver #2: Realization (cont.) Example: $25,000 = 50 Hours X $500 (Revenue at standard rates) $23,750 = 5% Discount reduces it by $1,250 (95% Realization) $22,500 = 5% Write-down reduces it another $1,250 (90% Realization) $21,250 = 5% Write-off reduces it another $1,250 = (85% Realization) $21,250 is 85% of $25,000 Realization is 85% in this example Caveat: Some firms measure realization off of discounted rates. How can a partner be expected to collect any more than the agreed rates? This approach can hide the discount impacts. 8 4

6 Profit Driver #3: Productivity Hours billed per time keeper per month/year Higher = Better (158 per month = 1900 per year) Impact: As Productivity drops (less hours billed) the cost per hour per timekeeper rises Math Example: $750,000 annual cost for a senior associate Includes both comp and overhead Divided by 1900 hours billed per year $395 total cost per hour Productivity drops 5% to 1800 hours per year $417 new cost per hour ($750k 1800) 5.5% increase 9 Profit Driver #4: Leverage Percentage of Equity Partner Hours Billed on a Matter Less is Better Impact: As That Number Drops, Profits Go Up Non-equity partner hours generate the profits that pay equity partners A tool for counteracting drops in Realization Market Average: About 25% A.K.A. 3:1 Caveat: Equity Partner time still matters At 25% leverage, about a third of the revenue comes from their time 10 5

7 Profits at the Timekeeper Level Hours Billed s minus discounts, write-downs & write-offs = Realized minus Cost = Hours times Time Keeper Type Hours Std at Realization Cost Revenue Associate 41 $503 $478 $271 $207 $19,592 $8,481 Full Standard s Cost = Comp and Overhead Costs on a per hour basis This associate has an annual cost of $515k, which includes both comp and overhead. $515k 1900 = $271 per hour Revenue = Realized times Hours 11 Baseline Sample Matter Leverage Based on averages s Averages Realization 92% of Standard s 25% Leverage 92% Time Keeper Type Hours Std at Realization Cost Revenue Eqt Partner 25 $858 $789 $763 $26 $19,734 $659 Inc Partner 14 $683 $628 $519 $109 $8,797 $1,531 Sr Counsel 20 $599 $551 $388 $163 $11,022 $3,262 Associate 41 $503 $463 $271 $192 $18,973 $7,862 % $58,526 $13,314 23% 100 total hours PPP Calculated using 1800 billable hours as benchmark PPP $1,937,

8 Testing Assumptions: Lower by 5% Higher = Better Effective minus Cost equals 25% Leverage 87% Time Keeper Type Hours Std at Realization Cost Revenue Eqt Partner 25 $858 $746 $763 -$17 $18,662 -$413 Inc Partner 14 $683 $594 $519 $75 $8,319 $1,053 Sr Counsel 20 $599 $521 $388 $133 $10,423 $2,663 Associate 41 $503 $438 $271 $167 $17,942 $6,831 % $55,345 $10,133 18% A negative for a Eqt Partner reflects that comp is profit 5% Discount = 12% Drop in PPP PPP $1,708,780 5% Discount = 21% Drop in 13 Testing Assumptions: Realization 82% of Standard s 5% Discount + Additional 5% Write-off from 92% Baseline Fees Collected minus Cost of Delivery Equals Profit 25% Leverage 82% Time Keeper Type Hrs Std Realization Cost Revenue Cost of Hours Eqt Partner 25 $858 $704 $763 -$59 $17,589 $19,075 -$1,486 Inc Partner 14 $683 $560 $519 $41 $7,841 $7,266 $575 Sr Counsel 20 $599 $491 $388 $103 $9,824 $7,760 $2,064 Associate 41 $503 $412 $271 $141 $16,911 $11,111 $5,800 % $52,164 $45,212 $6,952 13% PPP $1,479,766 82% Realization = 24% Drop in PPP 82% Realization = 42% Drop in 14 7

9 Testing Assumptions: Productivity Decrease Higher = Better But: Firm / Practice Group Levels Versus Client / Matter Levels 25% Leverage 92% +5% Time Keeper Type Hours Std at Realization Cost 5% Increase in Cost s due to drop in Productivity Revenue Eqt Partner 25 $858 $789 $801 -$12 $19,734 -$295 Inc Partner 14 $683 $628 $545 $83 $8,797 $1,168 Sr Counsel 20 $599 $551 $407 $144 $11,022 $2,874 Associate 41 $503 $463 $285 $178 $18,973 $7,307 % $58,526 $11,053 19% PPP $1,843,700 5% Cost Increase = 5% Drop in PPP 5% Cost Increase = 17% Drop in 15 Testing Assumptions: Leverage Less Equity Partner Time = Better Non-equity partner time = Profits for Equity Partner comp 14% Leverage 87% Time Keeper Type Hrs Std at Realization Cost Revenue Realization Assumes an extra 5% Write-off Eqt Partner 14 $858 $746 $763 -$17 $10,450 -$232 Inc Partner 16 $683 $594 $519 $75 $9,507 $1,203 Sr Counsel 24 $599 $521 $388 $133 $12,507 $3,195 Associate 46 $503 $438 $271 $167 $20,130 $7,664 Vs % Baseline $52,595 $11,831 22% 11% reduction in fee compared to Baseline. The Client Goal PPP $2,500,326 29% Leverage from 25% to 14% = 29% Increase in PPP 16 8

10 Behavior Changes? s Don t be afraid to ask for standard rates Write downs and Write offs Avoid giving work away Leverage Push the work down How Can We Get Partners to Change? We need something immediate and (unfortunately) negative Solution: Give your lawyers grades The Kicker: Not all of them will get A s 17 C- 18 9

11 The Real Goal: Motivate Behavior Changes People Change When They Are Forced To Change Absent some immediate benefit What Forces People? Negative Competition Loss of income Immediate or later? Positive Competitive Advantage Increase in income Law Firm Culture Not lined up with change Greed actually not a great motivator Unless it s immediate 19 Create a Profit Culture Educate, Educate, Educate Approval Authority - Reporting Stats Be a Resource Compensation: The Holy Grail Become the Prophet of Profit 20 10

12 Questions? Thank You! 21 11

13 Your opinion matters! Please take a moment now to evaluate this session.

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