2012 redwood analytics® user conference analysis. insight. action. profitability 101 what they...
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2012 Redwood Analytics® User ConferenceAnalysis. Insight. Action.
Profitability 101What They Don’t Teach in Law Schools
Chris BurgessConsultant, Redwood Analytics
2012 Redwood Analytics® User ConferenceAnalysis. Insight. Action.
Agenda
• Profit Drivers
• Hours Based Revenue
• Partner Comp
• Attorney / Client View Cost Basis
• Q&A
3
Looking at Profit
The success of your firm cannot be assessed through hours or billings alone
Profitability is the true measure of success
It’s about more than just firm profit, or profits per partner
4
Profitability Drivers: OverviewF
ee
Cap
acit
y
Rev
enu
e
Con
trib
uti
on
Mar
gin
Op
erat
ing
Pro
fit
Net
Inco
me
Cap
acit
y
Dir
ect
Cos
ts
O/H
Investmentcosts
6. Client Investment Speed (Time Value of Money)
1. S
tan
dar
d V
alu
e of
Pro
du
ctio
n
3. Realization2. Utilization
4. Leverage
5. Margin
Business Model of a Law Firm
2012 Redwood Analytics® User ConferenceAnalysis. Insight. Action.
Hours Based Revenue
6
Methodology
Current month collectionsLessCurrent month expenses“Profits”
Matches firm’s financials Lagging measurement No client view
Expected collectionsLessMatching time period expenseExpected profits
Unfamiliar Captures all profit drivers Leading measurement Client profitability
Cash Based Hours Based
7
Methodology—Expected Collect Amount
• What has happened?• Discounting• Writeoffs
• What can happen?• At-risk WIP• At-risk AR
8
Bill Risk
Collect Risk
Writeoffs
Expected Collect Amount
DiscountingStandard Amount
Expected Collect Amount
9
Expected Collections—Forward Realization Curves
10
Expected Collect AmountValue Rate
Value of work @ standard(Hours worked X standard rate)
$36,350,000 $302
Discounting: hours & rate -$1,853,000 -$15
Write-offs -$176,000 -$1
Billable amount $34,321,000 $286
FORWARD REALIZATIONS
Bill risk adjustment * -$342,000 -$3
Collect risk adjustment ** -$1,345,000 -$11
Expected amount $32,634,000 $272
* Unbilled total: $1,995,445
** Uncollected total: $4,237,212
11
WIP Losses
Client discounts
Alternate billing arrangements
Written down hours
Time never billed
A/R Losses
Bills never collected
Write-offs
• Partial payments
• Zero payments
Realizations
12
Intended vs. Effective Discounts
Intended discount Effective discount
13
Direct Margin
Expected amountLess: Direct costs
Direct margin
Equivalent to contribution margin or gross profit
“Starting point” to view client profitability
Includes all costs directly attributable to client
14
Net Margin
Direct MarginLess: Indirect Costs
Net Margin
Captures all firm costs except:• Time Value of Money (TVM)• Discretionary attorney compensation
• Bonus• Excess of partner cap
2012 Redwood Analytics® User ConferenceAnalysis. Insight. Action.
Partner Comp
16
Cost Methodology—Partner Comp
• No partner comp• Clarity of “available”
profits• Client & partners’ profit
linked• Doesn’t encourage
leverage• Obscures intra-rank
information• Eliminates meaningful
comparisons
• Fully loaded comp• Includes leverage• Aligns attorney comp
with client base• Eliminates arbitrary cap• Partners’ work =
unprofitable• Defining result hampers
analysis
None FullyLoaded
PartiallyAllocated
17
Cost Methodology—Partially Allocate
• Standards• Maintain relative
relationships• Non-arbitrary approach• Analytic clarity
• Approach• Capped direct-cost
rates• Allocation to client• Management
excluded• Bonuses excluded• Fully loaded costs
in model
NoneFully
LoadedPartiallyAllocated
Models:Simplified accurate view of reality
18
Partner Compensation
Total Partner Compensation
Arbitrary Comp Adjustment
Management Comp
Partner Cap – Comp Adj.
PORTION OF PARTNER COMP ALLOCATED TO DIRECT COSTS
19
Partner Cap - Comp Adjustment
20
Leverage
Shifting work down to lower-level timekeepers
Firm source of profits other than partner work
Enhances client profitability
Enables “growing of the pie”
21
Real Life Leverage
Hours Worked Last Year % Current Year
%
Partner 206 164
Other Timekeepers 15 77
All Work Attorney Titles
221 241
Leverage 7% 32%
Std Rate 505 449
Std. Amt $111,605 100% $108,209 100%
Direct Costs ($120,074) -108% ($21,693) -20%
Direct Margin ($8,469) -8% $86,516 80%
Indirect Costs ($46,992) -42% (43,657) -40%
Net Margin ($55,461) -50% $42,859 40%
$98,000 more profitable
No leverage Some leverage
Less Revenue
LessCost
2012 Redwood Analytics® User ConferenceAnalysis. Insight. Action.
Attorney / Client View Cost Basis
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Client/Attorney View
Basis of Cost AllocationIndirect and Direct Cost Allocations
Attorney View = Actual Hour cost basisClient View = Std Hour cost basis
24
Cost Allocation Basis
• Separates utilization
• Matter based profitability
• Focus on client/matter drivers, not work effort
• Includes utilization• Attorney based
profitability• Individual performance
focus
StandardHours
ActualHours
“Cost rates” … the cost of a billable hour
25
Methodology—Profitability Dimensions
Matt
er-
based
Att
orn
ey-b
ased
Client &matter
Billing(responsible)
attorneyArea of law Arrangement
Department OfficeTimekeepertitle & class
Workingattorney
Utilization Bridge
26
Profit Methodology Overview
3 key points
1. Cash vs. forecast cashExpected collect amount
2. Cost allocations• Partner comp allocation• Standardized actual hour costs
3. Attorney/Client View • Addresses the impact of utilization
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Conclusion—How To Effectively Use It
• Understanding the methodology is essential
• Methodology must be clearly communicated to key individuals
• True profitability analysis demands a holistic approach
• Monitor key drivers and identify areas of improvement and opportunity
28
Questions?