profitability 101 what they don’t teach in law schools · profitability drivers: overview fee...

2012 Redwood Analytics® User Conference

Analysis. Insight. Action.

Profitability 101 What They Don’t Teach in Law Schools

Chris Burgess Consultant, Redwood Analytics



Agenda

• Profit Drivers • Hours Based Revenue

• Partner Comp

• Attorney / Client View Cost Basis

• Q&A

2

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

3

Profitability Drivers: Overview F

ee

Ca

pa

city

Rev

enu

e

Co

ntr

ibu

tio

n

Ma

rgin

Op

era

tin

g

Pro

fit

Net

Inco

me

Ca

pa

city

Dir

ect

Co

sts

O/H

Investment

costs

6. Client Investment Speed (Time Value of Money)

1. S

tan

da

rd V

alu

e of

Pro

du

ctio

n

3. Realization 2. Utilization

4. Leverage

5. Margin

Business Model of a Law Firm



Hours Based Revenue

5

Methodology

Current month collections

Less

Current month expenses

“Profits”

Matches firm’s financials

Lagging measurement

No client view

Expected collections

Less

Matching time period expense

Expected profits

Unfamiliar

Captures all profit drivers

Leading measurement

Client profitability

Cash Based Hours Based

6

Methodology—Expected Collect Amount

•What has happened? –Discounting

–Writeoffs

•What can happen? –At-risk WIP

–At-risk AR

7

Bill Risk

Collect Risk

Writeoffs

Expected Collect Amount

Discounting Standard

Amount

Expected

Collect

Amount

8

Expected Collections— Forward Realization Curves

9

Expected Collect Amount

Value 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

10

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

11

Intended vs. Effective Discounts

Intended discount Effective discount

12

Direct Margin

Expected amount

Less: Direct costs

Direct margin

Equivalent to contribution margin or gross profit

“Starting point” to view client profitability

Includes all costs directly attributable to client

13

Net Margin

Direct Margin

Less: Indirect Costs

Net Margin

Captures all firm costs except:

– Time Value of Money (TVM)

– Discretionary attorney compensation • Bonus

• Excess of partner cap



Partner Comp

15

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 Fully

Loaded

Partially Allocated

16

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

None Fully

Loaded Partially Allocated

Models: Simplified accurate view of reality

17

Partner Compensation

Total Partner

Compensation

Arbitrary Comp

Adjustment

Management Comp

Partner Cap – Comp

Adj.

PORTION OF

PARTNER COMP

ALLOCATED TO

DIRECT COSTS

18

Partner Cap - Comp Adjustment

19

Leverage

Shifting work down to lower-level timekeepers

Firm source of profits other than partner work

Enhances client profitability

Enables “growing of the pie”

20

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

Less Cost



Attorney / Client View Cost Basis

22

Client/Attorney View

Basis of Cost Allocation

Indirect and Direct Cost Allocations

Attorney View = Actual Hour cost basis

Client View = Std Hour cost basis

23

Cost Allocation Basis

• Separates utilization

• Matter based profitability

• Focus on client/matter drivers, not work effort

• Includes utilization

• Attorney based profitability

• Individual performance focus

Standard

Hours

Actual

Hours

“Cost rates” … the cost of a billable hour

24

Methodology—Profitability Dimensions

Matt

er-b

ased

A

tto

rn

ey-b

ased

Client & matter

Billing (responsible)

attorney Area of law Arrangement

Department Office Timekeeper title & class

Working attorney

Utilization Bridge

25

Profit Methodology Overview

3 key points 1. Cash vs. forecast cash

Expected collect amount

2. Cost allocations •Partner comp allocation •Standardized actual hour costs

3. Attorney/Client View

• Addresses the impact of utilization

26

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

27

Questions?

profitability 101 what they don’t teach in law schools · profitability drivers: overview fee...

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