2012 Redwood Analytics® User Conference
Analysis. Insight. Action.
Profitability 101 What They Don’t Teach in Law Schools
Chris Burgess Consultant, Redwood Analytics
2012 Redwood Analytics® User Conference
Analysis. Insight. Action.
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
2012 Redwood Analytics® User Conference
Analysis. Insight. Action.
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
2012 Redwood Analytics® User Conference
Analysis. Insight. Action.
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
2012 Redwood Analytics® User Conference
Analysis. Insight. Action.
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?