The profitability index is an important metric in the 2011 Am Law 200 performance reports when comparing top US law firm performance.
However, as the authors state: “Some of this year’s Am Law 200 metrics, such as gross revenue, PPP, and revenue per lawyer, are straightforward. And because they are easy to comprehend in a list, they get a lion’s share of the attention. Other metrics are equally powerful but less-often cited; they lend themselves to a different sort of presentation. Here are four of them: profitability index, leverage, profit margin, and value per lawyer.”
I have always found the profitability index (which we simply called the Am Law Index) very useful (particularly when I ran multi-office firms and wanted to compare performance between them
and against other competitor firms).
The Profitability Index measures a firm’s performance based on the relationship between leverage (lawyers per partner) and the firm’s profit margin (relationship between income and expenses).
Here is a snapshot of a smart interactive bubble graphic reflecting the Profitability Index results for the Am Law 200:
Some of the benefits of the profitability index ratio:
- the profitability index enables you to validly compare performance between different offices of a firm or different firms in different regions and countries. This in itself makes it enormously powerful and I think unique. It can go some way to reducing defensive arguments from some regional offices or country offices based on ‘special factors’ justifying why they should not be expected to meet certain key performance indicators.
- It also assists in comparing performance between different types of firms.
- Once you understand what the profitability index measures and what it tells you it is a relatively simple metric. It makes some sense – think about it – if a firm has high leverage and has managed to achieve high profit margins (the ratio of its income to expenses and vica versa) – there is a more than fair chance it is performing exceptionally well.
- If you look at the bubble chart you will see that Am Law firms get results in the ones, twos and threes – I have always felt that scores above 2 are excellent and invariably firms that hit these are producing very impressive numbers. It is worth doing for your own firm and those that you compare yourself with – it is also relatively easy to glean leverage and profit margin figures about other firms so you can compare your firm to them.
A few things to watch out for:
- It seems that Am Law use profits per equity partner into which they divide revenue per lawyer, and not profits per all partners (both equity and salaried). Bear this in mind when you do your own analysis.
- I think this is a powerful and useful ratio but possibly for the reasons mentioned above does not get as much air-time as other ratios. As a result it is not widely understood. I think firms are missing a great opportunity here.
- I have also found the profitability index is a harder ‘sell’ to a partner group within a firm – they don’t always ‘get it’. I recall reporting on it each year for a number of years in one of my firms (because of the benefits above) but still finding that each year we had to re-explain it to partners – even then some were sceptical! It definitely didn’t carry the punch it warranted.
I suggest have a play with the bubble graph and consider if something similar may be relevant for your firm? I would love to hear of any alternative thoughts or experiences anyone may have on this index. It seems to have unrealised potential for law firms.