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Your biggest ‘hidden’ law firm expense – and how to turn it into your best return on investment

Posted in Leadership, Legal Profession, Management, Partners

It is always fascinating to hear partners talk about firm finances – usually it involves a focus on fee income, very selected expenses and 100% equity partner profit. The expense focus usually hones in on areas where they feel management is wasting money, maybe on marketing, the library, IT or support staff.

Not managing the utilisation of your fee earners, or having individual partners do this, is akin to burning a pile of dollars when you open the office each morning.(Sean Larkan graphic © 2012)

Mysteriously, there is seldom mention of the firm’s biggest opportunity cost, and one which individual partners directly control – the cost incurred by not fully utilising one of the largest recurring expenses in any law firm – the direct and indirect cost of fee earners. Remember when considering this expense item that you are not just looking at direct staff costs but also overhead costs associated with that expense.

A quick rough and ready calculation brings home the seriousness of the issue! For instance one partner with 3 lawyers (say earning $100k p.a.each and whose overhead allocation is say $110k p.a. each) utilised on average to a level of 75%, will be burning nearly $160k p.a. It is even more if one also takes into a account the opportunity cost of the fees they would otherwise have earned.

It is the one expense item which all partners should be responsible for managing, almost to the exclusion of all else on the financial side. Many decades ago David Maister highlighted the importance of this variable in his well-known profit formula (Profit per Equity Partner=margin x rate x utilisation x leverage) including utilisation as a key variable.

Again and again I come across firms who are bemoaning one or more rising expenses (including payments to external consultants!) or firms which have undertaken wide-spread analyses of expenses, sometimes with the help of their financial advisers, but seldom given proper attention to this crucial item. If there is, it is merely listed and no real steps are put in place to manage it and get results around it.

Some of the reasons for this?

  • the issue is not so much the expense item, it is the utilisation of it that is at issue and this utilisation is controlled by partners;
  • it accepted that partners need lawyers so the expense associated with this seems more ‘acceptable’ and part of being in practice;
  • very few firms seem to hold their partners directly responsible (and truly accountable) for how well their fee earners are managed and utilised – there is at best talk about it, but that is where it ends;
  • partners operate in loose teams so direct linkage and responsibility to a particular partner is tenuous;

On the other side of the coin I also often come across firms where individual partners are loath to gear up or leverage as they are concerned about the expense of doing so. They should not focus just on the expense but rather see it as an investment. The focus should be on getting a top return on that investment by driving work down to the lowest competent level and achieving qualitative gearing – high calibre staff doing good work for good clients.

What can you do?

  • don’t just talk about it and highlight it at partners’ meetings. They will walk out the door and nothing will change – make this a specific KPI for individual partners coupled with gearing up (in a qualitative sense) and fully utilising that gearing;
  • make partners responsible for particular lawyers/fee earners (bear in mind their easiest way out of this responsibility is where there is a loose link between particular partners and responsibility for particular lawyers). Expect to get push-back from this with statements like ‘I like my lawyers to get experience from other areas of the firm‘. Of course, putting this structure in place does not prevent this;
  • measure it;
  • publish the results;
  • recognise high achievers;
  • make partners accountable by making this count in the final analysis of their year-end performance and ideally have some impact on their overall equity standing.
Benefits:
  1. achieving good utilisation requires good management of so many other areas of a partner’s practice that it soon becomes self-regulating i.e. partners who are achieving full utilisation in a qualitative sense are usually doing just about everything else right. This takes a lot of pressure off management;
  2. lawyers are happy as they get a fair share of work;
  3. the partner is released from pressure and has more time to market;
  4. once this is working partners start building succession into their teams;
  5. the firm starts to enjoy real profitability;
  6. you get a more realistic appraisal of expenses in the firm; and
  7. the partner become more businesslike and self-disciplined – a perfect outcome.

By not managing the utilisation of your fee earners, or having individual partners do this, is akin to burning a pile of dollars every day when you open the office.  In fact maybe not such a bad idea – burn some paper in a waste bin every day for a few weeks as partners walk into the partner lunch-room with a sign saying ‘that is the $1200 we are burning each day by not managing our fee earners to full utilisation!’

all the best, Sean, Partner, Edge International