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.
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The challenging future legal and business environment which is widely anticipated will demand a lot more from law firms than providing quality legal advice. This is the view of Ian Robertson, long-standing managing partner of Holding Redlich’s Sydney office, writing in The Australian (apologies; link requires subscription or log-in) recently.

Whether it be around service offerings, fee levels, management of fee-related activities or developing individual brands and thought leadership around industry sector knowledge, law firms will want to work out what they will bring to the client table in future. Simply basing decisions on past experiences is not likely to be enough.

This advice backs up on the findings of a recent survey of Australian managing partners and chief executive officers indicating tighter times ahead – with recruitment levels and profit margins expected to be down over the next five years based on deteriorating business confidence.

For Australasian law firms the writing is on the wall for some or more of the following:

  1. Better service at lower fees: this is simply because clients have more choices, are more canny and have realised it is increasingly a buyer’s market. Even more challenging is that given market conditions this will be coupled with fewer and smaller transactions and disputes. The only possible exceptions will be in resource–rich states such as Western Australia.
  2. Fee estimates, fee capping and fixed fees will be the order of the day: on top of this clients will look for real value and will carefully analyse all charges to ensure they are justified.
  3. Quantitative leverage will be rejected: clients will accept leverage, but only qualitative leverage, in the sense of high calibre, suitable staffing on a team where work is pushed down to the lowest (highly)competent level and charge-out rate.
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I had always assumed a practice area like family law, by its nature, required direct partner intervention at every level – particularly ‘face-time’. It was also a practice that could not be commoditised. Nor could it be spread geographically. Also, unlike some other practice areas, there didn’t seem to be scope for a para-legal to play as significant a role.

Scott McSwan, innovative Managing Partner of McKAYS Lawyers in Queensland, Australia, had other ideas and debunks these reservations – his ‘think different’ approach has led to the establishment of a successful, geographically distributed and highly leveraged Family Law practice and business model. He agreed to share some of his experiences. I believe there are lessons in this for law firm leaders, and not just in relation to Family Law

A Family Law practice, traditionally regarded as requiring face-time from partners, can be leveraged – if you have the right calibre people and excellent support systems

Sean: where did this all start – what was the spark?
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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.
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