Calculating Client Profitability: Analysis to Action

Performlaw.com

CALCULATING CLIENT PROFITABILITY

Analysis to Action

Presented By: Brian Kennel

Client Profitability Perform Law

Session Topics

•  Reliable methods for computing client profitability

• Client profitability data and client pricing, AFA’s workload distribution and overhead control

• Opportunities, pitfalls and first time considerations

• Client profitability data and compensation

• Advantages of using client profitability models in lateral recruiting and merger analysis


Methodology

•  The repor(ng result (samples to follow) : •  Detail client net income report – Originator Sort

•  Client net income report – (mekeeper sort

•  Timekeeper profitability report

•  Summary Net Income Reports – Client Level


Uses of Client Profitability Data

• Client pricing (Rates other pricing); •  hGp://performlaw.com/strategically-‐seKng-‐billing-‐rates/

• Client staffing efficiency; • Overhead efficiency; • Rate increase alterna(ves; and • Compensa(on


How is it calculated?

•  Data needed from (me and billing system •  Fees billed by working aGorney (WA) by client or maGer*

•  Hours billed by WA by client or maGer

•  Origina(on credit by client or maGer

•  AR write off by client or maGer •  Fees billed and received by (mekeeper

* If running at the maGer level



•  Other data needed •  Payroll and benefit history for the period •  Secretarial or direct support payroll •  Income statement -‐ direct and indirect alloca(ons •  Employee starts and terms during the period •  Alloca(on policy defining specific and general alloca(ons



•  Scaling Concerns (es(mates based on a sample set of 2):

Data Table Es8mates (#Records) *

Number of Lawyers 50 100 200 300 500

Client Level 1,667 3,333 6,667 10,000 16,667 MaRer Level 10,000 20,000 40,000 60,000 100,000

Factor 6 6 6 6 6

*Actual number of records may vary widely by firm and pracIce type



•  Financial system profitability module •  S(ll have to perform most of the cost calcula(ons and load

•  May need enhanced repor(ng

•  Should try first •  Other op(on is to use a 3rd party module

•  Create an in house u(lity



•  Direct costs •  Timekeeper salaries and benefits

•  Billable hour versus standard hour divisor •  Easy to iden(fy



•  Specifically allocated overhead •  Some(mes also referred to as direct costs

•  Secretarial and clerical support salaries and benefits •  Business development costs

•  IT Costs*

* As per seat cos(ng con(nues to become more prevalent, IT costs may be direct.



•  Generally allocated overhead •  Facility costs; •  Equipment and prac(ce aids •  Prac(ce development*; and •  General and administra(ve costs.

•  Sample chart of accounts * As men(oned previously, some of this is being specifically allocated.



• Overhead applica(on •  Graduated level of overhead absorp(on recommended

•  Example: •  Equity Partner – full share •  Non Equity Partner -‐ .75 share •  Associates -‐ .50 share •  Paralegals -‐ .25 share


Why I recommend a graduated level of overhead absorpIon



Expense Common Range Direct Indirect

Payroll and Related 44% 40% 4%

Facili(es 6% 6%

Equipment Prac7ce Aids 4% 2% 2%

Prac(ce Development 3% 3%

General and Administra7ve 3% 3%

Total 60% 45% 15%

Percent Total 75% 25%

AllocaIng indirect: 70-‐75% is normally direct with 25-‐30% indirect



• Graduated overhead absorp(on • Allow younger lawyers (me to build value resul(ng in higher billed rates;

• Remove disincen(ves to use associates for fear of high overhead rates;

• Paralegals and associates don’t really need or use as much overhead as a partner; and • Waste and inefficiency defaults to the partners



• Billable Hours or Billed Hours for overhead applica(on •  Billable hours as the denominator

•  Timing differences

•  Overhead is applied hourly as it is billed •  Compu(ng client profitability on a billed basis

•  AR and Allowance reserve to reconcile to cash

Cost types Amounts

Total expenses 9,000,000

Less direct (mekeeper costs (4,500,000)

Sub-‐total direct 4,500.000

Less specifically allocated overhead (1,400,000)

Generally overhead for alloca7on 3,100,000

•  Overhead alloca(on report •  Hourly overhead report •  Secretarial alloca(on Report

Recap of overhead allocaIon

17


Strategic ConsideraIons

• Gross Margin •  Gross margin is the amount remaining aeer accoun(ng for direct costs.

•  Nega(ve gross margins

•  Par(al contribu(ons to overhead and no contribu(on to profit



• Gross Margin Con(nued •  Examples of marginal cost thinking

•  Start-‐up branch office, new prac(ce area

•  AGrac(ng work from certain clients

•  Firm growth

•  Short term and long term



All (mekeepers ul(mately need to cover direct costs, absorb overhead and contribute to profits, but there are strategic components to a (mekeepers contribu(on at a given (me.


InterpreIng Results and AcIon Steps

• Net Profit •  Ability to cover all direct costs and overhead •  Acceptable profit margins •  Client ranking tools

•  percent profit, •  actual profit dollars contributed, •  gross fees generated and •  overhead absorbed


InterpreIng Results and AcIon Steps

•  Net Profit Con(nued •  Analyzing a high-‐volume but underperforming account

•  Efficiency of the staffing mix

•  Compe((veness of the firm’s overhead structure

•  Realiza(on performance and indicated quality issues

•  Billing rate increases


RecommendaIons

•  U(lize client profitability data, rates, staffing mix, costs per hour and overhead structure to expand the op(ons a firm has for improving profits. •  Singular strategies are not op(mal


Uses of Client Profitability Data

• Client pricing (Rates other pricing); •  hGp://performlaw.com/strategically-‐seKng-‐billing-‐rates/

• Client staffing efficiency; • Overhead efficiency; • Rate increase alterna(ves; and • Compensa(on


Client Profitability Data and Pricing

• When pricing client work, firms should consider the following : •  Exis(ng posi(on in the client’s buying strategy? •  Exis(ng and foreseeable market factors?

•  Efficiency of client account staffing?

•  Efficiency of overhead; •  Intangibles including fixed cost absorp(on , training opportuni(es etc.; and •  Opportunity costs


Client Profitability Data and Pricing

• Alterna(ve pricing approaches •  Blended rate •  Price at fixed point (median, low, high etc.) •  Data needed •  Analysis


Client Profitability in CompensaIon

• A management tool • Origina(on spliKng policy • Methodology for equa(ng client net income to compensa(on • Mechanics li(gated – LOL • Powerful mo(vator

Nobody likes losing money

on clients or timekeepers



• Before we start, a note about originators and support partners •  Origina(on polices •  Support partner origina(ons •  Recommenda(ons

•  Origina(on credit •  Produc(on bonuses


Client Profitability & CompensaIon

• How should we think about compensa(on? •  Market for compensa(ng aGorneys is mature

•  Run compensa(on results / market payout

• Which system gives us the best chance at a right result? •  Objec(ve with a subjec(ve component

•  Pure objec(ve •  Pure subjec(ve



• Distribu(ng income using objec(ve and subjec(ve components •  Sample income alloca(on

•  90% objec(ve based on 2 year rolling average client net by OA •  10% subjec(ve component

•  Managing partner compensa(on fixed at $75,000 •  Model scales to any size


Client Profitability & CompensaIon GeVng Started

•  Fears & Resistance •  Truth in the numbers

•  Compensa(on changes

•  Moving from subjec(ve to objec(ve


• Challenges •  Data and resources not always available •  Financial systems not fully implemented

•  Analysis usually sought in hard (mes

Client Profitability & CompensaIon GeVng Started



• Opportuni(es •  Measurable results

•  Produc(ve partner reten(on •  AGract beGer laterals and improved likelihood of successful mergers

•  Increased rates of change



• Concerns •  Large swings in compensa(on from one year to the next

•  SpliKng origina(on credit

•  Incen(ves for working with other partners •  Adjus(ng points of ownership



• Opportuni(es and Concerns •  Linking client profitability to compensa(on can best be described as a process that takes (me to mature.

•  Partners will come to understand that changes to their pricing, staffing and management approach may be necessary. •  Over(me contribu(on to profit = market pay


Final Thoughts

• What should partners expect? •  Am I in the right firm? (hGp://performlaw.com/am-‐i-‐in-‐the-‐right-‐firm/)

• Benefits and limita(ons of any compensa(on system • Main benefits of compensa(on based on client profitability

Final Thoughts

• What is a modern partnership? • What should partners expect?

• Benefits and limita(ons of compensa(on systems • Compensa(on Considera(ons • Br

b r i a n@p e f o rm l aw . c om

Calculating Client Profitability: Analysis to Action

Leadership & Management