8/11/15

Realizations About Law Firm Realizations

Clients are not the only ones who act as if outside lawyers are inefficient. Individual outside lawyers censor themselves for inefficiency. Their firms then cut their time for perceived inefficiency before sending it to the client. The clients cut their time even further. Everyone seems to agree there is considerable waste that must be excised from the bill.

The existing economics of law are such that it is easy to reconcile improved quality and lower costs for clients with better realizations and higher profits for law firms. Five years ago, I did not know this. I thought we were playing a zero sum game. Nor would I have cared if anyone had told me. As detailed in previous posts, I’ve evolved in my thinking about coprosperity. This change in perspective means I have to work at trying to understand what makes for a prosperous law firm. In helping me appreciate how realizations and profit differ from raw revenue, I have to thank Toby and our mutual friend Vince Cordo of Shell. Please do not blame them, however, for the simple-minded drivel that follows.

Understandably, we lack hard data on time that lawyers decide not to record (let alone how this practice may have changed over time). But my anecdata (frequently, a lawyer who performed poorly in Basic Technology Benchmarking would inform me that I need not worry because they cut their own time) lines up with the few bits of empirical speculation I can find. These surveys suggest that 33% of worked time is not billed. The primary culprit is identified as administrative tasks but another factor is individual lawyers deciding “to purposely ‘discount’ the actual number of hours worked in order to keep clients happy.” Similarly, back when firms reported such things to NALP, the average associate at DLA Piper, for example, worked 2,462 hours to bill 1,831 hours (74% of worked time was billed). To use round numbers then, let’s assume for discussion that an exemplar lawyer works 2,500 hours and bills 75% of it (1875 hours). Let’s further assume (I’ve got no statistics on this) that a minority—say 20%—of the unbilled hours are due to self-censorship.
Lawyer Janes works 2,500 hours of which 2,000 are eligible to be billed. She bills 1875 hours.
The 1875 hours is what the firm sees. But 1875 hours is not what the firm sends to its clients. We have good data that billed realizations—the percentage of the 1875 hours billed to clients—have dropped from 93.5% to 86.7% in the last decade. But the data does not tell us how much of the recorded-hours-not-billed-to-clients are due to writedowns versus pre-negotiated discounts. The concept of standard rate, on which realization figures are based, is a maddeningly vague, used differently in different reports, and often reliant on self-reporting (Toby will have to explain). Because I can find it with Google, I will just accept previous findings that pre-negotiated discounts account for about half of the spread (this, admittedly, remains a crude exercise) between time recorded and time billed. Thus:
In 2004, Lawyer Janes works 2,500 hours of which 2,000 are eligible to be billed. She bills 1875 hours. The firm has already negotiated discounts that bring her total down to 1813 standard hours. In addition, the firm writes down her time to 1753 hours actually billed to clients.
In 2014, Lawyer Janes works 2,500 hours of which 2,000 are eligible to be billed. She bills 1875 hours. The firm has already negotiated discounts that bring her total down to 1746 standard hours. In addition, the firm writes down her time to 1625 hours actually billed to clients.
That is not the end of the story. Clients have grown much more aggressive in cutting legal invoices since the Great Recession. Or so the story goes. The story is true. Comparing collected realization pre- and post-Recession, clients increased the average amount they cut from bills by 500%. That’s a big jump. But this framing obscures the low baseline. In 2004, the average client was paying 99.1% of their billed invoices. In 2014, the average client is still paying 95.7% of their billed invoices. So:  
In 2004, Lawyer Janes works 2,500 hours of which 2,000 are eligible to be billed. She bills 1875 hours. The firm had already negotiated discounts that bring her total down to 1813 standard hours. In addition, the firm writes down her time to 1753 hours actually billed to clients. The firm collects 1738 hours.

In 2014, Lawyer Janes works 2,500 hours of which 2,000 are eligible to be billed. She bills 1875 hours. The firm had already negotiated discounts that bring her total down to 1746 standard hours. In addition, the firm writes down her time to 1625 hours actually billed to clients. The firm collects 1555 hours.
I’ll go Excel on the 2014 numbers and add a $400/hr billable rate with some additional crude data on the cost of an associate. And we’ll spread the billed work evenly among 4 clients.

Now, let us imagine an alternative scenario where some initiative (e.g., a Service Delivery Review) leads both to (i) actual improved integration of process and technology into the workflow producing modest BFC (Better, Faster, Cheaper) results and (ii) a structured dialogue between the client and law firm that convinces both sides there is less waste in the delivery of legal services. In this hypothetical, the law firm lawyers, who are closest to the improvements, are more convinced of the gains than their clients. Because of the increased efficiency, the law firm can serve more clients in fewer hours. 
 

These are modest gains. Yet, the client is spending 15% less, and the law firm is profiting 16% more, while the individual lawyer spends 50 less hours in the office (an hour per week or a real vacation). The foregoing exercise also drives home one of Toby’s favorite points: discounts and writedowns come entirely at the expense of profits. What may only be a small percentage of raw revenue can be a substantial percentage of total profit. The margins are where the magic happens.

The above assumes that the law firm has picked up a new client. It is nice to believe that improvements in quality paired with reductions in cost would result in additional work and new clients. But even if the total work is finite, the law firms can still increase profits without charging their clients more. This, however, means fewer lawyers. While subsisting with fewer lawyers may sound like a post-apocalyptic hellscape straight out of Mad Max (water, gas, bullets, and lawyers all in scare supply), it is the world in which we have lived for the last half-dozen years. Using the preceding scenarios, compare how many lawyers are required to collect on 200,000 hours of time and the attendant impact on profits:


The gains can still be shared. The finite client base can spend appreciably less (i.e., save money) on legal services while the law firm profits more:


The foregoing is an admittedly crude explanation of why we are not necessarily playing a zero-sum game, even in an environment still dominated by the billable hour. Client cost reductions need not come out of law firm profits. Increased law firm profits need not come at the expense of clients. Structured dialogue between the two can result in Better, Faster, Cheaper benefiting both parties. 

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Casey Flaherty is the founder of Procertas. He is a lawyer, consultant, writer, and speaker focused on achieving the right legal outcomes with the right people doing the right work the right way at the right price. Casey created the Service Delivery Review (f.k.a., the Legal Tech Audit), a strategic-sourcing tool that drives deeper supplier relationships by facilitating structured dialogue between law firms and clients. There is more than enough slack in the legal market for clients to get higher quality work at lower cost while law firms increase profits via improved realizations.
The premise of the Service Delivery Review is that with people and pricing in place, rigorous collaboration on process offers the real levers to drive continuous improvement. Proper collaboration means involving nontraditional stakeholders. A prime example is addressing the need for more training on existing technology. One obstacle is that traditional technology training methods are terribleCompetence-based assessments paired with synchronous, active learning offer a better path forward. Following these principles, Casey created the Legal Technology Assessment platform to reduce total training time, enhance training effectiveness, and deliver benchmarked results.
Connect with Casey on LinkedIn or follow him Twitter (@DCaseyF).

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