2012 Redwood Analytics® User ConferenceAnalysis. Insight. Action.

Profitability 101What They Don’t Teach in Law Schools

Chris BurgessConsultant, Redwood Analytics

2012 Redwood Analytics® User ConferenceAnalysis. Insight. Action.

Agenda

• Profit Drivers

• Hours Based Revenue

• Partner Comp

• Attorney / Client View Cost Basis

• Q&A

3

Looking at Profit

The success of your firm cannot be assessed through hours or billings alone

Profitability is the true measure of success

It’s about more than just firm profit, or profits per partner

4

Profitability Drivers: OverviewF

ee

Cap

acit

y

Rev

enu

e

Con

trib

uti

on

Mar

gin

Op

erat

ing

Pro

fit

Net

Inco

me

Cap

acit

y

Dir

ect

Cos

ts

O/H

Investmentcosts

6. Client Investment Speed (Time Value of Money)

1. S

tan

dar

d V

alu

e of

Pro

du

ctio

n

3. Realization2. Utilization

4. Leverage

5. Margin

Business Model of a Law Firm

2012 Redwood Analytics® User ConferenceAnalysis. Insight. Action.

Hours Based Revenue

6

Methodology

Current month collectionsLessCurrent month expenses“Profits”

Matches firm’s financials Lagging measurement No client view

Expected collectionsLessMatching time period expenseExpected profits

Unfamiliar Captures all profit drivers Leading measurement Client profitability

Cash Based Hours Based

7

Methodology—Expected Collect Amount

• What has happened?• Discounting• Writeoffs

• What can happen?• At-risk WIP• At-risk AR

8

Bill Risk

Collect Risk

Writeoffs

Expected Collect Amount

DiscountingStandard Amount

Expected Collect Amount

9

Expected Collections—Forward Realization Curves

10

Expected Collect AmountValue Rate

Value of work @ standard(Hours worked X standard rate)

$36,350,000 $302

Discounting: hours & rate -$1,853,000 -$15

Write-offs -$176,000 -$1

Billable amount $34,321,000 $286

FORWARD REALIZATIONS

Bill risk adjustment * -$342,000 -$3

Collect risk adjustment ** -$1,345,000 -$11

Expected amount $32,634,000 $272

* Unbilled total: $1,995,445

** Uncollected total: $4,237,212

11

WIP Losses

Client discounts

Alternate billing arrangements

Written down hours

Time never billed

A/R Losses

Bills never collected

Write-offs

• Partial payments

• Zero payments

Realizations

12

Intended vs. Effective Discounts

Intended discount Effective discount

13

Direct Margin

Expected amountLess: Direct costs

Direct margin

Equivalent to contribution margin or gross profit

“Starting point” to view client profitability

Includes all costs directly attributable to client

14

Net Margin

Direct MarginLess: Indirect Costs

Net Margin

Captures all firm costs except:• Time Value of Money (TVM)• Discretionary attorney compensation

• Bonus• Excess of partner cap

2012 Redwood Analytics® User ConferenceAnalysis. Insight. Action.

Partner Comp

16

Cost Methodology—Partner Comp

• No partner comp• Clarity of “available”

profits• Client & partners’ profit

linked• Doesn’t encourage

leverage• Obscures intra-rank

information• Eliminates meaningful

comparisons

• Fully loaded comp• Includes leverage• Aligns attorney comp

with client base• Eliminates arbitrary cap• Partners’ work =

unprofitable• Defining result hampers

analysis

None FullyLoaded

PartiallyAllocated

17

Cost Methodology—Partially Allocate

• Standards• Maintain relative

relationships• Non-arbitrary approach• Analytic clarity

• Approach• Capped direct-cost

rates• Allocation to client• Management

excluded• Bonuses excluded• Fully loaded costs

in model

NoneFully

LoadedPartiallyAllocated

Models:Simplified accurate view of reality

18

Partner Compensation

Total Partner Compensation

Arbitrary Comp Adjustment

Management Comp

Partner Cap – Comp Adj.

PORTION OF PARTNER COMP ALLOCATED TO DIRECT COSTS

19

Partner Cap - Comp Adjustment

20

Leverage

Shifting work down to lower-level timekeepers

Firm source of profits other than partner work

Enhances client profitability

Enables “growing of the pie”

21

Real Life Leverage

Hours Worked Last Year % Current Year

%

Partner 206 164

Other Timekeepers 15 77

All Work Attorney Titles

221 241

Leverage 7% 32%

Std Rate 505 449

Std. Amt $111,605 100% $108,209 100%

Direct Costs ($120,074) -108% ($21,693) -20%

Direct Margin ($8,469) -8% $86,516 80%

Indirect Costs ($46,992) -42% (43,657) -40%

Net Margin ($55,461) -50% $42,859 40%

$98,000 more profitable

No leverage Some leverage

Less Revenue

LessCost

2012 Redwood Analytics® User ConferenceAnalysis. Insight. Action.

Attorney / Client View Cost Basis

23

Client/Attorney View

Basis of Cost AllocationIndirect and Direct Cost Allocations

Attorney View = Actual Hour cost basisClient View = Std Hour cost basis

24

Cost Allocation Basis

• Separates utilization

• Matter based profitability

• Focus on client/matter drivers, not work effort

• Includes utilization• Attorney based

profitability• Individual performance

focus

StandardHours

ActualHours

“Cost rates” … the cost of a billable hour

25

Methodology—Profitability Dimensions

Matt

er-

based

Att

orn

ey-b

ased

Client &matter

Billing(responsible)

attorneyArea of law Arrangement

Department OfficeTimekeepertitle & class

Workingattorney

Utilization Bridge

26

Profit Methodology Overview

3 key points

1. Cash vs. forecast cashExpected collect amount

2. Cost allocations• Partner comp allocation• Standardized actual hour costs

3. Attorney/Client View • Addresses the impact of utilization

27

Conclusion—How To Effectively Use It

• Understanding the methodology is essential

• Methodology must be clearly communicated to key individuals

• True profitability analysis demands a holistic approach

• Monitor key drivers and identify areas of improvement and opportunity

28

Questions?