Lower Realization -- Sometimes an Acceptable Tradeoff

Parsley Sage Rosemary & Ginsburg LLP

“Always a reasonable result for a reasonable fee, always”

MEMORANDUM

To:	Managing Partners; Practice Group Leaders
From:	Mike Marget
Date:	January 9, 2013
Re:	Lower Realization – Sometimes an Acceptable Tradeoff

Since the onset of the recession, clients have gained the advantage in fee negotiations.  Yet Legal Industrial Complex firms still managed to increase their hourly rates in 2012.  According to a survey published last month by The National Law Journal, median partner rates jumped 4.5% to $517 an hour and median associate rates increased 3.5% to $323.  The survey covered 55 firms ranging in size from 128 to 3,000+ lawyers.

While these rates may not resonate with your particular practice, it is a prudent business exercise to review pricing issues from time-to-time.  

Over the years I’ve had “discussions” with partners and practice group leaders who prided themselves on high realization.  They seldom needed to write-down time, collecting 98%-99% as compared to their standard hourly rates.  High realization percentages are wonderful when you are absolutely certain those rates are at the ceiling as to what the market will bear.  But such certainty, you should be bold and sacrifice a few realization percentage points in a quest for higher aggregate fees.  Let me demonstrate how this is important.

Assume you work 1,800 billable hours a year; have a $250 standard hourly rate; and enjoy 98% realization.  You will collect $441,000 on your work. [1,800 x $250 x 98% = $441,000]  Digging into the details of your practice reveals 900 of those hours are worked and collected at your standard $250 hourly rate, while the balance is for more rate-sensitive clients who are charged $240.  (This is illustrated in Example 1.) 

Then further assume, you decide to test drive a 4% rate increase on your standard rate, pushing it to $260 an hour. 

What is the worst that could happen?  Your rate-sensitive clients balk at the increase, so those hours remain at $240.  Theoretically, you could lose the other 900 hours if the new $260 rate is too high.  But in the real world, you are a lawyer and everything is negotiable.  If necessary, you’ll discount the new $260 standard rate with the pitch, “My standard rate is $260, but for you … $250.”  As illustrated in Example 2, you will still generate $441,000 in revenue even though your realization has dropped to 94.2%.  In essence, you enjoy the same revenue stream despite a lower realization statistic. 

On the other hand, if you manage just 1 additional hour at a rate higher than $250, you are ahead.

What is the best case scenario?  Assume you get the 4% increase on all your time currently billed at $250 an hour.  This is illustrated in Example 3.  The additional $10 an hour jumps your total revenue up to $450,000.  However, due to the $20 an hour negative spread between your new standard rate of $260 and the $240-an-hour cap on half your time, your realization drops to 96.2%.  Again, you achieve higher revenue despite the lower realization rate.

There is also an alternative almost-best case scenario.  Assume you cannot replace all 900 hours at the new higher standard rate?  Instead of 900 billable hours at $260 an hour, you produce only 865.  No worries, I’d still call this a win.  See Example 4.  With these numbers you are still generating the same $441,000 of revenue, but need to work only 1,765 billable hours in the process.  Sure, your realization drops to 96.1%, but the lower number of billable hours provides you 35 additional hours without any revenue decline.  That’s 35 free hours to devote to business development efforts which will eventually generate new work and create incremental revenue.

	Example 1	Example 2	Example 3	Example 4
Standard hourly rate	$250	$260	$260	$260
$240/hr clients
Billable hours	900	900	900	900
Effective hourly rate	$240	$240	$240	$240
Fee revenue generated	$ 216,000	$ 216,000	$ 216,000	$ 216,000
Other clients
Billable hours	900	900	900	865
Effective hourly rate	$250	$250	$260	$260
Fee revenue generated	$ 225,000	$ 225,000	$ 234,000	$ 225,000
Result
Billable hours	1800	1800	1800	1765
Effective hourly rate	$245	$245	$250	$ 250
Fee revenue generated	$ 441,000	$ 441,000	$ 450,000	$ 441,000
Realization rate	98.0%	94.2%	96.2%	96.1%

Now, I’m not about to paraphrase Dick Cheney and say “realization rates don’t matter.”  Rather, the point is realization rates, like deficits, need to be evaluated in a larger economic context.  Higher rates may mean higher write-offs and lower billable hours – but what is important is the bottom line. 

Maybe a higher standard rate for new clients simply becomes a starting point for fee discussion in 2013.  After all, a 10% discount from $260 an hour is preferable to discounting from $250.  Like the aphorism says, “If you don’t ask, you don’t get.”  Sometimes you do get! 

Time to Evaluate Billing Rates?

Parsley Sage Rosemary & Ginsburg LLP

“Always a reasonable result for a reasonable fee, always”

MEMORANDUM

To:	Managing Partners; Practice Group Leaders
From:	Mike Marget
Date:	January 9, 2013
Re:	Time to Evaluate Billing Rates?  What to Consider

        Although this may have no application to your particular practice, Big Law raised their hourly rates in 2012 despite all the chatter about clients having the upper-hand in fee negotiations.  According to 55 Legal Industrial Complex firms surveyed by The National Law Journal, the median partner hourly rate increased by 4.5% to $517 and the median associate rate jumped 3.5% to $323. 

        If your firm has been thinking about tweaking billing rates – whether across-the-board, for specific individuals, applicable to a specific practice area or just for new clients or new matters opened from some date forward – here are a few things you might want to consider: 

1.   Can some of the partner rates be increased to narrow the gap between them and the partner with the highest hourly rate?

2.   Can individual associate rates be increased to reflect increased seniority, experience and efficiencies?

3.   Is the gap between the lowest partner rate and highest associate rate appropriate for what each individual brings to the table?

4.   Are paralegal rates generating sufficient “profit” for the firm (e.g., there is an old adage that paralegal productivity should be 1/3 comp and benefits; 1/3 to cover overhead; and 1/3 contributed to partner profits)?

5.   Will “the market” permit increases for lesser-productive timekeepers to narrow the pay-versus-performance gaps?

 

Increasing rates is always a sensitive matter, but remember:  You can always negotiate downward and a 10% discount from $260 an hour is preferable to a 10% haircut from $250.

Managed Financial Care -- Patient Heal Thyself

Parsley Sage Rosemary & Ginsburg llp

“always a reasonable result for a reasonable fee, always”

MEMORANDUM

To:	Management Committee
From:	Mike Marget
Date:	August 25, 2012
Re:	Managed Financialcare for the Law Firm – Patient Heal Thyself

Regular health exams and diagnostic tests contribute to a longer, healthier life.  They help detect problems early, when chances for corrective lifestyle changes, treatment or cure are best.  My primary care physician has me on a 6-month schedule, alternating between a routine office visit and a more thorough, rigorous annual physical.  Additionally, I see an occasional specialist as needed.  The goal is to maintain me in peak performance for my benefit and for my family, partners and clients who depend upon me.

What about a managed financialcare regime for the law firm?  There are numerous opportunities to check on the financial wellbeing of the law firm.  A financial bill of health is important for multiple stakeholders – clients, lawyers, and staff.  Attention to the financial health of the firm is a shared responsibility of the administrator, managing partner and each partner in his/her individual capacity. 

Monthly Routine Financial Checkups

The normal business cycle of recording time and invoicing clients provides a natural opportunity to perform routine financial self-examinations.  The monthly production and financial reports are a good place to start looking for possible unhealthy symptoms. 

·        Are the firm’s timekeeper’s appropriately engaged on client work as demonstrated by the billable hours and billable hour time value reports? 

·        Are invoices being produced and collected on a timely basis according to the aging reports of unbilled time/costs and uncollected accounts receivable? 

·        If the firm has a budget (and it should), is the firm’s actual financial performance inline with the year-to-date budget projections?    

 

Quarterly Financial Assessments
To avoid unpleasant surprises (or bad tasting medicine) at year-end, it is good practice to expand upon the routine monthly examinations at least four times a year.  For planning purposes, these expanded assessments should occur in April (following the end of the first calendar quarter), July (end of second quarter), early October (immediately after receiving 3^rd quarter financial results), and mid-November (before Thanksgiving and the last month of the year).  In addition to the questions covered in a routine monthly checkup, the firm should consider:

·        Is the budget still viable?  Have there been significant operational changes not contemplated in the budget (e.g., additions/departures of personnel; unanticipated major expenditures)? 

·        Is the firm’s year-to-date financial performance on target to achieve the partners’ compensation goals? 

·        Has cash flow matched budget projections?  Are firm liabilities (e.g., bank borrowing; total unpaid vouchers) inline with the budget’s cash flow forecast? 

·        Is the firm’s cash balance growing in anticipation of funding last year’s pension/profit-sharing contributions, bonuses and other major obligations in the normal course of business? 

·        Is the firm on track to meet all of the financial covenants required under the terms of its borrowing agreements?

·        Are the timekeeping and client billing procedures operating on schedule?

·        Is the firm providing the types of schedules required by its bank and other lenders?

 Annual Financial MRI

At least once each year, a more thorough evaluation is prudent, with everything considered to see if there are latent symptoms of poor performance which should be addressed.  This is a time when the old adage, “If it ain’t broke don’t fix it,” must be ignored.  To paraphrase management guru Tom Peters:  It may not seem broken, but maybe you haven’t looked hard enough; look again and make sure there is nothing that shouldn’t be fixed now for the better.[i]  Peters’ notion is that success comes through constant improvement and continuous change.

The annual budget process (which should begin early in the 4^th quarter) is an opportunity to assess the financial strengths and weaknesses of the organization as a whole.  It should be a complete diagnostic workup. 

·        Do timekeeping, billing and collection policies and procedures require attention?

·        Are the monthly production and financial reports accurate and timely?  Do they deliver informative and actionable data necessary for financial stewardship of the enterprise?

·        Are bank accounts reconciled on a timely basis and is client trust accounting compliant with bar rules?

·        Are lawyers spending too much time on back office financial issues to the detriment of tending to current client issues and attracting new clients to the firm?

·        Are individual timekeeper rates commensurate with both salary expectations and reasonable assessment of value provided?

·        Are partners’ capital and firm debt[ii] levels appropriate to provide cash liquidity without resorting to late payment penalties and adverse credit reports?

·        Is the firm happy with its payroll service provider; its profit-sharing/401k service provider?

·        Is it time to take a new look at the firm’s life, disability and health insurance?  Is the firm happy with its insurance agent?  Is agent providing additional value, advice, direction, cost-savings ideas/solutions?

·        Is it time to reevaluate the firm’s errors and omissions insurance program?  Should the firm consider increasing/decreasing risk retention? 

·        Does the firm have an exit strategy worked out for key partners?[iii]

·        When was the last time the firm looked seriously at its partnership agreement?  Is the arbitration clause up to date?  Does the agreement spell out rules regarding a partner’s withdrawal and obligations to make sure the firm gets paid for continuing work (especially with respect to contingency cases taken)?

·        Does the firm have a strategic plan and do all the partners understand their roles in fulfilling the plan’s goals?

·        Is the firm’s compensation plan working; achieving the desired results?

This is not an exhaustive list of potential questions, but you get the idea.

Not Necessary to First Consult your Physician

The scariest things about all those pharmaceutical ads on TV are the worrisome disclaimers and the admonitions to check with your physician before taking any affirmative steps.  (Neither encourages me to get off the sofa and find out more about the product.)  The good news is a law firm’s new financialcare regime can begin without consulting an expert. 

The first step is to consider whether “things” are working the way the firm believes they should work.  Paraphrasing again:  If the firm’s financial operation isn’t hitting on all cylinders, “[you’ll] know it when you see it....”[iv]  An expert is contraindicated for this first step or to self-prescribe some initial corrective action (like regular exercise, smaller food portions and a daily “baby aspirin”).  Before calling in an expert, consider this malapropism:  First step is for the patient to heal thyself; if that doesn’t work, then make an appointment.  After all, there are a lot of people depending upon the financial wellbeing of the law firm.

 

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[i] Tom Peters, Thriving on Chaos, p. 3 (1988).  Peters gained fame with the 1982 publication of In Search of Excellence.  He updated Chaos in 1995 and Excellence in new additions in 1989, 2004 and 2012.  I once joked I decided not to read In Search of Excellence because it obviously had no application to law firms, but that when Thriving on Chaos came out – it was obviously aimed at law firm managers.  Sadly, the joke is no longer funny.

[ii] I’ve always taken the position that debt is like cholesterol – there is good debt and bad debt.  Good debt includes equipment leases and a reasonable line of credit to accommodate cash needs early in the year following payment of prior year’s bonuses if first quarter collections may be lagging due to the prior year-end collection push.  Bad debt is extraordinary borrowing to supplement high partner draws.

[iii] Succession/buyout planning is one area where procrastination can have dire long-term side effects.

[iv] Justice Stewart’s concurring opinion in Jacobellis v. Ohio, 378 US 184 (1964).