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The economics of practice management (Pt. 2 of 2)

Posted by Jack Bostelman on Apr 29, 2012 | 0 Comments

In Part 1, Keith Mayfield, chairman of an AmLaw 100 firm, was pondering two ways to improve profitability, utilizing the elements of the basic law firm economic model described in Part 1. The first was to increase associate leverage without sacrificing work quality through increased training that allows associates to move up the work food chain. The second was to improve average realized rate by having star partners and lateral partners in a practice group upgrade the skills of the other partners so the group could capture premium work.

Modeling the economic effect of practice management changes

The general training example

The question left at the end of Part 1 was whether the investments of partner time in training and of associate time in attending training would offset the benefit of increased associate leverage. Applying the basic law firm economic model to the general training example is instructive. Let's assume:

    Up arrow graph for pt 2 of law firm economics 77378277 81
  • A quarter of the firm's partners shift 2 hours/week of billable time to training, forms, mentoring and tools-building. All the firm's associates shift 1 hour every other week of billable time to attending training.
  • As a result of this partner effort, associates take on 10% of partner billable time, but require 50% more time to accomplish what a partner could have done.
  • New billable work is available and the partners use their extra time (that is, the time freed up by the associates' taking on some partner work) to take on new work.
  • The firm hires additional associates to satisfy the need for associates to take on 10% of partner work and to handle the additional work taken on by partners with their 10% available time.

Using the model, these changes result in profits per equity partner improving by 4.6%. Clients also see a 2.2% decline in fees. This kind of improvement obviously does not happen overnight. Most likely a few practice groups will initiate the effort. Others will follow in response to the proper direction and incentives from management and inspiration from the successful groups. (The details of the economic model used to arrive at this illustration can be reviewed here, at Example #2. Further discussion about application of the model to various practice management scenarios can be reviewed here.)

The premium work example

Addressing Keith's second idea – having star partners and laterals invest time to upgrade the skills of other partners to enter a premium practice area – can also be analyzed under the model. For example, assume:

  • 10% of the partners in a practice group devote 5 hours/week to training and supporting the other partners in the group.
  • The other partners spend 1 hour/week receiving training.
  • The practice group is able to replace half its work with new work commanding a 20% premium over the firm's average rates.

The model shows profits per partner for the practice group improve 21%. The increase in average realized rate more than offsets the lost fees from training time. This strategy will, of course, be suitable for only some practice areas.

The misconception of hourly rates and efficiency

A common misconception is that lawyers who bill by the hour have no economic incentive to become more “efficient.” The model can demonstrate that assertion is untrue for several reasons:

  • As shown by the previous example, efficiency of the type that allows associates to do work at a more senior level in fact improves the bottom line (and slightly reduces fees for clients).
  • Every firm has soft write-downs (reductions taken before the bill is sent) and hard write-offs (reductions in the amount originally billed). In the current economic environment, these are increasing. Increased efficiency goes straight to the bottom line if it allows lawyers to reduce or eliminate write-downs/write-offs by completing the work in fewer hours. For example, if 5% of partner hours and 10% of associate hours are now written down/off, cutting those figures in half would result in profits per equity partner improving by 11% if the saved time is billed and collected on other new work.
  • A pure efficiency improvement that allows the firm to complete the same work in less time and for lower fees will not reduce profits if more work is available to fill the saved time. In fact, new work may be in great supply if the firm becomes more fee-competitive than others for the same work.
  • Efficiency improvements in nonbillable activities, such as preparing pitch materials, will improve profits by allowing the saved time to shift to billable work.

Back to real life

Economic models are interesting to play with, but aren't always good predictors of what will really happen. In the case of practice management changes, inputs to the model about efficiency improvements are at best educated guesses. The purpose of considering the model, though, is to analyze the directional relationships and sensitivities among the factors that are within the power of management to change. This analysis can lead to insights that may not be intuitive, such as the payback from investing in training and practice support tools. While it may not be possible to predict the amount of change in profits, the fact that profits will increase from a particular action by at least some amount should be practical to conclude.

With respect to sensitivities in the model, if associates in the general training example took on 15% of partner time, rather than 10%, profits would increase by 9.1% instead of 4.6%. If associates took on only 5% of partner work, profits would essentially not change. This suggests the effort would be worthwhile if management believes associates will be able to take on more than 5% of partner work, even if the precise increase is uncertain.

In the premium work example, if the practice group achieved a 30% premium on half its work, rather than 20%, profits of the group would increase by 33% instead of 21%. If only a quarter of the practice group's work, instead of half, is replaced by the 20% premium work, profits in the group would increase by 9% instead of 21%. This suggests that the effort would be worthwhile if management believes the group would capture a 20% premium on at least 15-20% of the group's work.

Examining the sensitivities can assist in deciding which changes to pursue. Identifying reasonable break-even scenarios can support a decision to proceed, even if the specific outcomes are uncertain.

One leader's conclusions

Having run through some examples with the model, Keith realizes it is worth spending time developing a plan to improve the way partners in the firm support each other and support the associates in performing client work. He decides that efficiency improvements relating to knowledge strategy can benefit the firm in a variety of ways, from increasing profits through greater associate leverage in certain practice areas, to avoiding write-downs and write-offs, to making the firm more fee-competitive. He decides to begin a pilot of the general training approach with one of his firm's most promising practice groups.

Convinced that the economics of training and practice support tools makes sense, Keith also decides to pursue the premium work/lateral partner idea. He has in mind another practice group, which has been facing increasing fee pressures. His goal is to reposition the group to capture premium work.

Future blog posts

Future blog posts will consider various practice management changes that Keith's firm could consider in support of his two initiatives – moving lawyers more quickly up the work food chain and capturing premium work. They will also consider how Keith can actually get those initiatives implemented in the change-resistant climate that characterizes most law firms.

[Photo credit: © Imagezoo/Getty Images]

About the Author

Jack Bostelman

Jack Bostelman is the president and principal consultant of KM/JD Consulting LLC. Before founding KM/JD Consulting, Jack practiced law in New York for 30 years as a partner of pre-eminent AmLaw 20 firm Sullivan & Cromwell.

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Before founding KM/JD Consulting LLC, Jack practiced law in New York for 30 years as a partner of pre-eminent AmLaw 20 firm Sullivan & Cromwell.

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