Previous posts have promoted practice management – specifically, knowledge strategy – as an effort that is relevant to execution of all law firm strategies. Let's take a step back and consider how the economics of law firms can inform this approach to practice management.

Today's law firm economics – aka The New Normal

It is Spring 2012 and preliminary 2011 financial results for more than half the AmLaw 100 have been published. Keith Mayfield, chairman of the AmLaw 100 firm introduced in my first post, somberly reviews these results in his office one evening when the phones have finally quieted. While revenues and profits per partner are up at many firms, they are down at many others. Keith wonders how many of those increases in profits per partner were engineered through gimmickry, such as de-equitizing partners.

More significantly, at the firms he considers peers, the numbers show a disquieting trend:  Revenues are up slightly, but expenses are up more. Profits per equity partner, the litmus test for partner morale, are down several percentage points. Unfortunately, these averages accurately presage his firm's results, which haven't yet been published. Keith concludes that external forces, mainly client fee pressures amidst increased competition, are responsible for these trends. He wonders what his firm can do to turn this profit squeeze around before the situation becomes precarious. He is well aware that even a solvent firm can collapse quickly if its partners lose confidence in the firm's future and its leadership.

The law firm economic model

Keith thinks about the basic law firm economic model underpinning the performance of all firms that bill by the hour. Hourly billing remains the predominant approach among AmLaw 200 firms, at least for now.

Profits per partner = Average realized rate (revenues/# hours billed) x Leverage (# lawyers/# partners) x Margin ((revenues – expenses)/revenues) x Utilization (# hours billed/# lawyers)

While his firm has a more sophisticated model, Keith finds the basic model an easier framework for brainstorming. He remembers from David Maister's seminal book (Managing the Professional Service Firm, Free Press Paperback, 1993) that there is only so much that can be done to increase margin (through expense control) and utilization (how many hours lawyers work). Also, increasing utilization requires available new work, which has been spotty lately. Maister asserted that the real success drivers are average realized rate (ARR) and leverage. Client fee pressures and competition have boxed Keith in on increasing ARR through hourly rate increases. Increasing leverage by itself also seems problematic. Replacing partner time on matters with more associate time to increase leverage would likely result in lower quality work, higher fees from having to fix problems and reduced client service from problems not caught.

Ideas for change

Keith has two ideas. First, the firm could increase its associate leverage ratio without sacrificing work quality if it could find a way for associates to perform at a higher level. Keith struggles to think, though, how he could accomplish this.

Second, the firm could increase ARR if it could attract more premium work. That, of course, requires special talent among the lawyers performing the work. A few star partners and some new lateral partners could start that effort, but how can the other partners “upgrade” their skills?

Enter practice management

Keith may not yet realize it, but practice management changes can help him bring both his ideas to fruition.

For example, if the leading partners in a practice group organize an in-depth educational program for associates, it is likely these associates can move up in the work food chain, handling more “senior” work. That frees up the partners to engage in more billable work and more client development efforts. More junior lawyers would need to be hired to perform the work of the associates handling more senior work. Average realized rate would decline slightly (because associates at a lower billable rate would be performing a greater proportion of overall work) but the leverage effect should more than offset that decline, resulting in higher revenues and profits per partner.

Of course, the partners performing the training will be taking time from billable client work to prepare and conduct the educational program. They will also spend additional time giving ongoing feedback and mentoring. They may even develop practice tools, such as a knowledge base, detailed checklists of steps for completing a matter or of provisions needed in an agreement, and model forms. The associates will need to take off billable time to attend training. Would this investment of lawyer time offset the benefits of increased associate leverage?

In the next post

My next post will provide numerical examples applying the law firm economic model to Keith's two ideas to show the effect on profits per equity partner. The post will also suggest some conclusions that can be drawn and discuss the real life usefulness of modeling practice management changes.

[Photo credit: © Art Glazer/Photodisc/Getty Images]