This joint post by Blaqwell and KMJD Consulting describes an article authored by our partners in the American Lawyer on the subject of law trends revealed by the Am Law 100 results for 2016.

When the Am Law 100 results for 2016 are issued later this month, we believe they will confirm several key trends. A small group of approximately 20 firms is widening its lead over all other firms and concentrating its share of Am Law 100 profits. For now, there are a couple dozen firms in the mid-tier between the leaders and the lower tier. Each year, though, the mid-tier becomes emptier and a wider gap opens between leaders and the rest. Some mid-tier firms join the leaders and most fall into the lower tier. Many related trends are also described in this post.

One of the challenges to implementing efficiency changes in a law firm is getting buy-in from the practicing lawyers. Practice group leadership may be on board because they more readily "get it" (or at least some do). The question is, how does one reach the practicing lawyers? The Practice Smarter webinar series produced by the ABA's Knowledge Strategy Group addresses this question. The next webinar is Thurs., Feb. 25 at 12:00 Noon, Eastern (30 minutes).

The recent "2016 Report on the State of the Legal Market" by Georgetown Law-Thomson Reuters likens law firms to Kodak. Its unwillingness to adapt in time to the dramatically changing market environment of digital photography, in order to protect its historically lucrative film business, led to bankruptcy. The report presents much financial information about the law firm market in 2015, and draws some conclusions from the data about trends. The report concludes with the prediction that ultimately the firms that succeed will be those that not only understand the dynamics of today's market, but also "have the courage to make the necessary changes to respond to them." Only hindsight will tell how valid the Kodak analogy is, though. Still several of the report's assertions, described in the conclusion of this post, do appear correct.

The ABA Law Practice Division is launching a monthly free webinar series focusing on how to practice more efficiently and deliver better client value, while improving your financial performance. The webinars are aimed at practicing lawyers, both in large firm and small firm settings. The first webinar is Jan. 28 at 12:00 Noon, Eastern (30 minutes). More information and registration are available at http://www.kmwebinars.org.

Please join my webinar sponsored by Practical Law Company entitled "Tracking and Growing Your Profitability: Strategies for Competitive Law Firms". This 75-minute webinar is free to Practical Law subscribers.

My article on Matter Profitability was recently published in the American Bar Association's monthly e-zine for law practice matters.

The Citibank/Hildebrandt report paints a picture of recovery for large law firms. It also reinforces the point made in the recent American Lawyer report covered in my prior blog that the improving averages mask an increasing disparity in performance among large firms, with a few doing extremely well, many doing somewhat well and many doing badly. The performance differences cannot be explained simply, but the trend suggests there is a formula for success that firms must discover and apply. Citibank/Hildebrandt make their suggestions. I urge that investing in practice group re-engineering be included in the formula as well.

In the past 10 years, the market for business legal services shrank by 25% in real terms, but the AmLaw 200 firms hung on by increasing their share of that market, by raising rates and by increasing leverage. The top 10% of those firms pulled away from the pack and have thrived. These conclusions come from a recent special report by the American Lawyer based on its extensive database and U.S. Census economic data. The report urges firms to survey their clients and develop an action plan - essentially to prepare and execute a strategic plan. The remainder of this post describes the steps to formulate a strategic plan and the importance and difficulty in actually executing the plan.

Keith Mayfield, chairman of an AmLaw 200 firm, is reflecting on a presentation that advocated: (1) paying practice group leaders primarily based on the performance of of their group, (2) requiring them to devote a majority of their time to non-billable management of the group, and (3) empowering them to influence compensation of the partners in their group.

Keith Wetmore, former chairman of Morrison & Foerster, raised a very fair point after reading my prior blog post: Is matter profitability smoke and mirrors? (June 30, 2014). He correctly pointed out that tying partner compensation to matter profitability, as opposed to using profitability purely as a diagnostic tool, was a major and unexplained leap on my part. Assuming a firm is using matter profitability as an analytical tool to drive decisions about what matters to pursue or take on, today's post explores the further question of tying partner compensation to profitability.

Keith Mayfield, chairman of an AmLaw 100 firm, is worrying about expense allocation issues as he prepares to introduce profitability of matters as a new metric to his partners. Keith views hooking partner compensation to matter profitability as essential to steering partner behavior in the right direction. At the same time, he regards the subject as fraught with peril. He is deliberately proceeding at a slow pace, to improve the chances that his partners will embrace this new approach. Getting them to understand and accept the judgments inherent in matter profitability calculations is an important step towards success of the initiative.

Keith Mayfield, chairman of an AmLaw 100 firm, reads the recently published Altman Weil annual survey of law firms in transition. More than half the firms with over 250 lawyers believe they have too many non-equity partners. Yet only 2.2% of surveyed firms have an up-or-out policy for this partner category. “Law firms need to manage the non-equity tier with much more attention and discipline, including standards for entry and exit,” advises Altman Weil.

This post discusses a key point in Altman Weil's 2014 annual survey of law firms in transition, which was released last week, and its implications for law firms. An addendum to the post also summarizes other highlights of the survey. The law firms that are successful in improving efficiency will have the advantage. The hard part isn't deciding what to do; it's getting it done. Start with a pilot group and keep up the pressure. This is a long-term investment that will take time and effort at the outset but can bring great benefits over time.

"[2013] ... was a year in which a handful of the richest firms got much richer, the far-flung vereins got much bigger, and almost everyone else struggled just to keep up with inflation," reported the American Lawyer earlier today. The performance gap between firms appears to be increasing. Strategy and execution may be part of the reason. Improving collaboration and efficiency in its practice groups will be a necessary element in most cases.

Keith Mayfield, chairman of an AmLaw 100 firm, is reading the recent press report on the survey by Wells Fargo’s private bank of law firm results for the first nine months of 2013: Gross revenue increased 2.5%, Expenses also increased 2.5%, Total hours billed declined 0.75% and hours per lawyer declined 1.1%, and Effective rates increased 3.6%. Keith reads a press report about the Citibank survey for the same period, which is in line with the Wells report, though showing that revenue gains outpaced expenses by 0.4%. Citibank concludes with, "[T]he underlying challenges facing the legal industry remain: tepid demand and excess capacity." “That’s about where we are,” Keith thinks to himself. “Our expense increases have cancelled out our revenue gains from rate increases, client demand is soft and we have too many partners.”

The private banks of both Citibank and Wells Fargo recently reported the results of their first half 2013 law firm surveys, which portrayed similar pictures: Flat-profits Very modest revenue growth (0.5% and 1.5%, respectively) over the prior year period. Higher growth in expenses (up 2.4% and 3.5%) than revenues, resulting in declining margins. Growth in billing rates of 3.7% and 3.5%, part of which may be due to staffing more senior lawyers on matters and part due to hourly rate increases. The much lower revenue growth implies that much of these rate increases did not “stick” (in other words, that the rate increases were significantly offset by lower realization rates). Lower lawyer productivity (also known as utilization; in other words, average hours billed per lawyer) than the prior-year period (down 2.4% according to Wells Fargo).

Keith Mayfield, chairman of an AmLaw 100 firm, closes the book he's just finished on the long flight back from visiting several of his firm's offices. The book, published in April 2013, is one of the latest prognostications about the possible end of Biglaw. It's called The Lawyer Bubble, by Steven Harper, who is a retired partner of Kirkland & Ellis. As Keith gazes out the window, he thinks about the book's message: Biglaw doesn't have a sustainable business model in today's world. That conclusion doesn't sit well with Keith. Not because he doesn't like it, but because he thinks the book dramatizes and over-simplifies the problems faced by large law firms. In Keith's view, the book is a long read with a short message. It contains extensive discussions of statistics that are intended to support the author's arguments but too often come across as not directly relevant to the points being made or as jumping-off points for unsupported inferences.

Keith Mayfield, chairman of an AmLaw 100 firm, is debating with his management committee the pros and cons of introducing to his firm's partners the metric of profitability of a matter rather than realization rate, the metric currently used. Keith believes using realization rate gives only part of the picture and doesn't permit comparisons across practice groups. A high realization rate on a low-leverage tax advisory matter could produce lower profitability than a medium realization rate on a high-leverage routine bank-loan matter. In other words, realization rate measures only the revenue side, whereas profitability also takes into account expenses attributable to the matter, driven principally by the lawyer resources used.

There are gaps between what law firm leaders acknowledge they should be doing and what they are actually doing, according to Altman Weil's annual “Law Firms in Transition” survey, released last week. For example, while 96% of respondents believe more price competition and a focus on improved practice efficiency are permanent changes in the law firm environment, only 55% of firms with 250 or more lawyers have significantly changed their strategic approach to efficiency in delivery of legal services. This post comments on improving efficiency in delivery of legal services, then presents a summary of the full survey, which also covers other topics.

A recent American Lawyer article described a study* showing that AmLaw 200 firms saw significant fee increases from major clients in 2012 and 2011 over the prior year. Yet the AmLaw 200 financial surveys by the same publication show profits increased only modestly in 2011 (2012 not yet being available). How can this be? The study also showed hours were flat year-to-year, but that doesn't explain why the profit trend didn't follow fees.

This Part 3 describes cautions to be considered in taking action based on profitability data and sharing this sensitive data more widely within the firm. Because actual cash collections lag, often by a significant amount of time, the performance of the work and incurrence of related expenses, using actual collections as a basis for profitability calculations may be disadvantageous when the calculations are being used to aid management decisions. The profitability information would be significantly delayed in relation to when the work was performed, correspondingly delaying any action management may choose to take. One way to address this delay involves using forecasted collections (revenues) based on hours worked on a matter. Under this method, the theoretical collectible amount at standard rates would be reduced by historical rates of discounts, write-offs and write-downs. Expenses would be calculated the same way as for the cash collections method of calculating profitability previously discussed. Using forecasted revenues, though, aggregate annual profitability for all matters will not precisely equal the firm's actual profitability for the year, which could be confusing to some.

This Part 2 discusses allocating general expenses to matters and issues arising in calculating profitability by other sub-units, such as by client, practice area, office and lawyer. General expenses, also known as indirect expenses or overhead, will be allocated to matters, offices and lawyers on a more arbitrary basis. Examples of general expenses include book and electronic library subscriptions, technology infrastructure costs, compensation and benefits for most administrative staff and occupancy costs for administrative staff. One allocation method for these general expenses is to allocate them to a matter in proportion to the share of firm revenues of the matter. A somewhat more accurate method would be to allocate general expenses to a matter in proportion to the matter's share of direct margin. Direct margin is revenues minus the specifically allocated expenses discussed in the previous section, such as timekeeper compensation and occupancy expense.

This Part 1 discusses why it may be a good idea to consider profitability at a more granular level than the firm as a whole, such as by client, matter, practice area or even partner. It also discusses how to allocate some types of expenses at the matter level. Keith Mayfield, Chairman of an AmLaw 100 law firm, is spending another Sunday morning looking at his firm's recent financial reports. He wishes he had more granularity. Today he's focusing on profitability. Keith's colleagues seem enamored these days with looking at overall realization rates, which are the amounts actually collected as a percentage of what was worked at standard billing rates. Keith understands that realization rates are important, but believes profitability is the purest measure of financial success. Because it takes into account rates, leverage, margin and utilization, Keith believes profitability should be the starting point. High realization rates on work with low profitability aren't such a great thing. Low realization rates on high-profit work, such as work that utilizes lots of associate leverage, may be an area for improvement but worth the effort to fix. Realization rate is but one of those four key variables that mathematically combine to equal profits, as discussed in an earlier post, “The Economics of Practice Management,” Parts 1 and 2. “Wouldn't it be great,” thought Keith, “if I could see profitability by client, by practice area, by office and by type of work? Wouldn't it be even greater if I could see it by matter, by type of fee arrangement and even by lawyer and partner?”

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: 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.