Calculating Client Profitability: Analysis to Action
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The document outlines methods for calculating client profitability in law firms, emphasizing the importance of data from billing systems, payroll history, and expense allocation. It discusses various reports and analyses used to assess client profitability, such as net income reports and overhead allocation, and offers considerations for strategic improvements in pricing and staffing. Additionally, it addresses compensation strategies linked to client profitability, highlighting both opportunities and challenges in implementation.
Calculating Client Profitability: Analysis to Action
- 1. Performlaw.com CALCULATING CLIENT PROFITABILITY Analysis to Action Presented By: Brian Kennel
- 2. Client Profitability Perform Law Session Topics • Reliable methods for computing client profitability • Client profitability data and client pricing, AFA’s workload distribution and overhead control • Opportunities, pitfalls and first time considerations • Client profitability data and compensation • Advantages of using client profitability models in lateral recruiting and merger analysis
- 3. Client Profitability Perform Law Methodology • The repor(ng result (samples to follow) : • Detail client net income report – Originator Sort • Client net income report – (mekeeper sort • Timekeeper profitability report • Summary Net Income Reports – Client Level
- 4. Client Profitability Perform Law Uses of Client Profitability Data • Client pricing (Rates other pricing); • hGp://performlaw.com/strategically-‐seKng-‐billing-‐rates/ • Client staffing efficiency; • Overhead efficiency; • Rate increase alterna(ves; and • Compensa(on
- 5. Client Profitability Perform Law How is it calculated? • Data needed from (me and billing system • Fees billed by working aGorney (WA) by client or maGer* • Hours billed by WA by client or maGer • Origina(on credit by client or maGer • AR write off by client or maGer • Fees billed and received by (mekeeper * If running at the maGer level
- 6. Client Profitability Perform Law How is it calculated? • Other data needed • Payroll and benefit history for the period • Secretarial or direct support payroll • Income statement -‐ direct and indirect alloca(ons • Employee starts and terms during the period • Alloca(on policy defining specific and general alloca(ons
- 7. Client Profitability Perform Law How is it calculated? • Scaling Concerns (es(mates based on a sample set of 2): Data Table Es8mates (#Records) * Number of Lawyers 50 100 200 300 500 Client Level 1,667 3,333 6,667 10,000 16,667 MaRer Level 10,000 20,000 40,000 60,000 100,000 Factor 6 6 6 6 6 *Actual number of records may vary widely by firm and pracIce type
- 8. Client Profitability Perform Law How is it calculated? • Financial system profitability module • S(ll have to perform most of the cost calcula(ons and load • May need enhanced repor(ng • Should try first • Other op(on is to use a 3rd party module • Create an in house u(lity
- 9. Client Profitability Perform Law How is it calculated? • Direct costs • Timekeeper salaries and benefits • Billable hour versus standard hour divisor • Easy to iden(fy
- 10. Client Profitability Perform Law How is it calculated? • Specifically allocated overhead • Some(mes also referred to as direct costs • Secretarial and clerical support salaries and benefits • Business development costs • IT Costs* * As per seat cos(ng con(nues to become more prevalent, IT costs may be direct.
- 11. Client Profitability Perform Law How is it calculated? • Generally allocated overhead • Facility costs; • Equipment and prac(ce aids • Prac(ce development*; and • General and administra(ve costs. • Sample chart of accounts * As men(oned previously, some of this is being specifically allocated.
- 12. Client Profitability Perform Law How is it calculated? • Overhead applica(on • Graduated level of overhead absorp(on recommended • Example: • Equity Partner – full share • Non Equity Partner -‐ .75 share • Associates -‐ .50 share • Paralegals -‐ .25 share
- 13. Client Profitability Perform Law Why I recommend a graduated level of overhead absorpIon
- 14. Client Profitability Perform Law How is it calculated? Expense Common Range Direct Indirect Payroll and Related 44% 40% 4% Facili(es 6% 6% Equipment Prac7ce Aids 4% 2% 2% Prac(ce Development 3% 3% General and Administra7ve 3% 3% Total 60% 45% 15% Percent Total 75% 25% AllocaIng indirect: 70-‐75% is normally direct with 25-‐30% indirect
- 15. Client Profitability Perform Law How is it calculated? • Graduated overhead absorp(on • Allow younger lawyers (me to build value resul(ng in higher billed rates; • Remove disincen(ves to use associates for fear of high overhead rates; • Paralegals and associates don’t really need or use as much overhead as a partner; and • Waste and inefficiency defaults to the partners
- 16. Client Profitability Perform Law How is it calculated? • Billable Hours or Billed Hours for overhead applica(on • Billable hours as the denominator • Timing differences • Overhead is applied hourly as it is billed • Compu(ng client profitability on a billed basis • AR and Allowance reserve to reconcile to cash
- 17. Cost types Amounts Total expenses 9,000,000 Less direct (mekeeper costs (4,500,000) Sub-‐total direct 4,500.000 Less specifically allocated overhead (1,400,000) Generally overhead for alloca7on 3,100,000 • Overhead alloca(on report • Hourly overhead report • Secretarial alloca(on Report Recap of overhead allocaIon 17
- 18. Client Profitability Perform Law Strategic ConsideraIons • Gross Margin • Gross margin is the amount remaining aeer accoun(ng for direct costs. • Nega(ve gross margins • Par(al contribu(ons to overhead and no contribu(on to profit
- 19. Client Profitability Perform Law Strategic ConsideraIons • Gross Margin Con(nued • Examples of marginal cost thinking • Start-‐up branch office, new prac(ce area • AGrac(ng work from certain clients • Firm growth • Short term and long term
- 20. Client Profitability Perform Law Strategic ConsideraIons All (mekeepers ul(mately need to cover direct costs, absorb overhead and contribute to profits, but there are strategic components to a (mekeepers contribu(on at a given (me.
- 21. Client Profitability Perform Law InterpreIng Results and AcIon Steps • Net Profit • Ability to cover all direct costs and overhead • Acceptable profit margins • Client ranking tools • percent profit, • actual profit dollars contributed, • gross fees generated and • overhead absorbed
- 22. Client Profitability Perform Law InterpreIng Results and AcIon Steps • Net Profit Con(nued • Analyzing a high-‐volume but underperforming account • Efficiency of the staffing mix • Compe((veness of the firm’s overhead structure • Realiza(on performance and indicated quality issues • Billing rate increases
- 23. Client Profitability Perform Law RecommendaIons • U(lize client profitability data, rates, staffing mix, costs per hour and overhead structure to expand the op(ons a firm has for improving profits. • Singular strategies are not op(mal
- 24. Client Profitability Perform Law Uses of Client Profitability Data • Client pricing (Rates other pricing); • hGp://performlaw.com/strategically-‐seKng-‐billing-‐rates/ • Client staffing efficiency; • Overhead efficiency; • Rate increase alterna(ves; and • Compensa(on
- 25. Client Profitability Perform Law Client Profitability Data and Pricing • When pricing client work, firms should consider the following : • Exis(ng posi(on in the client’s buying strategy? • Exis(ng and foreseeable market factors? • Efficiency of client account staffing? • Efficiency of overhead; • Intangibles including fixed cost absorp(on , training opportuni(es etc.; and • Opportunity costs
- 26. Client Profitability Perform Law Client Profitability Data and Pricing • Alterna(ve pricing approaches • Blended rate • Price at fixed point (median, low, high etc.) • Data needed • Analysis
- 27. Client Profitability Perform Law Client Profitability in CompensaIon • A management tool • Origina(on spliKng policy • Methodology for equa(ng client net income to compensa(on • Mechanics li(gated – LOL • Powerful mo(vator Nobody likes losing money on clients or timekeepers
- 28. Client Profitability Perform Law How is it calculated? • Before we start, a note about originators and support partners • Origina(on polices • Support partner origina(ons • Recommenda(ons • Origina(on credit • Produc(on bonuses
- 29. Client Profitability Perform Law Client Profitability & CompensaIon • How should we think about compensa(on? • Market for compensa(ng aGorneys is mature • Run compensa(on results / market payout • Which system gives us the best chance at a right result? • Objec(ve with a subjec(ve component • Pure objec(ve • Pure subjec(ve
- 30. Client Profitability Perform Law Client Profitability & CompensaIon • Distribu(ng income using objec(ve and subjec(ve components • Sample income alloca(on • 90% objec(ve based on 2 year rolling average client net by OA • 10% subjec(ve component • Managing partner compensa(on fixed at $75,000 • Model scales to any size
- 31. Client Profitability Perform Law Client Profitability & CompensaIon GeVng Started • Fears & Resistance • Truth in the numbers • Compensa(on changes • Moving from subjec(ve to objec(ve
- 32. Client Profitability Perform Law • Challenges • Data and resources not always available • Financial systems not fully implemented • Analysis usually sought in hard (mes Client Profitability & CompensaIon GeVng Started
- 33. Client Profitability Perform Law Client Profitability & CompensaIon • Opportuni(es • Measurable results • Produc(ve partner reten(on • AGract beGer laterals and improved likelihood of successful mergers • Increased rates of change
- 34. Client Profitability Perform Law Client Profitability & CompensaIon • Concerns • Large swings in compensa(on from one year to the next • SpliKng origina(on credit • Incen(ves for working with other partners • Adjus(ng points of ownership
- 35. Client Profitability Perform Law Client Profitability & CompensaIon • Opportuni(es and Concerns • Linking client profitability to compensa(on can best be described as a process that takes (me to mature. • Partners will come to understand that changes to their pricing, staffing and management approach may be necessary. • Over(me contribu(on to profit = market pay
- 36. Client Profitability Perform Law • What should partners expect? • Am I in the right firm? (hGp://performlaw.com/am-‐i-‐in-‐the-‐right-‐firm/) • Benefits and limita(ons of any compensa(on system • Main benefits of compensa(on based on client profitability Final Thoughts
- 37. • What is a modern partnership? • What should partners expect? • Benefits and limita(ons of compensa(on systems • Compensa(on Considera(ons • Br b r i a n @ p e f o r m l a w . c o m