5 Tips For Improving Law Firm Profitability

We’re now into the fourth quarter of 2016, and we all know what that means in Biglaw: time to start collecting from clients. Those Hamptons homes (and associate bonuses) won’t fund themselves, after all.

So now’s a good time to talk about law firm profitability, the subject of an interesting panel discussion I attended at the Thomson Reuters Law Firm Leaders Forum called “A Comprehensive Update on Law Firm Financial Performance & Metrics.” It featured the following panelists:

Beau Grenier (moderator), Chairman, Bradley Arant Boult Cummings LLP David Gaulin, Partner, Law Firm Services Leader, PricewaterhouseCoopers LLP William Josten, Senior Analyst, Client Relations & Thought Leadership, Thomson Reuters Elizabeth A. Sharrer, Partner & Firm Chair, Holland & Hart LLP Ted Tinson, Chief Operating Officer, Sheppard, Mullin, Richter & Hampton LLP

Beau Grenier opened the discussion by noting that back in the day, law firm profitability was simply a matter of working the hours. That’s no longer the case today; in this challenging climate, law firms need to be more knowledgeable about their operations and have better systems for tracking productivity and profitability.

What can law firms do to make themselves more profitable in a highly competitive environment with little to no demand growth? Here are a few ideas that emerged over the course of the discussion.

1. Realization, realization, realization.

To paraphrase the 1992 election slogan, “It’s the realization rate, stupid.” Law firms need to bill a higher percentage of worked hours and collect on a higher percentage of billed hours if they want to maximize profits.

Bill Josten, a law firm profitability specialist at Thomson Reuters, described the results of a study that TR conducted to compare financially successful firms (the “haves”) and financially struggling firms (the “have-nots”). He described some surprising findings about factors that did not dictate law firm profitability, including billing rates, geography, and market segment (e.g., an Am Law 100 firm versus an Am Law Second Hundred Firm). In other words, there are many paths to profitability as a law firm; you don’t have to be, say, Am Law 100 firm based in New York City with sky-high billing rates.

So what did make a difference in financial performance? Realization rates — how much of worked time got billed, and how much of billed time got collected — played a big role. Nudging up realization rates by just a few points can mean millions for some firms.

What can be done to improve realization rates? Law firms come up with all sorts of strategies, including rewards or punishments for timely entry of time. But at the end of the day, according to Ted Tinson of Sheppard Mullin, it’s mainly a matter of discipline. Some firms are just more disciplined than others about sending out bills on time.

Elizabeth Sharrer added that it’s important to educate your timekeepers about why time entry matters. At Holland & Hart, partners talk to associates about the business of law — which many firms fail to do — and the importance of factors like realization rates. “We want them to think like owners,” she said.

2. Have the right mix of timekeepers.

Comparing the “have” and “have-not” firms, Bill Josten noted that the “have” firms have a higher percentage of associates among their timekeepers. At “have” firms, 39 percent of timekeepers are associates, compared to 35 percent at “have-not” firms.

Associates are some of the most profitable timekeepers at a firm. Beau Grenier said that Bradley Arant enjoys a 40 percent profit margin on associates, compared to just 16 percent on non-equity partners. (Non-equity partners, who generally have higher salaries and lower billables than associates, are some of the least profitable timekeepers at a firm — sometimes even less profitable to the firm than paralegals.)

3. Attorney retention: it’s a thing again.

Josten pointed out that many firms don’t have enough senior associates — some of the most profitable timekeepers at a firm — because they either laid off too many lawyers during the recession or cut back on hiring too much. Now that the business climate has improved, attorney retention is an issue once again for firms (as it was during the pre-recession period).

In one recent survey conducted by Thomson Reuters, law firm respondents said that entry-level hiring was one of their top priorities. This surprised the TR team at first — they expected lateral hiring to be a bigger priority — but it reflects the desire of many firms to train their lawyers from the beginning and grow headcount organically. The general trend in entry-level hiring, per Josten, is to bring in fewer lawyers but retain them at a higher rate; if you’re going to invest so much in your lawyers, you don’t want to lose so many of them after a few short years.

At Holland & Hart, the firm is working on creating valued career paths that don’t necessarily include partnership, according to Elizabeth Sharrer. It has intentionally tightened up its partnership ranks (a general trend in the law firm world), but at the same time, it has tried to do as much as it can to retain talented attorneys who might not want partnership. It has done this through a strong commitment to pro bono, as well as bonuses and mini-sabbaticals for lawyers of a certain seniority. (The firm’s geographic focus on the Mountain West helps on the recruiting and retention front; Sharrer observed that Denver and Colorado are hugely popular with millennials.)

4. Sometimes you have to spend money to make money.

In their study, Josten and his colleagues at Thomson Reuters compared expense growth at “have” versus “have-not” firms. One might expect the financially thriving firms to keep a tighter lid on expenses, but that’s not what TR’s study found. In 2015, the average firm saw about 3 percent grown in expenses, while the thriving firms had above-average expense growth, in the 4-5 percent range.

Josten’s takeaway: successful firms are willing to spend in order to grow. In terms of where they are spending their money, the “have” firms have beefed up their budgets for recruiting and marketing/business development.

One can see the logic here. Law is a talent-driven business, so one shouldn’t skimp on recruiting (or on lawyer compensation, including associate salaries and bonuses). And in a low-demand environment, marketing and biz dev are key to getting a larger slice of a static or shrinking pie. David Gaulin of PWC stressed that client relationships are more important than ever — so if you have to pay to fly out and see a client or take a client out to dinner, that’s marketing money well-spent.

5. Don’t ignore the importance of culture.

Beau Grenier closed the discussion by raising the issue of culture, citing studies showing that higher workplace morale and motivation can increase productivity and profitability. He asked the panelists if they agreed and, if so, what can be done to strengthen a firm’s culture.

Not surprisingly, the panel members agreed that culture is key. Elizabeth Sharrer emphasized that a law firm can’t be held together just by money; lawyers need to enjoy working and spending time with each other. To that end, Holland & Hart gladly pays to send partners on multi-day trips so they can bond with each other over activities like fly fishing. These trips can cost a few thousand dollars a person, but given the increased cooperation and cross-selling they promote, they’re totally worth it. (See tip four above about spending money to make money.)

An important component of culture is making sure the firm has an open and flexible approach to staffing and talent management. David Gaulin praised Davis Polk’s new alumni rehiring program, in which lawyers who previously worked at DPW for three or more years before leaving the legal profession for at least two years can reapply for associate-level positions. He also said that law firms could learn a thing or two from his employer, PricewaterhouseCoopers, which gives employees the flexibility to ramp up and scale down in the workplace depending on what else is going on in their lives. For example, PWC has one program where employees can receive 20 percent of their compensation and retain full benefits while they take time off to deal with family responsibilities.

Culture isn’t just a buzzword to toss around during recruiting season. It is, as Elizabeth Sharrer put it, “a business imperative.”

21st Annual Law Firm Leaders Forum [Thomson Reuters]

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David Lat is the founder and managing editor of Above the Law and the author of Supreme Ambitions: A Novel. You can connect with David on Twitter (@DavidLat), LinkedIn, and Facebook, and you can reach him by email at dlat@abovethelaw.com.

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