Wisconsin Lawyer
Vol. 82, No. 8, August 2009

• Sample Client Intake Policies and Procedures 
• Additional Resources on Profit Potential 

“How can we do better this year?”

That is the question posed by lawyers each year as they focus on the financial performance of their law firms. In the past, such discussions may have resulted in plans for improvement, but those annual plans often miss the mark. In fact, sometimes the plans can be counterproductive, leaving the firm in a continuing spiral of meritocracy.

The biggest mistake lawyers make is to assume that the road to better profits must include reducing costs, increasing hourly rates, and increasing the number of billable hours. These tactics have been far too prevalent as our profession faces increased challenges. Often, these tactics fail to achieve the desired results, while likely resulting in client dissatisfaction and problems with lawyer and staff morale.

The approach presented here focuses on producing more revenue while at the same time improving client satisfaction. By implementing this approach to revenue enhancement, your firm will better satisfy its clients and will strengthen its compliance with the applicable Rules of Professional Conduct for Attorneys.

This approach has three parts: 1) the financial indicators a firm should track in analyzing revenue and identifying opportunities for improvement; 2) client expectations and techniques for improving client satisfaction in a way that will contribute to improved revenue; and 3) specific aspects of law firm leverage that are critical to surviving and thriving in today’s economy.

The Power of Revenue Focus

A focus on cost reduction to the exclusion of the more meaningful revenue approach is a common failing. While extravagant and unnecessary spending must be eliminated from a law firm’s budget, cost cutting has serious limitations and, if taken to the extreme, can undercut the firm’s production capacity. No firm has forged its way to long-term success though cost cutting.

On the revenue side, firms that limit their analysis to adjustments in billable hours and hourly rates make a mistake. While some firms survived the 1990s by regularly increasing billable-hour requirements and raising their hourly rates, those strategies are self limiting over time and in many cases have resulted in increased client dissatisfaction and serious declines in lawyer morale.

The following concept is key:

Increasing revenue, while maintaining the same expense structure, is the most powerful approach to improving the firm’s bottom line.

Simple math demonstrates that those extra revenue dollars go straight to the bottom line and make a profound impact on partner profits. If the firm has an expense ratio of 50 percent, a 10 percent increase in revenue will boost partner profits by 20 percent. The math is quite favorable. If costs can be held constant, those extra dollars can make a big difference to the partners’ lifestyle and satisfaction.

Too many firms have already pushed their hourly rates and their hourly production numbers to the limit. Further rate increases may adversely affect client relationships and result in problems attracting new business. Similarly, increasing billable-hour requirements of hardworking lawyers and paralegals is not a good idea. The goal is to find places to improve revenue within the existing cost structure that will not adversely impact client relationships or lawyer morale.

Lawyers need to understand that there are both healthy and unhealthy approaches to improving revenue. The following recommendations are based on approaches that are consistent with maintaining healthy attorney/client relationships and a positive law firm environment.

The Capacity of a Law Firm

The revenue capacity of a law firm is the amount of money that the firm should be able to generate with its lawyers and paralegals working at their highest and most efficient level in the context of the firm’s existing support, systems, and technology. It represents the most revenue that the firm might hope for with its present operating structure and practice methods. The firm’s capacity should be used as a benchmark to get a sense of how the firm is doing and the extent to which it has unrealized revenue potential.

Start by multiplying the standard hourly rate of each lawyer and paralegal by the anticipated number of billable hours. The hours to be used in the analysis should be realistic, based on the firm size and location, the type of work involved, the firm culture and, most importantly, historical information as to each individual’s performance in prior years. Figure 1 shows a sample calculation to determine a law firm’s revenue capacity.

The analysis assumes that the work performed is billed based on hourly rates or, if other billing methods are used, that the hourly rates provide the basis for estimating anticipated revenue. The analysis also assumes that each lawyer and paralegal has an adequate workload, that all billable hours are billed to clients, and that all clients pay their bills in full. While these are optimistic assumptions, they do represent decent goals for a firm, although they might not be achieved.

Then compare your firm’s revenue capacity to its actual revenue performance. What you have accomplished is to highlight the room for improvement. Many seemingly hard-working firms are operating at 50 to 60 percent of their actual capacity. Moving the percentage up as little as 5 to 10 percent will result in a substantial increase in firm profits.

The Financial Indicators on the Revenue Side

There are several places to look for additional revenue potential within an existing law practice.

• Billing Realization Rate. Determine the firm’s billing realization rate and then adopt a plan for improvement. A 5 percent increase in billing realization can make a big improvement to the bottom line.

• Collection Realization Rate. Determine the firm’s collection realization and then adopt a plan for improvement. Again, a 5 percent improvement will make a big difference to the bottom line.

• Efficiency of Lawyers and Paralegals. Lawyers and paralegals may need to be more productive during their hours in the office. In many circumstances, better work habits can add billable hours without increasing the length of a working day. By shifting 30 minutes a day per employee from nonbillable time to billable time, a firm can make a significant increase to its revenue.

• Increased Profit Margin. By incrementally shifting away from hourly billing, law firms can achieve higher profit margins on the billable hours invested.

By improving results in any of these areas, the firm is increasing revenue production not only in the current year but also in each succeeding year so long as the improved methods of operation continue.

But the analysis does not stop here. Some additional areas for improved revenue can provide one-time gains.

• Billing Turnover Rate. The billing turnover rate is the amount of time it takes on average until the work performed is billed. It is determined by dividing year-end work-in-progress by the average monthly billings. See Figure 2 for an example.

If the firm can improve its billing turnover rate by 15 days, the firm can expect a surge of revenue equal to about one-half of the firm’s monthly revenue.

• Collection Turnover Rate. The collection turnover rate is the average time it takes to collect a bill from the day it is mailed until the day payment is received. It is determined by dividing the year-end accounts receivable by the average daily billings. See Figure 3 for an example.

If the firm can improve the average collection time by 15 days or so, it can expect a surge of revenue equal to about one-half of the firm’s monthly revenue.

Unlike the realization rates, the extra revenue flow from an improvement in turnover rates will represent a one-time surge of revenue.

The Effect of Client Expectations

Following an initial visit with a lawyer, the client has certain expectations that will guide the client’s thinking as the matter proceeds. Ideally, those expectations will be based on what the lawyer has said during that first meeting. However, in some cases, the expectations will be based on what the client thought he or she heard.

The expectations that will be set at that initial client meeting will include:

• how the legal process will work;
• how long the legal process will take;
• the plan for addressing the legal issue at hand;
• the range of likely results;
• the overall cost of the legal services;
• how the services will be billed;
• when payment of the legal fees will be expected; and
• what will happen, if anything, if fees are not paid as they are billed.

The better the information and the more realistic the client’s expectations, the more successful the attorney/client relationship will be and the easier it will be to bill for those services and collect fees in a timely fashion.  

A collection problem is a signal that there was a problem at the beginning of the attorney/client relationship and that a problem at the time of client intake may have been exacerbated by poor client service or unsatisfactory client communications during the process.

A client who is well-informed, is engaged in the process, and sees the matter proceeding in line with expectations will tend to be more satisfied with the service and more likely to send a check by return mail.

Properly managing client expectations will result in the improvement of many of the firm’s financial indicators, such as billing realization, billing turnover, collection realization, and collection turnover. Improving each of these indicators by a few percentage points can result in significant additional revenue.

Getting it Right

The key to avoiding many client problems is to recognize the significance of the client intake as the most critical meeting you will have with the client. See the accompanying sidebar for a sample Client Intake Policy. Any problems resulting from misunderstandings at that first meeting may not surface until much later in the process. Often they emerge as collection issues at or near the end of the matter.

Client intake is only the first step, but it establishes critical aspects of the client relationship that are destined to affect firm revenue and profits.

After the intake meeting, client communications continue to be crucial, most particularly in situations in which events occur that will affect the client’s expectations. Let the client know of any change immediately. Let the client participate in any changes, particularly those that will affect the fee estimate. Never surprise a client with the amount of a bill.

Leveraging Expertise

Ironically, as clients have become less willing to pay to have a matter handled by inexperienced associates, they are more willing to pay high fees for the experienced “go to” lawyers in any particular field. The best lawyers are able to leverage their own experience and wisdom by charging a premium for their services.

While commodity legal work will always be price sensitive, the work of lawyers with high levels of expertise will not be price sensitive. In the present marketplace, the goal for most lawyers should be to develop a reputation in their community as an expert, or better yet, as the go-to person for a particular type of matter. Once that status is achieved, the lawyer can leverage his or her own knowledge and wisdom to achieve greater profits.

However, it is difficult to leverage a lawyer’s expertise to best advantage in matters that are billed by the hour. Higher rates can make a difference, but they do not capture the true value of a lawyer’s expertise. As a result, lawyers seeking to leverage their expertise to best advantage are exploring and adopting alternative value-based fee methods.

Leveraging Paralegals

While some of the world’s largest firms continue to leverage associates, many firms got in trouble with liberal partnership policies that caused firms to become partner heavy. Sophisticated clients, who will pay high hourly rates for the partners, have become increasingly unwilling to pay for the work of inexperienced associates. As a result, leveraging with associates has diminished as a revenue producer for many firms.

The emergence of the paralegal profession has offered an alternative to associate leverage. Associates continue to be important to law firms as the partners of tomorrow.

Qualified paralegals who are properly managed are able to help lawyers provide better client service at a lower cost, while at the same time providing improved profits for the law firm. While paralegals bring many advantages to lawyers and their clients, the analysis here is limited to the use of paralegals in leveraging profits for the law firm.

The revenues produced and the costs associated with maintaining a paralegal will vary depending on the location and the type of practice. However, the following tabulation reflects a typical breakdown into broad categories of paralegal costs in some communities:

For the purpose of this analysis, revenue potential is determined by multiplying the paralegal’s rate by the billable hours anticipated. An hourly rate of $85 multiplied by 1,500 hours equals a revenue potential of $127,500. To shift from potential revenue to actual revenue, a factor representing write-offs and uncollectibles must be applied. Assuming a factor of 10 percent, compare revenues of $114,850 with costs of $80,000, leaving an anticipated profit in the vicinity of $34,750. In actual practice, the amount of profit will vary widely depending on the paralegal’s qualifications and experience and the firm’s billing rate and cost structure.

It is critical for the lawyer to know whether the work performed by paralegals is returning a profit. This can be accomplished either by a careful analysis of costs and revenues or by applying a rule of thumb, such as the “Rule of Three.” The test is met if the revenues generated by the paralegal equal three times salary. Assume that the first one-third represents the paralegal’s salary, the second one-third represents fringe benefits to share of the overhead costs, and the balance represents profits to the lawyer. See Figure 4: “Rule of Three” Paralegal Profit Test. Although such a rule of thumb is a good starting point, it is always better to look at actual costs.

The initial reaction of most lawyers is that well-qualified paralegals require high salaries and will not yield the profits desired. They are mistaken in thinking they can make more money with a low-paid, entry-level paralegal. Nothing is further from the truth.

In most circumstances, the lawyer can justify billing the time of an experienced paralegal at double the rate of an entry-level paralegal. Even if the firm pays an experienced paralegal twice as much as the entry-level paralegal, the profits generated by the experienced paralegal will be greater. This is so because the overhead costs will be nearly the same for both paralegals. Consider the two extremes presented in Figure 5: Comparison of Paralegal Profit Potential.

There are firms that manage acceptable profits from entry-level paralegals by increasing their billable hour requirements. For example the $2,500 profit shown in Figure 2 can be increased to $16,000 by increasing the billable-hour requirement at the entry level from 1,500 to 1,800.

Modifications can be made to the model based on individual circumstances. However, the resulting analysis is likely to demonstrate that in most settings, larger profits are achieved by hiring or developing and retaining experienced paralegals.

Leveraging with Alternative Billing Methods

When evaluating alternative fee methods, think about the factors to be considered in establishing a fair fee. For example, a fair fee will normally:

• reflect the client’s perception of the value of the services performed,
• offer the client predictability concerning the fee,
• reward the lawyer for efficiency and productivity,
• provide the lawyer with a return on the investment in technology, and
• where feasible, include a sharing of risk.

No one fee method fits all situations. The Rules of Professional Conduct for Attorneys set out several factors that can be considered in setting a fee. Lawyers need to understand the broad range of fee agreements possible in order to effectively explore the options and select one that best fits a particular situation.

The Fixed Fee. Under a fixed-fee arrangement, the lawyer agrees to perform certain work for a stated fee. The lawyer needs to understand the nature and extent of the work to be performed and clearly document the scope of the work in the fee agreement. Any changes or extension of the work beyond what is described will necessitate another agreement or perhaps a change order. It is crucial that there be no misunderstanding of the work to be performed for the fee and that additional work requires an additional fee.

Fixed fees are best used for any matter for which the lawyer can project the amount of work with some accuracy. The special-focus lawyer is in the best position to quote fixed fees for a range of related services.

The Contingency Fee. The fee is a percentage of the amount recovered. This is a pure form of value billing. It is traditionally offered to clients in personal injury cases, but it can be used in many cases that involve the recovery of money or a benefit that can be translated to money. A percentage fee is a similar concept and is based on a schedule of fees tied to the result.

Combination Hourly Rate and Fixed Fee. There are circumstances when the initial portion of the work can be performed at an hourly rate with the balance for a fixed fee. The lawyer charges by the hour for exploring the client’s needs. Once a determination of the scope of the work has been made, the lawyer can charge the balance of the work at a fixed fee.

Combination Hourly Rate and Contingency. There are other situations when the initial portion of the work can be performed at an hourly rate with the balance of the work based on a contingency. For example, an hourly rate billing might apply to the initial investigation and evaluation to be followed by a contingency for the actual project or litigation. In litigation matters, the contingency could be something less than the traditional 33.33 percent.

A variation of this combination fee is a reduced hourly rate plus a contingency based on result. The reduced hourly rate provides some cash flow for the lawyer during the course of the project.

Combination Flat Fee and Contingency. The lawyer can quote a flat fee, perhaps to be paid in monthly installments, and also receive a percentage based on the amount recovered or on the extent to which the client’s objectives are met. 

These combination methods are useful for situations when the client cannot afford a straight hourly fee and the lawyer cannot take the risk of a full contingency arrangement. They allow for a middle ground, with the lawyer achieving some level of cash flow while at the same time sharing the risks and rewards with the client. A significant amount of the need for legal services, which otherwise might not be met, could be accommodated with one of these combination methods of billing.

Alternative billing methods require the lawyer to predict and analyze the effort that will be involved, to lay out the plan to be followed, and to factor in the likely outcome. These alternative methods favor lawyers who have good management skills and a level of expertise in the substantive area involved. The task will seem formidable to the lawyers who are generalists or who have become lazy under the billable-hour fee method.

Leveraging With Technology

Technology has changed how we live and how we work. Some law firms struggle to live with technology; other law firms can’t live without it. Technology managers are forever working with issues of cost justification, implementation, lawyer buy-in, training, and computer crashes. For all the problems, technology has improved many aspects of client service and law firm operations.

Each technological advance makes lawyers more efficient and more cost effective. With increased price competition, law firms that do not take advantage of the technological advances are at a distinct disadvantage.

In the law firm setting, who benefits from technology? If the work is billed by the hour, the answer is simple. The clients benefit. The lawyer receives no direct benefit. For work that is billed on flat fees, it is the lawyer who stands to benefit from improved use of technology. Similarly, lawyers who handle contingency cases will benefit from technology. The problem in most firms is that the vast majority of legal work is still billed by the hour.

Arthur G. Greene is a principal of Boyer Greene LLC, a law firm consulting organization with locations in Michigan, New Hampshire, and Nevada (www.boyergreene.com; email agg@boyergreene.com). He formerly was managing partner of a firm that grew to 70 lawyers. His consulting practice now includes profitability studies, revenue enhancement, firm audits, strategic planning, governance, succession planning, compensation plans, alternative billing methods, and other aspects of maintaining a healthy firm. His book, The Lawyer’s Guide to Governance, was released by the ABA in February 2009.

Greene made a presentation on “Increasing Revenues” at the State Bar of Wisconsin 2009 Annual Convention.

Theoretically, increases in overhead should be covered by increased hourly rates. However, in most legal markets competition will not allow rate adjustments to reflect the additional cost of technology. Many firms have given up and are simply accepting technology as a cost of doing business.

There are two management aspects to technology in the law office. First, technology managers need to evaluate the firm’s use of technology and eliminate wasted time, effort, and money. Second, the firm needs to develop an approach to clients that permits attorneys to share in the rewards of technology.

The real solution is for firms to move away from hourly rate billing and employ alternative billing methods. Hourly billing has come under attack as being not fair to the client and not fair to the lawyer. But, as it relates to the issue of this discussion, hourly billing (by design) eliminates the lawyer from benefiting from technology. Technology costs become an expense item to be covered by the hourly rate. While the investment in technology justifies an increase in rates, the competition in the marketplace does not allow it. The only real way to achieve leverage from technology is to detach billing from time entries. If the fees are set on other grounds, then productivity that advances from technology will benefit the lawyers.

Let Your Clients Do the Marketing

In most well-run law firms, 50 percent of the business comes from current or former clients or referrals from current or former clients.

A law firm that focuses on providing superior client service, including effective client intake and careful management of client expectations, will find an increased percentage of its work coming from existing or former clients.

Satisfied clients are a law firm’s most powerful marketing tool and the price is right.

Conclusion

Any time a firm can improve revenue without adding costs, the rewards to the lawyers can be great. In that case, 100 percent of the additional revenue goes to the bottom line, not 50 percent or 60 percent, which is the existing percentage of profit attained by many firms.

Understanding the financial indicators is critical to identifying opportunities for increased revenue. But improving revenue is not about numbers; it is about clients.

Beyond the numbers, lawyers need to focus on the effective management of client expectations and recognize this factor will drive the financial indicators to improved levels. At the same time, an effort to take advantage of the opportunities offered by modern leverage concepts will contribute to enhanced profits.

Wisconsin Lawyer