Law Firm Profitability Defined
Law firm profitability is a measurement of how successfully a law firm generates profit from the combined efforts of its lawyers and staff. There are a number of metrics that are used to determine a firm’s profitability, but these generally boil down to a few categories such as revenue per lawyer (RPL), profit per lawyer (PPL), profit margins, and overhead (which is the combination of fixed and variable costs of operating and servicing the firm). Not all firms track profitability by the same measure and some law firms will require different approaches to find the right mix for tracking and measuring profitability.
RPL is one of the primary measures of profitability. RPL indicates whether a firm is spending more on its lawyers than it is taking in from clients. RPL can also indicate whether a firm is charging appropriately for the services it provides to its clients. A firm needing to improve its RPL can reap a huge benefit by looking at its overhead and cutting out superfluous spending. By doing so, a law firm can immediately improve its bottom line without changing any of its revenue-generating practices. While there are strict limits as to how much a law firm can charge its clients , RPL indicates whether a firm is appropriately pricing its services to cover its overhead cost (including the cost of its lawyers).
PPL is another of the primary measures of profitability. PPL indicates whether a law firm is converting billable work into profit for the firm. PPL is different than RPL in that profit often is derived not from undercharging clients, but from cutting spending and reducing overhead. As with RPL, PPL is driven down when a firm has high overhead. By cutting overhead, a firm increases its PPL without changing its income. PPL also overlaps RPL to some extent in that PPL is determined by dividing the revenue generated by each lawyer (or the firm as a whole) by the total number of lawyers. PPL provides a key comparison to RPL that indicates whether a firm is charging too little for its services.
Profit margins provide a useful metric for law firms to determine whether they are both charging clients appropriately for their services and being a good steward of their resources. Having a good balance of these two attributes is vital for a law firm to maximize its profitability.
What Does It Take to Make a Law Firm Profitable?
The primary factors that can impact the profitability of a law firm include several key areas. First and foremost is market competition. If competition is fierce, a firm can engage in price wars on billing in order to win market share, particularly when serving a client or prospect for the first time. Secondly, an important factor affecting profitability is client retention. A firm that signs up and retains clients over a long period of time has a larger, steady stream of fees, even if the fees per client are lower. Third, billing practices also impact the factors of profitability, particularly in the area of accounts receivable (A/R). The longer A/R is allowed to age, the more difficult it becomes to collect. Many firms due to either poor management or economic downturns fall substantially behind in billing and A/R. As the old saying goes: "for every month of work that goes by, there is one month of A/R" (this is a goal to be avoided!). Finally, operational efficiency practices must be in place in order to ensure that fees are collected promptly, with minimal writeoffs. Firms that struggle with A/R often report much higher costs of collection with significant amounts of write-offs due to inefficient billing software or practice management systems. Other common causes of significant write-offs include poor time entry practices (often time is forgotten or poorly documented), lack of (or poor) conflict checks and poor client intake practices.
Enhanced Billing Practices
Part of maximizing profitability is focusing on improving efficiencies and reducing leakage in an organization. In this section we will discuss three strategies that can help maximize billable time while improving profitability to your law firm. They are: alternative fee arrangements, time tracking technologies, and regular billing reviews.
Alternative Fee Arrangements: The only way to improve efficiency and reduce leakage is to set your rate based on a fixed predetermined amount. While not all engagements fall under the "AFAs" category, you will be surprised how much efficiency you gain when you set a fixed cost to doing specific work for a client. After you have done it once, the next engagement usually goes faster if you use what you learned and apply it to the next engagement. This is one of the main reasons why AFAs help you improve efficiency. When you set a fixed cost, you are more likely to start working right away. You search out ways to complete the work faster. You find areas where you can save overtime or use less senior associates. You stop the time you are billed on the clock. The bigger your firm is, the more time you can bill because the higher your overheads are, which allows you to bill at a lower rate.
Time Tracking Technologies: The next technology that can help you maximize profitability is time tracking technologies. These technologies can help attorneys bill more time and make sure that all their billable time is captured. Examples of technologies are: Chrome extensions that notify you when you have not entered time in a specific case in a certain number of days; accounting systems with integrated time entry fields in them and notification systems that alert clients and/or attorneys that certain tasks were completed, or alerts when deadlines approach; mobile applications that allow time to be entered quickly and easily from anywhere anytime.
Regular Billing Reviews: The third strategy that most firms could do better is regular billing reviews. Most firms have a process that takes place when the matter is completed, and they write-off time that was incurred but never captured for the file. However, if you want to maximize profitability, you should review billing every month. When you recognize that you are billing at less than what you expected or have not billed time for a specific project, you can do something about it before the project is closed. We strongly recommend that you use software that makes this process easy so you can do it whenever you have a few minutes or a day each month. Even seven minutes a day will have a positive impact.
Improved Client Relations
Client satisfaction and retention are two terms that get thrown around often in the legal industry but are not always fully understood. Simply put, when you are focused on maximizing profitability, the goal is to attract clients and retain them long-term to prevent the need to constantly replace clients that you lose. Understanding your clients and their needs is vital to building loyalty and retention. It is decidedly less expensive to retain clients than recruit new clients. This means setting up internal processes and methods for communication with clients and potential clients. Your clients want to feel valued, without it costing you any extra money. What this means is taking a vested interests in your clients and treating them as partners rather than as "just a number." For your part, it means using automated tools, such as portals, to allow clients to retrieve simple information on demand and on their time. Regular communications can be automated, too, such as weekly or monthly client newsletters. Staying top of mind with clients increases your visibility and keeps you in a good position when they need your services. Feedback plays an important role in client satisfaction, so you need to find methods to ask for and accept feedback. Most importantly, you need to be willing to listen and take corrective measures when you receive feedback from clients, whether positive or negative. Always strive to go the extra mile for your clients, and add value to your services. This can take many different forms and will vary from one client to the next. One way to add value is to provide more frequent updates to your clients on their legal matters without charging them for this service. This shows clients that you are proactive with their matters and that you are available to answer questions that may arise. When you take the time to communicate with your clients regularly, it helps prevent misunderstandings and unnecessary friction between you and them. Communication in the legal field is all about clarity.
Using Technology to Create Efficiencies
In the digital age, maximizing efficiency and minimizing costs is essential for law firms seeking to boost profitability. One way to achieve this is by leveraging legal technology, which can streamline operations and enhance productivity. Embracing tools such as case management software, document automation, and virtual meeting platforms can bring significant benefits. Case management software can be a game-changer for law firms of all sizes. This software provides a comprehensive solution for organizing client information, tracking deadlines, managing calendars, and overseeing multiple cases simultaneously. By consolidating these key tasks into one user-friendly platform, law firms can reduce administrative time and effort, allowing attorneys to focus on serving their clients more effectively. Document automation is another proven method for improving efficiency in law firms. Many legal documents contain standard language and repetitive text, which can be tedious and time-consuming to create manually. With document automation tools, firms can quickly generate customized documents based on relevant case details and templates . This not only saves attorneys valuable billable hours but also helps ensure that documents are accurate and standardized, reducing the risk of errors and omissions that could result in costly malpractice claims. Virtual meeting platforms like Zoom, Google Meet, and Microsoft Teams can also be powerful tools for increasing efficiency and reducing variable costs. By allowing firms to conduct meetings with clients, colleagues, and opposing counsel remotely, these platforms eliminate the need for expensive travel and give firms greater flexibility in scheduling. In addition, using virtual meetings can save on costs associated with renting conference space and provide a more convenient way for clients to participate in important discussions. In conclusion, integrating these tools can not only reduce overhead but can also enhance a firm’s ability to meet case-related demands. Investing in legal technology is an important part of maximizing law firm profitability. The bottom line is, in today’s competitive marketplace, when it comes to increasing profitability, efficiency is key.
Overhead Costs
To improve profitability, law firms need to be vigilant in managing overhead costs. As mentioned earlier, many firms have focused on increasing revenues with the thought that eliminating or reducing overhead costs was not necessary. However, in many of the conferences and meetings we have recently attended, speakers have pushed hard in their presentations for firms to look at managing overhead carefully. While it is important that firms look very closely at overhead, it is also important to focus on those overhead items that are not essential and can add to the bottom line. You have to minimize those expenses that do not relate directly to client services. One key observation is that a certain amount of fixed costs are not controllable, and therefore are a waste of time to review them from time to time. Expenses in this category are likely building leases, malpractice insurance, property taxes, loan repayments, technology support services, utilities, etc. Another category of non-controllable expenses are payroll liabilities, benefits, payroll taxes, and related expenses. For controllable expenses, look for opportunities to reduce: Several years ago, outsourcing became a trend as firms attempted to reduce costs. Today, with technology becoming more robust, outsourcing can give firms an even greater opportunity to explore. Non-essential services are ideal candidates for outsourcing. Clerical, marketing, and IT are prime examples. There are a variety of tips and strategies to analyze to see if you might be able to renegotiate your vendor agreements to your advantage: When reducing overhead expenses do not take on too much risk. All cost-cutting strategies should be balanced with the core values of the firm. Be sure cost-cutting will not negatively affect your clients or your efforts to attract new ones. Cost-cutting should not alienate your firm’s biggest asset—its talented professional staff.
Investing in People and Training
A major factor driving profitability is an investment in professional development and competitive compensation plans for staff. Having competitive salaries, as well as other sorts of compensation plans, is essential for attracting talent and retaining it. In a market where opportunities abound, firms cannot afford to keep losing their top legal minds to competitors. When a partner leaves, and takes his or her client base with them, the clients are usually lost. Even if they are kept on, clients are often looking for something more than a new face to do the job, especially if they have been with the firm for a very long time. There are plenty of young, ambitious lawyers out there willing to take on the challenge of building a client base and establishing a reputation in a new area of law. As such, even young associates are a threat to you. It is crucial that the best people stay with your firm for years to come. In addition, your young and bright associates should be given as many opportunities as possible to make their mark. Expose them to a variety of roles, so that they can find out what they are best suited for and gain valuable experience. Whether they work in management, client relations, or team building, they will learn the ropes of the business and be more willing to stay on as their role in the firm gets larger. Meanwhile, bringing in new talent is essential as well. You cannot afford to stifle opportunity for your lower level associates. If they are not taking on big files or high profile clients, you are going to start getting complaints. Always remember that one day partners were associates and they too deserved the opportunity to prove themselves.
Measuring and Monitoring Profitability
With the right tools and practices, you can regularly measure and analyze your law firm profitability metrics to ensure your firm stays on the right profitability track. Financial reporting tools, key performance indicators, and regular audits all play a role in this process.
Your financial reports not only tell you if you are making a profit, but they also provide valuable insight into your firm’s bottom line. In fact, financial reports are crucial for establishing the targets for profitability improvement initiatives. Key performance metrics are calculated based on the information found in these reports. It is not enough to have these metrics calculated, as these numbers need to be used to make important business decisions and establish budgeting and utilization targets. Periodically reviewing the profitability of different cases and clients can help you identify opportunities for improvement in resource allocation. For example, if you bill $2,000 for a particular matter but spend 40 hours of attorney time and 30 hours of partner time, your return on equity is well below the industry average. Here, you need to consider hiring outside vendors for lower-value tasks such as discovery and document review. When reviewing profitability data, consider not just how much you are charging but also the amount of resources you are using to deliver the work.
Key performance indicators (KPIs) offer a real-time view of where your firm stands in terms of profitability. Because the cost of operation is fixed, there is no material difference between the profitability of 200 billable hours and the profitability of 400 billable hours at your target realization and collection rates. With your KPIs , you should establish a target realization, a target collection rate, and your average hourly billing rates. Two long-term trends that need to be closely monitored include realization and collection. Increases in realization may suggest that attorneys expedite work to bill as much of their time as possible; however, reductions in realization could signal that lawyers are writing off fees beyond an acceptable limit. These numbers are an indicator of operational efficiency and the basis for your financial reporting and KPI calculations.
Regularly auditing your profitability metrics is essential to keeping your profitability on track. The mere act of reviewing profitability data forces your team to be more aware of the importance of profitability. Annual reviews will enable you to identify positive and negative profitability trends within your cases, billings, clients, and even people. The results of profitability audits can be used to establish improved budgeting and utilization targets. Overhead expenses can be compared to market standards to ensure you’re not overcompensating for business services versus the time-based fees you bill your client. Your profitability review should be written down, communicated, and regularly updated to maximize its impact. In addition, each lawyer should have their own set of profitability metrics that they use to review their success against the practice group’s targets. Ideally, every attorney should have an accurate view of their contributions to total law firm profitability.