Maximizing Information Technology Return on Investment

02/01/2012
Published in Accounting and Financial Planning FOR LAW FIRMS®
Volume 25, Number 2, February 2012

The recent death of Apple founder Steve Jobs brought a spate of stories about how his flair for sleek design combined with his innovative thinking to create products that the marketplace perceives as "cool." Law firms are not immune to the "cool factor" in their technology purchases. Firms want new technology because it's attractive or fun or helps them do more, more quickly. Firms also have a strong competitive streak, and they either want to be the first to tout using a new technology, or don't want to admit that others are using it and they are not.

However, technology expenditures should not be made on emotion. They must be made because they provide an adequate return. The return on investment ("ROI") for technology purchases is maximized when the firm defines its technology needs and makes purchases to fill those needs according to a budget, not according to emotion fueled by what's cool or what other firms are doing. No matter what the reason or replacement cycle, law firm computer technology should be a function of ROI. There is no one right or correct rate of return, but maximizing it is essential. The return selected or expected will be a function of client demands, available alternatives and investment resources. Technology must increase service levels and work volume if it is to lead to more client work assignments. Higher ROI on the technology expenditure must be the result.

ROI and Cash Flow

Awareness of what technology can consume from a firm's cash flow, as well as from lawyers' billable time, gives a true picture of the return the firm gets on its technology spending. A 10% return is usually considered too low to make the purchase (investment) unless there are other factors involved, such as new services it allows the firm to offer or greater efficiency that it provides. The return selected or expected is a function of personal choice, available alternatives, and available resources for investment. Because there are invariably a number of technology expenditures competing for priority, using ROI helps to rank them in the order of financial preference.

Then, depending on the budget and resources available, the most productive or profitable investment can be made first.

Here is a typical way to calculate ROI. Say the slated expenditure is $1,000, and the expected savings or the expected increase in net revenues is anticipated to be $100 annually. Taking the savings as the numerator and the expenditure as the denominator, the percentage is 10% per year, which is the return on investment of the purchase. Another way to look at this is to figure that the $100, if it occurs each year, will result in a "recovery" of the entire investment after 10 years, or, said another way, that the "payback period" is 10 years.

ROI and the Replacement Cycle

Don't automatically assume that a new computer or software will greatly increase lawyer or staff productivity, with a resulting increase in profitability. Projected ROI is often thwarted by human considerations: Support staff and lawyers can resist change, be afraid of the new technology, and have no emotional investment in its use. Fear of how much time it takes to negotiate the technology learning curve can be another factor. In any of such circumstances, the technology can languish until it becomes obsolete, with little of the expected savings or profits.

Such concerns keep too many small firms and solo practices behind the technology curve, even to the point of not using e-mail or not keeping electronic files of client records. Those that do use technology often do not spend enough or maintain upgrades to keep it current. This is done at their peril for two reasons. First, such firms are in danger of violating the Rule of Professional Conduct that requires lawyers to meet the standard of care in the local community — which today is generally assumed to mean using technology effectively for trial support, case management and the like. And second, if a lawyer contemplating retirement has not kept the practice's technology up to speed, the firm's value is going to be diminished in negotiations once a potential purchaser realizes that a substantial IT investment will be necessary.

By contrast to the four, five or even six-year technology replacement cycle at small firms, larger firms typically make technology a bigger focus of dollars and time. In a survey of selected large firms that I conducted several years ago, 66% of respondents allocated 2% or less of their gross revenue for hardware purchases; 75% of the respondents allocated an additional 2% or less of their gross revenue for software purchases. These numbers aren't large percentages, but represent large numbers of dollars. And 67% of the respondents age-out their computers and related technology before the end of a three-year cycle (17% in two years), guaranteeing a continual cycle of expenditures. Thus, the amount of dollars committed to technology purchases in a large firm can be substantial.

ROI and Financing

To pay for an upgrade, firms typically pursue one of several options.

  • Cash. This is typically done only for a small purchase (a single computer and its software licenses). It eliminates finance charges and fees, but even the few thousand dollars required are enough to be a deal-breaker for some firms.

  • Leasing. Leases facilitate more frequent upgrades, protect a firm's credit, and can even offer tax advantages. However, lease arrangements are typically limited to computer hardware, still leaving the firm to come up with cash for software and implementation.

  • Manufacturer Financing. These can include items such as technology and services that are usually not covered in lease packages, and may be for as short a period of time as two years. But such programs still are loans with organizations, often not as flexible as banks. Bank financing for technology purchases may be through a line of credit, equipment loan or term loan.

The cost of such loans varies; factors include the firm's bank balance, other services purchased, and credit rating. But the minute computers or software are purchased, their obsolescence is assured. Their value to the bank isn't nearly so great as a hard asset like real estate, no matter how expensive the technology is. Banks may accept technology as collateral, but will not put a high value on it. Thus, bankers are nervous when it comes to financing IT purchases. The prospective borrower must provide as much safety to the bank as is possible, especially by contributing both capital and collateral to the overall financing package.

ROI and Efficiency

Whatever financing method is used, thinking through the purchase and getting as many people as possible committed to using the technology before it is bought is the best way to achieve the level of usage that produces a higher ROI. Consider two expensive investments for any law firm, software for client relationship management ("CRM") and knowledge management ("KM").

Shared CRM databases on computer desktops can make available to all firm members the contact history and service requirements of any client or prospect, bringing far greater efficiencies to client service functions. But if partners zealously, jealously guard data rather than share it, because they fear that sharing information on "their" clients will negatively affect their compensation and bonus, the incompleteness of the firm-wide data means that CRM is a wasted investment with little useful return. Investing in KM poses a challenge similar to CRM. KM systems combine the work product of all lawyers into a single unified database that can be accessed to the benefit of all clients.

The KM process only works when the information is classified and categorized consistently and frequently. Many lawyers believe that this is not billable time, particularly after a transaction or case is completed, and so they either do not do it or do it incompletely. No matter how sophisticated the database, knowledge management only works when all knowledge is shared in a way that all lawyers can access it. Effective use of CRM and KM systems may well spell the difference between future thriving and dissolving of the law firm.

In these instances, the key to ROI analysis puts the greatest emphasis on efficiency. Few firms of any size can afford to ignore the way that global technology flattens the cost of legal service. Large multinational firms increasingly are pushed by large corporate clients into a flat- or fixed-fee billing mode. Increased profit by increased efficiency through the use of CRM or KM technology under a fixed-fee engagement agreement is a definite contrast to the traditional American law firm model, where profit was increased by raising the hourly billing rate. The Great Recession caused corporate America to revolt against that model with its annual price increases.

There is inevitable pressure to reduce fixed fees and squeeze the firm's profit margins. But the efficiencies from continually updated computer technology are the firm's secret weapon to turn legal knowledge into a high-volume commodity.

With a lower price through fixed fees, client demand could increase volume, profits and ROI. However, maintaining billings while becoming more efficient requires changing the billing system to embrace alternative fee arrangements. Using contingent, fixed, capped, value fee approaches is essential to make the most of the leverage from technology.

The premise of any such billing system is that time is not the relevant issue to determine the fee.

Law firms that partner with their clients in ways that use technology to meet client needs through greater efficiencies can reduce clients' legal costs while maintaining or increasing the law firm revenue.

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