What does it Profit the Firm?

How Associates Fit in the Profitability Mix
By Edward Poll
Reprinted from the January/February 2002 issue of Legal Management, published by the Association of Legal Administrators.

"We face challenging times."
"Competition has never been tougher."
"Change has never occured at a faster pace."

These are cliched comments we've heard a thousand times. But firm managers know how true they are. Administrators are the first to witness challenges and changes in the firm.

Another truism is that professional employees can retain their jobs only so long as they are providing value to the employer. Here's how employees add value in law firms:

  1. They make money for the firm by billing more than it costs to be retained.

  2. They complete some task that the employer wants performed, does not want to do him/herself, and/or is willing to pay for it without regard to the cost/benefit analysis.

Because point No. 2 is not generally sufficient reason for getting employment - and certainly not for guaranteeing it in the long-term - let's skip it and concentrate on the main objective of every professional service employee: to do good work in a way that produces net profits for the employer. In dealing with employers, only prof-itable employees will keep their jobs.

How Does This Apply to the Legal Profession?

In the boom of the 1990s, many associates developed an "entitlement mentality" They believed that a solid education, graduation from a good law school near the top of their class, and passing the jurisdiction's Bar exam entitled them to a job at a major law firm with a high compensation package. Many firms - especially on the U.S. coasts - fed that expectation by offering first years salaries nearing $150,000.

Managers in major law firms, however, are on the other side of the bar-gaining table. They are upset with lawyers having an entitlement mentality. And this mentality may be changing, considering the impact of recent events and the economic changes in law firms' finances. Many new lawyers are becoming more serious about their employment and "checking" their entitlement mentality at the door.

Managers realize that with the new economic reality profitability for those new associates is more important than ever. They are unsure about how to achieve the greatest production from the new associates for the money being invested. On top of that, law firms are also feeling the pressure from clients to give more value for the charges for legal services delivered - with no price increases. In other words, law firm management is being squeezed from both ends.

All told, law firms - even the large ones - must provide value to their clients. And they must be profitable in order to open their doors the following day. While the new, high-priced associates may not earn more than they cost the firm in the beginning, at some point that situation must change. In fact, large-firm managing partners agree that it takes, on average, from three to five years to break-even on the investment in a new lawyer.

These become the central challenges for law firm managers: How quickly can they educate their new lawyers about die culture of the law firm? The expectations of the firm's clients? The technical skills of lawyeringthat they didn't receive in law school? The firms that put education among their top three goals will ensure their long-term future and success.

When I was a new associate with a law firm, and having come from the business world, I knew, and believed in, the philosophy that every employee must be a profit center for the employer in order to keep the job. And I did want to keep my job. I liked the people, and I was eager to learn as much as I could about the practice. This was a good firm, and it was a good opportunity for me. That's why I kept track of my own "profit and loss" ("P & L") in order to be assured that, assuming a rational employer and no personality conflicts, this law firm would want to keep me on. When the management realized that I was concerned about their well being first and my advancement in the firm second, I was soon invited to become a partner - a dream come true.

Making Associates Think Like Businesspeople

Educate your associates in the business of law. Challenge them to think like businesspeople - not just lawyers:

  • What does your financial formula look like?
  • How can you determine your own "P& L" in order to place yourself in the best possible position with your firm?

To create their own P & L, associates will need to plug in the right numbers. They will first need to know their total billable hours. How many hours did each associate record for the month? This data should be easily within their grasp, but the next piece may not be: They may have to ask someone in the firm's management or staff how many hours the firm billed out for them? In other words, was there a markdown or write-off for some of the work? Did the firm consider some of the associate's work as a part of its investment in your learning curve?

Alternatively, associates may have to estimate the percentage of write-offs the firm will take on their work. This figure can be determined by asking one or more of the firm's management team what percentage, on average, does the firm write down associates' work product when it prepares its billings. Young lawyers might even be more specific by asking if there is a difference in the write-down percentage based on the "class" of the associate (first year, second year, etc.). Then, based on seniority with the firm, they can use that percentage for estimating purposes.

Now comes the harder part. Associates need to find out the other side of the equation, which means the expenses that are attributable to them. These include many factors -you'll need to educate your associates about them:

  • the cost of the compensation pack-age (gross salary, profit-sharing/pension plan contributions, car allowance, etc.);
  • the cost of a secretary;
  • the cost of the physical space they occupy, and
  • other expenses that can be called "direct expenses."

In addition, estimate the amount of office overhead, by percentage, that each associate accounts for. Overhead includes rent, insurance, utilities, entertainment and education. (In earlier days, you could simply use a figure of one-third of gross revenue, or in an individual associate's case, his or her billings. But, for many firms, the cost of overhead has increased considerably. Thus, today, it is easier to simply ask someone in the accounting department for the firm's overhead percentage and use that figure.)

Armed with the above information, you and your associates can now come up with a personal, financial formula that would look like this:

Billings - [Associate's Total Compensation + Direct and Indirect Expenses] = Net Profit

The net is the profit available resulting from an associate's effort. This is the bottom line in determining young lawyers' value to the firm. When analyzing the value of a partner to a firm, management will frequently talk about "realization." Realization focuses on "collect-ed" billings, not just billings. I have said nothing about collections in this discussion. Normally, an associate will not have any power to deal with a client directly to collect billings. Since the firm generally selects the client, it should be its responsibility to collect the fees.

The associate's responsibility is to do the work assigned in the most effective and efficient way possible and in the shortest amount of time. Fulfilling this responsibility in a way that produces net profits for the firm is a near-guarantee to keeping an associate's job. And, it will prepare the firm for the business challenges of the future.

Administrators and managers who realize the important contributions associates make to the bottom line will ensure their own success.

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