The True Cost of Hiring - and Terminating - a Lawyer

02/01/2013
Published in "The Bottom Line" February, 2013

As ongoing economic hard times make law firms look hard at their revenue and cost structure, it is apparent that the most critical cost factor for client service is staffing levels. Before the Great Recession began, most firms believed that the simplest staffing arrangement, a direct hire of an associate when needed, was best. However, this is only a feasible option if the overall business health of the firm supports it. There will be expenses incurred beyond the salary and benefits of the new lawyer, from additional liability insurance costs to overhead for staff and equipment. There is also the practical issue of whether the firm's office space can accommodate a new body.

"All associates can determine their own personal balance sheet if they plug in the right numbers."

The issues here relate directly to leverage – hiring and using associates as a cost-effective way to do billable work while boosting partner profitability. In the past, law firms with lagging profitability turned to associates to do more of the work, which instantly adjusts the staffing leverage. However, leverage is only effective when associates are effective and it is profitable for the firm to keep using them. While associates may not earn more than they cost the firm at the start of their careers, at some point that situation must change. The economics of hiring new law school graduates can no longer be taken for granted, given the time and expense of the process required to get them up to practice speed.

Recruiting Costs and Breakeven

The recruiting of new lawyers is a special cost situation, because the firm's current lawyers often are directly involved in the process. Consider this hypothetical example. New lawyer "A" is earning $160,000 and was hired via an "executive search" firm whose fee is 25% of the first year's compensation package, or in this case $40,000. Assume further that the firm is somewhat progressive and does have an education program which helps the lawyer new to the firm assimilate into the firm culture; in this case, the training time is 100 hours for the associate at the billable rate of $200 per hour, or $20,000. Don't forget the cost of the partners doing the training: 100 hours at their rate of $500 per hour, or $50,000. Assume still further that there was time spent by partners in the recruiting process and interviewing this lawyer to the tune of 50 hours at their billable rate of $500 per hour, or an additional $25,000 in costs.

Without considering additional items of reduced productivity in the beginning, when the lawyer new to the firm first gets started, and the cost to the firm of disruption, retraining and client concern/nervousness when another lawyer is assigned to his matter in the "middle of the stream," to the firm during the first year of employment the cost is already $295,000. This is hugely expensive. It is for this reason that the hiring dynamic is particularly expensive. Associates must earn more than they cost the firm, yet large-firm managing partners typically figure that it takes, on average, from three to five years to break even on the investment in a new lawyer.

Retention Costs and Profitability

What should firms expect from newly hired lawyers to justify keeping them? The fundamental question in this regard is obvious: is there enough work? In analyzing an associate's worth to the firm there is no formulaic expression that specifically depends on origination, billing or collection. To say that an attorney is worth the amount of profit due to billing or the amount of profit due to business brought in does not take into account the subjective factors that should be considered. For example, does the lawyer's combination of skill and attitude demonstrate potential for career growth beyond the immediate level of business? And skills mean both knowledge of the law and the ability to understand "The Business of Law"®.

This latter point leads to analysis of the associate's profitability, which is something different from worth to the firm. All associates can determine their own personal balance sheet if they plug in the right numbers. This is what they need to know:

  • Their total billable hours by month.

  • How many hours the firm billed out for them.

  • The percentage of write-offs the firm will take on their work when billings are done. In larger firms there may be a difference in the write-down percentage based on associate class (first year, second year, etc.).

  • Their direct compensation expense – salary, bonus, pension, allowances.

  • The indirect expenses they represent – overhead for physical space, insurance, education and more; if the firm lacks an accountant to provide this information, a general rule of thumb to use is one-third of gross revenue or billings.

With this information associates can compute the net profit that they provide to the firm: Billings - [Associate's Total Compensation + Direct and Indirect Expenses] = Net Profit. The net is the profit available resulting from an associate's effort. Generally within three to four years of hiring, associates should become net profit contributors. 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 essential for an associate to grow a career at a given firm.

But what type of career will that be, in terms of the financial benefit that both the associate and the firm get from it? Not every player on an athletic team is expected to be a star; should every lawyer in a law firm expected to be a rainmaker? The question arises because not every associate who does good work can develop new work. If the associate is doing good work, if the law firm understands, sets and monitors the metrics (whether by number of hours, matters or revenue) the associates need to reach, and if the associate reaches the metrics... and both sides accept the compensation being paid to the associate for this effort... then what is the problem? The associate is satisfied with the compensation, the law firm is getting quality work performed at a profit to the firm, and the clients are being well served. What's wrong with this picture?

The problem, of course, is the law firm model itself, which sees such lawyers as "clogging up the middle." They are good lawyers, but not great rainmakers. They were originally brought into the firm to provide leverage, doing work at much lower cost than the partners who billed out that work at the higher cost partner rate. The associates remain, their compensation rises, then after the eighth or ninth year, they are either invited to join the partnership, or are asked to find employment elsewhere. Today they often are let go even before the partnership decision time.

Termination Costs and Investment

The decision to terminate an associate, however, involves an entirely new dimension of the cost equation – termination costs. Firms sometimes are tempted to terminate associates that they presumably had good reason to hire in the first place, but subsequently decide they can't afford. That not only is costly due to the lost investment in people, it creates cost in two other ways. First, those terminated can file wrongful termination lawsuits that allege various forms of discrimination. If the plaintiffs are members of protected age, race and sex classes covered by antidiscrimination laws, they may have a valid case. And second, termination undermines the loyalty of the remaining associates, making them more inclined to bolt at the first reasonable opportunity – which again means the firm loses out on its investment in these lawyers.

The fact remains that most firms are unable to determine the cost of termination. They don't measure these costs (and if they do they tend to underestimate them); and, in any case, think the costs are unavoidable. However, most firms that approached the matter seriously would find they have many more measurable metrics than they care to admit. These include:

  • Hiring costs (recruiting and interviewing).

  • Training costs (orientation and training, plus the cost of compensation, benefits, and lost productivity while the new person is trained).

  • Client service costs (client dissatisfaction, reduced or lost business due to increased workload, lost productivity, stress and additional workload until a replacement is hired).

  • Direct termination costs (exit interviews, severance, and other administrative costs).

All of the foregoing illustrates that ultimately, the cost represented by people – the investment in finding and hiring them, and the loss of that investment when persons leave or are terminated – is the largest and least understood expense at any law firm of any size. The issue is not whether the costs of hiring and turnover are too great; it's that firms don't know what those costs are, have no idea what goes into them and how to calculate them, and cannot calculate the bottom line impact. Each firm's experience likely is different, but these specifics are not enough to prevent a realistic look at the costs embodied in a law firm's people.

Hiring, Termination and Realism

"Ultimately, the cost represented by people – the investment in finding and hiring them, and the loss of that investment when persons leave or are terminated – is the largest and least understood expense at any law firm of any size."

"Retain and gain" is the motto that makes most sense. One source has suggested that a 10% reduction in turnover is more valuable, more profitable, than a 10% increase in revenue or a 10% increase in efficiency/productivity. The most effective way to increase profits is to hire the right person and provide extensive education for that person to improve their skills, and then purchase the technology that will enable them to do what they need to do more efficiently. That is the course to sound, profitable growth for the firm, and for the lawyers it hires.

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