The profit metric that tells how efficiently work done at standard rates is converted into cash. It does not tell you how fast this happens, just the amount of slippage that occurs from end to end. There are key intermediate steps that are measured such as billing realization (converting time value into bills) and collection realization (converting bills into cash) and a number of variances (see below) critical to isolating and confronting slippage.
But first a bit of history and why it is now getting so much attention. Realization has been dropping since the mid 1980s — a long, gradual and persistent deterioration. But until the recent recession, rates were going up much faster; yielding a collected rate increase well in excess of inflation. Strip away the historic ability to increase rates and the realization slippage is uncovered for all to see. To confront this problem, examine realization where the slippage occurs. There are four general areas where losses occur that must be understood and managed.
1. Timesheet discounts — those adjustments individuals make to the time they record when they believe something took longer than it should. This is one area that does not show in the financial system realization numbers because it is not captured. It prevents firms from identifying budgeting issues and training needs.
2. Pricing discounts — the difference between standard and actual rates. Both the frequency of use and level of discount have been increasing and accordingly realization suffers.
3. Efficiency adjustments — those adjustments to the value of time recorded at actual rates before billing. These are done by the billing partner. They may be targeted or prorated across the timekeepers on the matter in proportion to their recorded time value.
4. Value adjustments — those adjustments made by clients when they perceive that the bill does not reflect fair value for the agreed to budget for services, the services rendered, and/or the outcomes achieved.
Each of these areas require separate tactics to tackle the associated realization decline. Terms like pricing variances, efficiency variances, value variances should accompany any discussion around realization. The realization journey begins with client acceptance and continues on to matter engagement, work planning, staffing, project management, billing and collections. Thus, firms should examine their policies about client selection, engagement letters, pricing/retainers, staffing, practice management, billing adjustments, AR write-offs and collection efforts. Those policies should be administered through the practice leaders who should hold individual partners accountable.
Also consider how the firm strategically positions itself with respect to pricing. Does it set high standard rates with an expectation of using discounts to satisfy financial and/or procurement departments in client organizations. Just look at the medical and accounting professions where these models have been in place for many years. Historically the legal profession did not adopt this pricing model, thus it has strived for high realization and little, if any, discounting. Clients are now more aggressive at pursuing pricing discounts, without the law firms having a pricing model with sufficient margin to easily accommodate them.
Realization issues also tend to concentrate among individuals, practices, offices and clients that are struggling — underperforming. It is important to look for outliers across these segments. Firms should manage their way through these issues by identifying the problem and taking corrective action. In the current market where there remains an imbalance between supply and demand for legal services, that corrective action is more likely going to be to shed the problem.
It is not fixable by changing status or compensation, which unfortunately, is what is attempted all too often.
So, if you are going to the Managing Partner or Executive Committee to talk about low realization; be prepared to talk about what kind(s) of variance(s) exist, where and who is the problem, and the targeted options to correct or shed it.