September 29th, 2008 by Jim Cotterman
Realization is one of the five factors that affect profitability. The others are utilization, pricing, margin and leverage. Unfortunately the five factors are interconnected so discussing one in isolation is a bit difficult. For example, I had a client who was thrilled with their 98% overall realization (percentage of the value of time recorded that is collected). Upon examination we discovered that their realization was so high because their pricing was significantly below market. Large accounting firms have often had realization figures in the low 80s due to routine discounts off of high retail rates. Another client had low realization but they were aggressive at time capture throwing every interaction with or thought about a client into the time and billing system. Another client did not have the proper leverage for the work being done. Accordingly higher level personnel were working on matters where the client expected a reduction to reflect that the work should have been done by less experienced (and less costly) individuals.
When we examine realization we like to assess the various components. Where does the slippage occur? Here are the components we look at and some of the questions we ask:
1. Timekeeper discounting at the timesheet: This is a hard item to measure because it is the un/under-reporting of time when the work is done. Sometimes an inexperienced individual may discount the time to research something believing that it took too long to complete the task. Other times sloppy time capture habits such as waiting until the end of the day (or worse) to write down time. This is a worthwhile issue to explore if utilization is low and the volume of work is sufficient to support higher productivity. The opposite of this is aggressive time recording as described above. Another factor, particularly in a firm where the work volume is not quite what it should be is a slow work pace to stretch the available work to meet recording expectations. All of these will affect realization later in the process.
2. Billing realization: What percentage of the time value recorded is lost at the time of billing? What policies are in place (and are they enforced) to limit discounts taken prior to billing? This also includes how discounts are taken. Some of the typical methods are specific identification, pro-rata reductions, and subordinates at full value with biller taking the adjustment. Our experience is that much of the lost realization occurs here. We have found that lawyers are often reluctant to bill for value the client would pay.
3. Collection realization: What percentage of the bill is actually collected? What adjustments are the clients demanding when they review the bill? The product of collection realization and billing realization is overall realization. The interplay between these two is worth considering along with the affect of clients if they see bills that are aggressive resulting in more oversight by the client.
4. Pricing variance: What portion of the realization represents discounting of the standard rate? Are pricing decisions clearly communicated to clients? Is there a mechanism to adjust rates (periodically or if material facts of the representation change)? Is your pricing risk adjusted? Does it consider the client’s payment history? You can measure this easily if you know realization at standard rates and realization at actual rates. The difference is due to pricing adjustments.
5. Efficiency variance: What portion of the realization represents adjustments for factors not including pricing. How are matters staffed and supervised? Does the firm have the proper staffing profile for the work it does? View the table which depicts realization for the legal profession in 2006. Data is presented for all firms and for the 25% most profitable law firms. Data will be different for different law firm size groupings as well as for different practice specialties.
6. Turnover of work-in progress (WIP or unbilled time): While somewhat different then pure realization, it is important to consider how quickly a firm turns its WIP. How many months of billings are sitting in inventory? Typically we see about 2.4 months with the most profitable firms at about 2.0 months. What provisions are their for retainers and advance billings? What percentage of the fees are determined on a contingency or end of matter or some other basis? Generally speaking the older the WIP the less billable it becomes and accordingly a loss of realization. As a reminder this will affect working capital needs as well as realization.
7. Turnover of accounts receivable (AR): How quickly do you get paid by the client? What policies are in place to follow up? Are there stop work thresholds (within the constraints imposed by legal ethics and responsibilities)? How many months of collections are sitting in AR? Typically we see about 2.2 months with the most profitable firms at about 2.0 months. Generally speaking the older the AR the less likely it will be collected. Consider this: a 500 lawyer law firm averaging $500,000 in revenue per lawyer would save approximately $12.5 million in working capital needs with a .6 month reduction in inventory (4.0 for a top firm instead of 4.6 for a typical firm).
This is not a comprehensive list of questions regarding realization, but it sets out the most common areas for review.