Combined, the work to invoice and invoice to payment cycles can represent three to eight months of cash flow for a law firm.  The median length of time is four months.  Some specialty firms can be much longer.  Law firm have over the past several years increased capital requirements and reduced their dependence on debt for financing.  This latest move by clients could add to capital needs even more.

The article also mentions how the companies are approaching this problem by bringing banks into the mix.  Essentially the bank buys the suppliers invoices at a discount and collects from the manufacturer.  There is a great graphic depicting this approach in the article.  While this may work well now, in measured amounts and with historically low interest rates; how it plays out when rates increase and the investment in these receivables grows is yet unknown.

Law firms can benefit from this insight.  I regularly request the application as part of merger due diligence to understand the firm’s practice as well as its known and anticipated claims.  As an overall picture of a firm’s business, is quite comprehensive.  Using that snapshot to evaluate and manage the associated risks (as the article suggests) is a tremendous opportunity. 

It is all fresh in your minds, so capture that knowledge now.  This does not need to be laborious.  Just a quick memo to the committee chair with bullet points and short narratives.  Capture both positive and negative aspects of this year’s efforts.  The Chair can organize this and determine how best to proceed.  The conclusion might be to continue as is, but I suggest there is always room to improve and ongoing incremental improvement should be integral to your operations.

The GAO goes further to point out that these new DB plans are sometimes sponsored to supplement an existing DC plan that has reached its statutory contribution limits.  Using a combination of plans can greatly enhance the ability to save for retirement.  The attractiveness of securing retirement savings on a tax deferred basis is significant with a GAO estimate of 18% improvement in after tax retirement income after 10 years and 40% after 20 years.

Unfortunately, even with significant tax advantages, the private plan participation remains stalled at roughly half of the private sector workforce.  Plan formation just barely surpassed plan terminations.  And this was prior to the recession.  Now un- and under-employment remain stubbornly high, with particular note to the growing problem of the long-term unemployed.  The consequences of all this on participation rates and asset accumulation are still largely unknown.

This article, Outsourcing Pioneer Brings Work Back To The U.S., in Law Technology News reminds us that not only is there no single correct answer, but that yesterday’s best approach may be replaced by a new, or even old, alternative tomorrow.   Some say first movers capture the bulk of any temporary advantage while late entrants capture very little.  This identifies an important trait of leadership — the ability to move quickly enough to seize on opportunity (even to change direction), yet simultaneously slow enough to be thoughtful and build consensus. 

1. Lateral candidates tend to promise more then they can deliver in terms of how much and how quickly their practice will move.  This is not an intentional overstatement as their firm is equally off at the other end on how much lost business will occur.  The clients have the final word on this matter and their response may not be what either the candidate or the firm anticipated.  Another factor (hopefully) is that candidates are inexperienced at picking up a practice and moving it.  If the partner is experienced at moving their practice that should tell you something as well!

2. Candidates may be making the change for reasons they do not fully understand (which could lead to post change remorse once it is all sorted out).

3. Firm’s due diligence is often lacking with little or no credentialing, insufficient analysis of candidate’s practice (see number 1 above) and insufficient evaluation of how good a fit this person is with group, office and firm overall (see partially number 2 above).

4. Each firm needs to have a really good handle on what it is paying its equivalently performing partners.  It is very bad for morale if current partners are paid less than the incoming laterals.  But how many times do we hear partners lament about this very situation?  And if this situation is a symptom of some problems with a current program, they are exacerbated when laterals are kept whole.

5. My personal observation is that firms will often pay very high in the market range, even above range, to seal the deal with a lateral partner.  But it is important to note that there is always someone who can and will outbid you.  Further, money does not buy loyalty — it can only arrange a short term rental.  Finally, once you set the initial compensation so high, where do you go from there and how do you recreate internal equity when the time comes to fully integrate the lateral into the firm’s program?

6. Smart candidates avoid having a target painted on their backs with a high signing bonus, high draw, high guarantee — they will look for assurance of “X” if they deliver “Y”, which is reasonable because they don’t have relationships in the firm or experience with the new firm’s particular politics.  They will be willing to share in risk and reward with the the rest of the partners to some extent and will look for a fair draw.  There is a real need to strike the right balance between comfort for the new person and full integration into the firm’s program.  Some may consider this next comment a bit unusual, but I recommend laterals have an active mentor — maybe the partner who sponsored their candidacy — to improve the integration and to catch/head off the difficulties that will invariably arise.

7. The above comment leads me to this next thought that there is really very little effort to integrate partners into the group, office or firm overall once they arrive (or at least after the initial honeymoon period).  Moreover, since they are not well plugged in they find themselves having to market internally nearly as hard as they have to externally.

For those of you who are precision minded it is possible to devise a cost accounting system so detailed as to take any activity and assign it to multiple cost centers — each of the aforementioned sub-groups.  The account numbering schematic for such a system would be quite complex as would the coding and verification tasks.  We will forgo the obvious political challenges involved in selling such a system.  So while such precision is a possibility, it is largely not a practical approach.

Simplification is preferable, although not altogether without its potential political challenges.  And there are some, probably acceptable, higher risks for analysis error.  But let’s use simplification at its best for this posting and reserve a more in-depth discussion for an upcoming article.  We will use the following assumptions:

1.  A single office law firm partnership with a collection of practices that are reasonably similar in their economic models.

2.  Partners and associates use/share resources (offices, secretaries, technology and the like) without any significant distinction from group to group.  This means that office sizes are very similar, secretarial sharing is equal across groups and that all timekeepers use a similar technology package.

3.  Paralegal use/sharing of resources is about one-half that of lawyers.  Thus each lawyer will be counted as one fee-earner and each paralegal will be counted as a one-half fee-earner.  This convention is commonly found in most economic surveys of the profession.

4.  Expenses include the net affect of cost advances and recoveries on the behalf of clients.

5.  Compensation deductions from total expenses for determining firm overhead define compensation as salary, bonus, benefits and associated payroll taxes.

Accordingly we can take the total expenses of the law firm and subtract the compensation costs of the associates and paralegals.  The remaining expenses represent the overhead of the firm. .Divide this remainder by the total full-time-equivalent (FTE) fee-earners to determine the overhead per fee-earner.

Once overhead is sorted out, we can turn to compensation.  Here there are three assumptions for our posting.

1.  We are looking for internal hourly rates for each group of individuals — partners, associates and paralegals — so average compensation for each group is used.

2.  Compensation for development of internal hourly rates includes only salary, benefits and the associated payroll taxes.  Including bonuses (with their associated benefit and payroll tax costs) is an option depending on your firm’s particular philosophy on bonuses.

3.  A partner’s compensation consists of a fair exchange for his/her labor (the portion we need) and the profits earned on the work done by others.  There may also be a return on capital component depending on whether interest is paid on partner capital or not.  Again, for simplification, we will use the partners’ draw as a proxy for the fair exchange portion we are interested in for our purposes. There are other proxies that could be substituted, such as extending the lock-step associate pay scale into the partner ranks or using an outside reference point such as a senior in-house lawyer.

So we now have the total average cost of the group to include allocated overhead and compensation before bonuses.  Divide the total average cost by the expected billable hours to obtain a preliminary internal hourly rate.  Divide that rate by the expected realization factor for the group to obtain a required internal hourly rate.  Attached is a sample calculation.

In the past, rate increases alone were sufficient to largely fund increased compensation levels.  Absent rate increases, lawyers will need to work harder (more billable hours), work more efficiently (better realization), and discount less (also better realization) to fund equivalent pay hikes.  How likely are each of these? 

Peak billable hours for lawyers occur during the 6th or 7th year of practice and exhibit a steady decline for the remainder of their careers (rate increases largely fuel the ever rising revenue curve of a lawyer over a career).  Add an aging lawyer population and the increased effort required to develop business to that hours profile and working harder is unlikely.  It is also unlikely that associates can sustain a much more aggressive work routine.  Many would argue that the job already has extreme hour expectations at all levels.  And there needs to be sufficient additional work to absorb the additional billable hours.

Improving practice skills and methods is an ongoing process.  Legal project management and more aggressive use of technology will aid in this area.  Some experts have postulated that 15% greater efficiency is achievable.  If you charge on an hourly basis this benefit inures to the client, unless you can raise rates.  Alternative fees may offer the provider some means to retain some of that benefit without an obvious rate increase. Otherwise the full revenue loss from efficiency gains must come from more work volume.

How about fewer discounts?  An argument can be made that increased efficiency should allow the provider to hold the line on discounts.  But this is a market populated with aggressive clients eager to negotiate discounted rates.

To increase compensation, revenue must increase or costs must decrease. Revenue increases are going to be harder to obtain when the primary driver — rate increases — is constrained, and the remaining drivers are significantly more difficult to improve.  My bet is on improved efficiency, greater use of AFAs and restructuring.

Cost reductions are also going to be harder to realize.  During the recession firms cut everywhere they could.  Much of what’s left to exploit will likely primarily benefit clients — the outsourcing of certain legal services.

The forecast for increased per timekeeper revenues is probably the bleakest it has been in some time.  The easy adjustments have been made.  In this environment, compensation expectations need to be equally muted.  And the job of making compensation decisions will be equally more challenging.  Or as one partner told me, “Playing Vegas is easier then making some of these decisions.”