Archive for the ‘Economics’ Category

Some thoughts on lateral hires

May 9th, 2011 by Jim Cotterman

I was asked recently about lateral hires and compensation practices.  My response, which goes beyond compensation, follows.  If the firms don’t do these other things well it matters very little about the compensation.  And even if the compensation is well done, the other things here are critically important for the hire to be successful.

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.


April 6th, 2011 by Jim Cotterman

Understanding how to use sampling as an efficient technique to draw conclusions about a large population of data is an important research tool.  It also has application to e-discovery as discussed in three blog posts by Doug Austin.  The first, sets out a framework for a defensible search process.  The second, discusses how to determine an appropriate sample size, and links to a easy-to-use tool to accomplish the math portion.  The third discusses how to obtain a random selection for the sample and again provides another link to a simple tool to accomplish the task.

Calculating internal hourly rates

March 22nd, 2011 by Jim Cotterman

Law firms have an increased interest in understanding internal rates as AFAs (alternative fee arrangements) take hold with clients.  Understanding costs at a firm level is easy once you sort through the differences between cash and accrual accounting.  The hard part is allocating costs to various sub-groups within the firm — such as individuals, classes or groups of individuals, matters, clients, offices and practice groups. 

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.

Timekeeping is still important

January 4th, 2011 by Jim Cotterman

Some have suggested that good timekeeping habits are well established in a profession, 1) schooled for nearly four decades in the basics of fiscal hygiene, 2) and well assisted by sophisticated and mobile technology.  Yet in this announcement we are reminded again, that constantly working on the fundamentals is as important in law as it is in sports.

Slower billing rate increases may limit compensation adjustments

December 10th, 2010 by Jim Cotterman

The 2010 NLJ Billing Rate Survey results indicate a 2.7% increase over 2009.  This is a significant departure from pre-recession increases.  But it is roughly consistent with inflation, which may offer some measure of solace.

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.”

AFA voided after successful conclusion of matter

November 29th, 2010 by Jim Cotterman

Is Your Alternative Fee Agreement Against The Law?

This is a situation that illustrates the care required when firms venture into new fee areas.  It also suggests the importance of knowing your client before agreeing to representation.

Mandatory retirement is back on management’s agenda

October 14th, 2010 by Jim Cotterman

Retirement, succession and transition are getting more attention in law firms again. And mandatory retirement provisions are one of the central topics at many firms.  Hopefully this is a good sign that firms feel reasonably confident about their economics to turn to other important issues.

Our last research on these issues were a 2007 flash survey and the 2008 Retirement and Withdrawal Survey (which is now owned by ALM Legal Intelligence).  The 2007 flash survey indicated that while 50% of participants had mandatory retirement provisions, only 38% agreed with enforcing those provisions.  The 2008 survey looked at, among many retirement topics, succession readiness.  Interestingly nearly half of those firms indicated that they had not done any succession planning and did not consider it an issue.
We believe that the profession will move away from mandatory retirement.  Three factors support this conclusion.
1.  Profession expectations:  The 2007 New York State Bar Association (April) and American Bar Association (August) statements strongly urged its members to abandon mandatory retirement.
2.  Regulatory enforcement:  The October 2007 US EEOC consent decree with Sidley Austin on an age discrimination claim the EEOC filed on behalf of 32 former partners establishes the EEOC’s interest and willingness to apply employment law provisions to partners in law firms.
3.  Competitive pressures:  Partners approaching mandatory retirement age, who wish to continue their practice and have a sufficient client following, are going to seek those firms where they are welcomed.  Admittedly this will require more robust partner evaluations to ensure that partners meet reasonable professional and performance expectations.  But those challenges can be met.
The profession will need to carefully consider its senior partners in terms of their best roles in the firm, community and clients.  Some of the value these practitioners contribute will require changes in what is compensated and how to seamlessly integrate this into the expectations of younger partners and firm culture.

Why is unemployment important?

September 22nd, 2010 by Jim Cotterman

One role of a CFO or Executive Director is to sense where the general economy is heading and how that will affect the law firm.  Lawyers can render better advice to their clients when they understand the clients’ business and how economic metrics affect it.  One important economic metric to understand is unemployment.

Unemployment is important because it is a proxy for labor market health.  Economic activity comes from consumer, business and government spending.  Businesses require buying customers and governments require a tax base.  The customers/taxpayers need jobs to do their part.  Unemployed workers do not have discretionary income to spend, do not contribute tax revenues and increase government subsidy expenditures.

BLS publishes six measures of unemployment.  U-1 is the most narrow definition.  U-3 is the standard definition widely published and discussed in the media.  U-6 is the broadest and the most important BLS definition in my view.  See Table A-15 for this data.  Another measure, presented by Shadow Stats, yields an even more accurate indication of the economic stress of the labor force.  This measure of unemployment adds the long-term discouraged workers to the BLS U-6 definition.

Another data point to understand unemployment comes from Calculated Risk.  If this chart is predictive, then we have a rather long haul before we climb out of the job loss hole we find ourselves in.  Also note that the preceding three recessions were the three longest to recover lost jobs and that each was successively longer.

Financial metrics - look behind the numbers

August 16th, 2010 by Jim Cotterman

Howard Schilit’s article, Financial Metric Shenanigans, in the August issue of the AAII newsletter (membership required to view article) provides solid advice on metrics that cover three key business reporting measures — revenue, earnings and cash flow.  The article reminds us how important it is to verify what management reports (including consistency in definitions of terms) and to be alert to what management does not report.  The article sent me looking for more and I found his book on the same topic.  The article and book are useful to anyone reviewing a business’s financial reports.

What Should We Measure, Part 2

July 26th, 2010 by Jim Cotterman

As a follow-up to my previous post, What Should We Measure?, I thought three slightly different perspectives would be quite useful. 

First, Ron Baker’s post at VeriSage discusses Key Predictive Indicators (KPIs) for professional knowledge firms.  It is based, in part, on another executive’s turnaround success leveraging and relentlessly focusing on three key success measures for his company — measures that are important to the customer!

Second, Fred Reichheld’s book, The Ultimate Question, suggests tracking a Net Promoter Score or NPS to understand best how your customers relate to your organization.  It is based on his research and expertise in the area of customer loyalty and economic results at Bain and Company.  It focuses on accountability for building customer relationships.

And finally there is the Hedgehog Concept in Jim Collin’s book, Good to Great.  The intersection of three key “circles” (what can you be the best at; what drives your economics; and, what are you passionate about).  Most important to this discussion is the second item - what drives your economics — “the single ratio that has the greatest and most sustainable impact on your economic engine”.

In each of these three perspectives, the focus is narrow.  Not one suggested a robust roster of metrics.  Technology has given us a means to measure, relate and track just about any activity we care about.  Finding the short list of truly important metrics is not as easy, but can lead to greater progress.