As law firms continue to embrace profitability reporting, the core competence of law firm partners will improve, and better decision-making will occur. This informative presentation will cover the following: - The most reliable methods for computing client profitability - The more common methods for allocating direct and indirect costs - The various uses of client profitability data in compensation, client pricing, overhead control, recruiting and other significant functions of the firm. -The pitfalls to avoid and methods to overcome partner fears about calculating client profitability for the first time.

1. Performlaw.com
CALCULATING
CLIENT
PROFITABILITY
Analysis to Action
Presented By: Brian Kennel

2. Client Profitability
Perform Law
Session Topics
• Reliable methods for computing client profitability
• Client profitability data and client pricing, AFA’s workload distribution
and overhead control
• Opportunities, pitfalls and first time considerations
• Client profitability data and compensation
• Advantages of using client profitability models in lateral recruiting and
merger analysis

3. Client Profitability
Perform Law
Methodology
• The
repor(ng
result
(samples
to
follow)
:
• Detail
client
net
income
report
–
Originator
Sort
• Client
net
income
report
–
(mekeeper
sort
• Timekeeper
profitability
report
• Summary
Net
Income
Reports
–
Client
Level

4. Client Profitability
Perform Law
Uses of Client Profitability Data
• Client
pricing
(Rates
other
pricing);
• hGp://performlaw.com/strategically-­‐seKng-­‐billing-­‐rates/
• Client
staffing
efficiency;
• Overhead
efficiency;
• Rate
increase
alterna(ves;
and
• Compensa(on

5. Client Profitability
Perform Law
How is it calculated?
• Data
needed
from
(me
and
billing
system
• Fees
billed
by
working
aGorney
(WA)
by
client
or
maGer*
• Hours
billed
by
WA
by
client
or
maGer
• Origina(on
credit
by
client
or
maGer
• AR
write
off
by
client
or
maGer
• Fees
billed
and
received
by
(mekeeper
*
If
running
at
the
maGer
level

6. Client Profitability
Perform Law
How is it calculated?
• Other
data
needed
• Payroll
and
benefit
history
for
the
period
• Secretarial
or
direct
support
payroll
• Income
statement
-­‐
direct
and
indirect
alloca(ons
• Employee
starts
and
terms
during
the
period
• Alloca(on
policy
defining
specific
and
general
alloca(ons

7. Client Profitability
Perform Law
How is it calculated?
• Scaling
Concerns
(es(mates
based
on
a
sample
set
of
2):
Data
Table
Es8mates
(#Records)
*
Number
of
Lawyers
50
100
200
300
500
Client
Level
1,667
3,333
6,667
10,000
16,667
MaRer
Level
10,000
20,000
40,000
60,000
100,000
Factor
6
6
6
6
6
*Actual number of records may vary widely by firm and pracIce type

8. Client Profitability
Perform Law
How is it calculated?
• Financial
system
profitability
module
• S(ll
have
to
perform
most
of
the
cost
calcula(ons
and
load
• May
need
enhanced
repor(ng
• Should
try
first
• Other
op(on
is
to
use
a
3rd
party
module
• Create
an
in
house
u(lity

9. Client Profitability
Perform Law
How is it calculated?
• Direct
costs
• Timekeeper
salaries
and
benefits
• Billable
hour
versus
standard
hour
divisor
• Easy
to
iden(fy

10. Client Profitability
Perform Law
How is it calculated?
• Specifically
allocated
overhead
• Some(mes
also
referred
to
as
direct
costs
• Secretarial
and
clerical
support
salaries
and
benefits
• Business
development
costs
• IT
Costs*
*
As
per
seat
cos(ng
con(nues
to
become
more
prevalent,
IT
costs
may
be
direct.

11. Client Profitability
Perform Law
How is it calculated?
• Generally
allocated
overhead
• Facility
costs;
• Equipment
and
prac(ce
aids
• Prac(ce
development*;
and
• General
and
administra(ve
costs.
• Sample
chart
of
accounts
*
As
men(oned
previously,
some
of
this
is
being
specifically
allocated.

12. Client Profitability
Perform Law
How is it calculated?
• Overhead
applica(on
• Graduated
level
of
overhead
absorp(on
recommended
• Example:
• Equity
Partner
–
full
share
• Non
Equity
Partner
-­‐
.75
share
• Associates
-­‐
.50
share
• Paralegals
-­‐
.25
share

13. Client Profitability
Perform Law
Why I recommend a graduated level
of overhead absorpIon

14. Client Profitability
Perform Law
How is it calculated?
Expense
Common
Range
Direct
Indirect
Payroll
and
Related
44%
40%
4%
Facili(es
6%
6%
Equipment
Prac7ce
Aids
4%
2%
2%
Prac(ce
Development
3%
3%
General
and
Administra7ve
3%
3%
Total
60%
45%
15%
Percent
Total
75%
25%
AllocaIng indirect: 70-­‐75% is normally direct with 25-­‐30% indirect

15. Client Profitability
Perform Law
How is it calculated?
• Graduated
overhead
absorp(on
• Allow
younger
lawyers
(me
to
build
value
resul(ng
in
higher
billed
rates;
• Remove
disincen(ves
to
use
associates
for
fear
of
high
overhead
rates;
• Paralegals
and
associates
don’t
really
need
or
use
as
much
overhead
as
a
partner;
and
• Waste
and
inefficiency
defaults
to
the
partners

16. Client Profitability
Perform Law
How is it calculated?
• Billable
Hours
or
Billed
Hours
for
overhead
applica(on
• Billable
hours
as
the
denominator
• Timing
differences
• Overhead
is
applied
hourly
as
it
is
billed
• Compu(ng
client
profitability
on
a
billed
basis
• AR
and
Allowance
reserve
to
reconcile
to
cash

17. Cost
types
Amounts
Total
expenses
9,000,000
Less
direct
(mekeeper
costs
(4,500,000)
Sub-­‐total
direct
4,500.000
Less
specifically
allocated
overhead
(1,400,000)
Generally
overhead
for
alloca7on
3,100,000
• Overhead
alloca(on
report
• Hourly
overhead
report
• Secretarial
alloca(on
Report
Recap of overhead allocaIon
17

18. Client Profitability
Perform Law
Strategic ConsideraIons
• Gross
Margin
• Gross
margin
is
the
amount
remaining
aeer
accoun(ng
for
direct
costs.
• Nega(ve
gross
margins
• Par(al
contribu(ons
to
overhead
and
no
contribu(on
to
profit

19. Client Profitability
Perform Law
Strategic ConsideraIons
• Gross
Margin
Con(nued
• Examples
of
marginal
cost
thinking
• Start-­‐up
branch
office,
new
prac(ce
area
• AGrac(ng
work
from
certain
clients
• Firm
growth
• Short
term
and
long
term

20. Client Profitability
Perform Law
Strategic ConsideraIons
All
(mekeepers
ul(mately
need
to
cover
direct
costs,
absorb
overhead
and
contribute
to
profits,
but
there
are
strategic
components
to
a
(mekeepers
contribu(on
at
a
given
(me.

21. Client Profitability
Perform Law
InterpreIng Results and AcIon Steps
• Net
Profit
• Ability
to
cover
all
direct
costs
and
overhead
• Acceptable
profit
margins
• Client
ranking
tools
• percent
profit,
• actual
profit
dollars
contributed,
• gross
fees
generated
and
• overhead
absorbed

22. Client Profitability
Perform Law
InterpreIng Results and AcIon Steps
• Net
Profit
Con(nued
• Analyzing
a
high-­‐volume
but
underperforming
account
• Efficiency
of
the
staffing
mix
• Compe((veness
of
the
firm’s
overhead
structure
• Realiza(on
performance
and
indicated
quality
issues
• Billing
rate
increases

23. Client Profitability
Perform Law
RecommendaIons
• U(lize
client
profitability
data,
rates,
staffing
mix,
costs
per
hour
and
overhead
structure
to
expand
the
op(ons
a
firm
has
for
improving
profits.
• Singular
strategies
are
not
op(mal

24. Client Profitability
Perform Law
Uses of Client Profitability Data
• Client
pricing
(Rates
other
pricing);
• hGp://performlaw.com/strategically-­‐seKng-­‐billing-­‐rates/
• Client
staffing
efficiency;
• Overhead
efficiency;
• Rate
increase
alterna(ves;
and
• Compensa(on

25. Client Profitability
Perform Law
Client Profitability Data and Pricing
• When
pricing
client
work,
firms
should
consider
the
following
:
• Exis(ng
posi(on
in
the
client’s
buying
strategy?
• Exis(ng
and
foreseeable
market
factors?
• Efficiency
of
client
account
staffing?
• Efficiency
of
overhead;
• Intangibles
including
fixed
cost
absorp(on
,
training
opportuni(es
etc.;
and
• Opportunity
costs

26. Client Profitability
Perform Law
Client Profitability Data and Pricing
• Alterna(ve
pricing
approaches
• Blended
rate
• Price
at
fixed
point
(median,
low,
high
etc.)
• Data
needed
• Analysis

27. Client Profitability
Perform Law
Client Profitability in CompensaIon
• A
management
tool
• Origina(on
spliKng
policy
• Methodology
for
equa(ng
client
net
income
to
compensa(on
• Mechanics
li(gated
–
LOL
• Powerful
mo(vator
Nobody likes
losing money
on clients or timekeepers

28. Client Profitability
Perform Law
How is it calculated?
• Before
we
start,
a
note
about
originators
and
support
partners
• Origina(on
polices
• Support
partner
origina(ons
• Recommenda(ons
• Origina(on
credit
• Produc(on
bonuses

29. Client Profitability
Perform Law
Client Profitability & CompensaIon
• How
should
we
think
about
compensa(on?
• Market
for
compensa(ng
aGorneys
is
mature
• Run
compensa(on
results
/
market
payout
• Which
system
gives
us
the
best
chance
at
a
right
result?
• Objec(ve
with
a
subjec(ve
component
• Pure
objec(ve
• Pure
subjec(ve

30. Client Profitability
Perform Law
Client Profitability & CompensaIon
• Distribu(ng
income
using
objec(ve
and
subjec(ve
components
• Sample
income
alloca(on
• 90%
objec(ve
based
on
2
year
rolling
average
client
net
by
OA
• 10%
subjec(ve
component
• Managing
partner
compensa(on
fixed
at
$75,000
• Model
scales
to
any
size

31. Client Profitability
Perform Law
Client Profitability & CompensaIon
GeVng Started
• Fears
&
Resistance
• Truth
in
the
numbers
• Compensa(on
changes
• Moving
from
subjec(ve
to
objec(ve

32. Client Profitability
Perform Law
• Challenges
• Data
and
resources
not
always
available
• Financial
systems
not
fully
implemented
• Analysis
usually
sought
in
hard
(mes
Client Profitability & CompensaIon
GeVng Started

33. Client Profitability
Perform Law
Client Profitability & CompensaIon
• Opportuni(es
• Measurable
results
• Produc(ve
partner
reten(on
• AGract
beGer
laterals
and
improved
likelihood
of
successful
mergers
• Increased
rates
of
change

34. Client Profitability
Perform Law
Client Profitability & CompensaIon
• Concerns
• Large
swings
in
compensa(on
from
one
year
to
the
next
• SpliKng
origina(on
credit
• Incen(ves
for
working
with
other
partners
• Adjus(ng
points
of
ownership

35. Client Profitability
Perform Law
Client Profitability & CompensaIon
• Opportuni(es
and
Concerns
• Linking
client
profitability
to
compensa(on
can
best
be
described
as
a
process
that
takes
(me
to
mature.
• Partners
will
come
to
understand
that
changes
to
their
pricing,
staffing
and
management
approach
may
be
necessary.
• Over(me
contribu(on
to
profit
=
market
pay

36. Client Profitability
Perform Law
• What
should
partners
expect?
• Am
I
in
the
right
firm?
(hGp://performlaw.com/am-­‐i-­‐in-­‐the-­‐right-­‐firm/)
• Benefits
and
limita(ons
of
any
compensa(on
system
• Main
benefits
of
compensa(on
based
on
client
profitability
Final Thoughts

37. • What
is
a
modern
partnership?
• What
should
partners
expect?
• Benefits
and
limita(ons
of
compensa(on
systems
• Compensa(on
Considera(ons
• Br
b r i a n @ p e f o r m l a w . c o m