Lawyers: Ask for the Order!

Mike O’Horo of RainmakerVT posted a great article, “Lead-generation is not the same as business-generation”.  See here. The article notes how the whole process of marketing as most law firms do it is essentially worthless if you “don’t ask for the order” and make the sale.  Most lawyers have great difficulty with this step, and miss out on a lot of very profitable business.

In most law firms, the number of real rainmakers is less than 10-20% of the total # of partners.  Yet all equity partners are expected to bring in business of a minimum $ amount to support the growth and profitability of the firm.  Rainmakers must be compensated to a level that keeps them happy, as they are a rarity in the practice of law.  You must motivate and retain these rainmaker partners with appropriate compensation packages to ensure the future success and profitability of the firm.  The rest of the partners must be satisfied with earning less if they can’t or won’t bring in the business.

You must reward your rainmakers with bonuses or higher units of compensation to keep them motivated and bringing in new business. You’re not just rewarding partners for hours billed, you’re rewarding partners for originating work, which needs to carry a bigger weighting at compensation time.  This is where many small and midsize law firms’ compensation systems fall short in my experience.  This is rewarding lawyers for increasing sales, and really no differs from paying bonuses to the best-performing car salesperson on the lot. The sooner law firms get this, the better off they’ll be.  Since all partners will share in an increasing pie, individual partners can’t be worried a rainmaker is making more than them, when everyone benefits from what a rainmaker does.

Law firms must operate in a business-like fashion.  For decades, law firms have operated with a partnership business model protected from the ravages of competition that other professions and businesses have had to endure.  Changes must now be made quickly to become more business-like in your operations and reward partners for “asking for the order” before your competitors beat you to it and steal your rainmakers away from you.

Win-Win Alternative Billing Strategies

This is the first installment of a three part series based on my presentation on “Win-Win Alternative Billing Strategies” at the CBABC Sixth Annual Branch Conference in Las Vegas November 18-20, 2011.

Current Situation

Alternative billing has been done in conjunction with commodity work for decades in Canada.  Fixed fees are common for personal services commodity legal work such as residential conveyances, wills, etc.  However, alternative billing is not common for most business law and litigation work in Canada. Canadian law firms are not proactively offering alternative billing to their clients either.  And clients aren’t happy about that!

Alternative billing is growing rapidly in the US and Europe, however.  Large clients are pushing big firms to offer alternative billing and they’re getting price discounts of 20% +.  This is what’s coming to Canada soon as well.  So you need to get ready for how to deal with that.

The New York State Bar Association “Report of the Task Force on the Future of the Legal Profession”, published in April, 2011, has a set of recommendations on alternative billing, and it predicts that alternative billing will be the dominant form of billing in the future in the legal industry. Clients are pushing for it, and Bar associations are supportive.

The Association of Corporate Counsel (ACC) is going to be setting up shop in British Columbia and Alberta soon, so it’s coming very fast.

What Do Clients Want From Alternative Billing?

Clients want lawyers to provide more value for money.  Legal chargeout rates have risen dramatically in the last decade, and clients want a price rollback!

Clients also want more predictability in legal costs.  They want fixed fees.  They want to be able to budget their legal costs as close as possible in order to satisfy their CEO’s desire to reduce overall legal costs.

Clients want law firms to share the risk when working for them.  At the moment, clients have all the risks under hourly billing.  Clients want to pay for results, not hours spent. If results aren’t achieved as planned, law firms should be sharing the downside as well.

Many clients are looking for lower overall legal costs.  Legal costs are spiralling out of control, and clients are fed up.

What Do Law Firms Want From Alternative Billing?

Law firms want to maintain or enhance profitability when doing alternative billing.

Law firms want to manage risks, and may prefer not to take on all the risk, but are willing to share risks with the client.  But the risks are a spectrum, and there is a different price all the way along the risk spectrum.  The more risk, the higher the risk premium, just like a stock portfolio.  The higher the return, the higher the risk.  Clients are willing to pay a premium for less risk as well.

Law firms want to retain clients, so they need to offer alternative billing, as clients are looking for it now.  And you want to offer alternative billing before your competitors offer it and steal your clients away.

Law firms want to satisfy clients, and alternative billing offers ways to satisfy clients even more than you are now!

Value Pricing – Part I

So what’s your unique value proposition?  What do you offer that no one else offers for the same value as you do?  Many firms do not focus on this question, and it’s the most important question you need to answer, because it’s the first question a client will be thinking about.  Why should I use you instead of your competitors?

You will need a unique value proposition in order to succeed with alternative billing.  If you don’t, it’s just about price, and that’s a losing game in the end.  You have to distinguish yourself from your competition in order to price at a premium and achieve profitability with fixed fees.

Ron Baker is a CPA who has been talking about the concept of value pricing for over 30 years.  He is the real guru of alternative billing.

Ron presents the formula: Value = Customer Profit minus Price.  What this means is that Value equals the impact your legal work has on a client’s profit less the price of your legal service.   Everything you do for a client will have a positive or negative impact on a client’s bottom line.

Some of the value you provide will be in the form of a tangible benefit, eg. hard dollars recovered or saved, and some will be intangible benefits such as enhanced reputation eg. client gets public financing with the help of your law firm’s blue-chip reputation.

The document “51 Practical Ways To Add Value” on the ACC website is an excellent overview of how you can add value for clients.  It is from a large firm’s point of view, but many of the points are relevant for small firms as well.

For example, ask the client what their strategic plan is. Many clients are very impressed by firms that actually talk to them to find out what their company goals are.  From there you can find out what the client values, and organize your legal services and resources in a way that can truly benefit the client.  And when you start thinking about the client’s profits before your own profits, then you really add value.  If you can help the client become more profitable, your profits will flow naturally as a result.

Trends in Partner Compensation Systems in Law Firms

An increasingly competitive legal environment is resulting in changes in how law firms pay their partners.

In my experience there are three main types of partner compensation systems:

1)      Equality/lockstep – Compensation is determined mainly by seniority. I’ve seen this system used by many small firms and some large US and UK firms.  The advantage is it encourages partners to work as a team, while the disadvantage partners may not feel it’s fair if other partners don’t pull their weight yet are paid the same as high performers.  This can lead to a lack of incentive for high performers, and creates a risk they may leave.

2)     “Eat what you kill” – Compensation is determined mainly by personal production. This system is used by small and midsize firms.  Objective systems like this usually focus on just the numbers, which makes it clear to all partners the expectations, and is fairly simple to determine compensation.  The downside is these objective systems also encourage partners to “game” the numbers to their own advantage.  This can lead to breakdowns in team-building, where partners act as “lone wolves” and talk about “my clients”, not firm clients.

3)     Subjective Merit – Compensation is determined by subjective analysis supported by objective factors. It usually involves a compensation committee of 3 or 4 partners, and is used mainly by midsize and large firms.  This system has the advantage of encouraging partners to operate at a higher level and get compensated accordingly.  The subjective merit system may have an objective component as a starting point, but subjective analysis reduces the potential for “gaming” the system in a purely objective formula system.

Depending on the culture of the firm, any of the above systems may work effectively.  However, my experience and research indicates the most effective system for increasing profits is the subjective merit compensation system.

Compensation System Trends

One of the major trends I see is towards more “pay for performance” in law firms, with an emphasis on rainmaking results.  Rainmakers are paid big bucks to switch firms, especially commercial lawyers able to command and move a large client base.

Compensation compression ratios (the $’s paid to the highest paid partners compared to the lowest paid partners) are increasing, as firms accommodate rainmakers at the top end of the pay scale.

Law firms are requiring an increasing minimum practice size to remain as an equity partner.

Non-equity partnerships are growing in popularity as firms attempt to maximize their leverage and equity partner compensation.

Large firm compensation systems are becoming more “corporate” in nature, as firms grow in size and scope internationally.  The larger the firm, the more corporate the model.  Managing partners and executive committees are wielding more power, and are providing more input to the compensation of individual partners, who are becoming more like employees in large firms.

Managing partners and practice group managers are being compensated more for their management accomplishments.  Some firms are compensating their managing partners using balanced scorecard techniques, for example.  Law firms are trying to run like real businesses, and are delegating more and more of the firm’s business functions to their management partners.

Many firms are requiring pre-retirement phase-downs in compensation and have established retirement policies at a set age eg. 65.  There is some controversy here, however, given challenges to the legality of forced retirement. Firms are continuing to try to enforce these retirement policies to maintain increasing equity partnership leverage and profitability objectives.

There is a trend for senior partners with portable practices to move from firms where they have spent their entire careers, after being forced out by the imposition of set retirement age policies.

Most firms have fairly “open” compensation systems, where partners know what other partners are being paid.  The trend is towards less compensation transparency in larger firms, however, with power and information centralized within a few management partners.  Compensation discussions can be too much of a time distraction for large firms.

More non-equity compensation arrangements are being used for hiring lateral partners and retaining good “up and comers” with long-term potential for building a practice.

Buy-in requirements are growing as firms grow and partner leverage increases.

More flexibility for balanced lifestyles and part-time partner arrangements are being demanded and received by the new generation of partners.

Compensation Criteria Trends

There is more emphasis on teamwork, and less emphasis on personal billable hours. This also ties in with growing recognition for the need to lever work, and the growth of alternative billing practices.

More firms are doing strategic plans in response to increasing competition, and this is leading to a need to recognize partners’ non-billable efforts in implementing strategic plans at the firm, practice group and individual partner levels. This also means more recognition of training, supervision, quality control, and various other non-billable tasks performed by partners.

More firms are recognizing client origination results, and firms are tracking client and matter origination more diligently.  Sales skills are being taught to partners and associates.

More peer evaluation is happening, especially in larger firms. There is also more emphasis on client feedback, realization and profitability of partners’ practices. More emphasis on cash in, and less on billings.

Compatibility with firm culture is becoming more important. Non-conformists with firm culture are punished, leaders are rewarded.

Summary

The key trend is toward more “corporate” compensation models, driven by competition and the corporate style of growth of large national and international firms.  Compensation is driven more by the strategic goals of the firm, and partners who contribute to firm goals are compensated at higher levels.  There is more emphasis on pay for performance as well.

Compensation compression ratios are widening, as firms attempt to accommodate and retain the rainmakers in their firms.  This has resulted in major dollars being spent to lure new rainmakers to the large firms.  Business development is more and more highly prized, and rainmakers’ compensation is increasing significantly.

The danger of a high compensation compression ratio is you could end up like Finley Kumble a few years ago.  They hired many rainmakers and paid them exorbitant dollars for their client originations without a sunset clause, and the whole firm came crashing down. Several factors were involved, but the extremely high compensation compression ratio was pointed to as a major factor in their demise.

Firms are also trying to encourage partners to lever more to others, and in the process institutionalize clients so it is more difficult to move clients when partners are offered more money by other firms to lure them away.  Buy-in requirements are rising as firms lever more and reduce the % of equity partners relative to non-equity partners and associates.

Large firms favor subjective merit systems, while smaller firms favor more objective systems. Large firms are increasingly profitable, and the gap is widening, so there may be some correlation/cause/effect with subjective merit systems which leads to increased profitability.