realization

The pointlessness of the ‘billable hour’ set out in two charts

Overnight, Australia-time, the Center for the Study of the Legal Profession at Georgetown University Law Center and Thomson Reuters Legal Executive Institute, relying on data from Thomson Reuters Peer Monitor, published the findings of its ‘2018 Report on the State of the Legal Market‘. Reviewing the performance of U.S. law firms in 2017, as well as looking at the trends expected in 2018, this annual report is typically the “first” big report publication of the year and so a trendsetter of where we may be going as an industry over the next 12 months.

As has been the case in other years, the first chart I typically like to see in this annual report is the one setting out ‘Collection Realization against Standard Rates by Law Firm Segment‘ – Chart 9 in this year’s publication – to hopefully give me an indication of how an industry that largely relies on increases in hourly rates each year to boost top-line revenue is fairing.

As you can see, yet again the results here can best be described as ‘disappointing’:

Chart 9

AM Law 100 firms are tracking an ever declining realised recoveries of circa 80 cents in the dollar. All others aren’t doing all that much better at circa 85 cents in the dollar.

Either way, those levels of realisation would have most bank managers in a panic. And the reason they don’t comes down to one small issue: in law firms this collection rate – other than telling you that the market doesn’t see your hourly value as highly as you do – is absolutely meaningless.

What it is, is pie in the sky internal budgetary metrics against market reality cash in the bank.

So we turn to my second “go-to” chart: ‘Collection Realization against Worked (Agreed) Rates‘. This year this is represented in Chart 10:

Chart 10

As the name suggests, what this chart is showing us is “Collected v Worked (Agreed)”. I’m   assuming the “agreed” here is upfront, and I’m accepting that the picture is far from perfect, but there is a far better flatline realisation rate here of 90-ish per cent, or 90 cents in the dollar.

So, what’s my take-out from the two charts?

If you want to try and get a better handle on your projected cashflow, no doubt better to have an upfront conversation with your client about how much you are going to be charging them – however that is (fixed fee, hourly rates, etc) – than having an arbitrary, and less and less meaningful, ‘billable hourly rate’.

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Report: Collected realization plummeted to 82.2% in Q1 2016

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Thanks to an article by Dave Galbenski of Lumen Legal – ‘Overcapacity, Underutilization and Realization Rates Plummeting‘ – I have just been made aware of the publication last month (May ’16) of the Q1 2016 Executive Report (.pdf download) undertaken by Peer Monitor Index (Report).

While the Report gives glimmers of hope (demand slightly up for certain practice areas), the overall message is bleak. And none so more than this:

“After showing some recent signs of stabilizing, collected realization took a sudden and sharp drop in the first quarter. For most of the past two years, collection rates have hovered around the 83% mark. But in Q1, collected realization plummeted to 82.2%. Not only is this a new historical low, it was the largest quarterly drop in more than three years.”

OK, two things here:

  1. a collected realization rate of 83% is not a benchmark we want to be heading to, but away from.
  2. if you keep putting your hourly rates up (recently BTI Consulting’s The Mad Clientist asked: ‘Is $5,000 an Hour Next?‘) but your collected realization rate is “plummeting”, then you’re most likely losing money (as well as the respect of your clients I might add).

My only other thoughts are:

  1. why do we insist on the hourly rate model as our primary means of charging if our collected realization amounts to 82 cents in the dollar? Seems absolute madness to me; and
  2. how many law firms out there can continue to operate on such an “historic” low collected realization rate? I know a number of accountants and bankruptcy lawyers who’ll happily tell you: “not many”.

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‘Drive for show, Putt for dough’

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According to a post earlier this week on the LexisNexis Business of Law Blog:

“A new legal spending trends report finds big law billing rates grew notably – pushing a 6% increase in the gap between the top two tiers of law firms, by attorney headcount, from 38% to 44%.”

Indeed:

“Median partner rates at the “Largest 50” law firms – those with more than 750 lawyers – rose to $711 per hour, based on 12 months of data ending June 30, 2015. That number is up from the last report where median partner rates came in at $675 per hour for the 12 months ending December 31, 2014.”

As I have posted before, however, this [rising headline hourly rates] is absolutely meaningless if your realization rates are in decline – an issue this particular report appears to remain silent on.

I have never understood, beyond ego, why a partner would be more interested in their hourly rate than their average realized billable rate (ARBR). After all, the ARBR amount is the amount that clients are willing to pay you – money in the bank – and is a more accurate reflection of your true worth/value.

Eventually you have to ask yourself which you would prefer: a headline charge-out rate of $1,000- with an ARBR of $700-, or a charge-out rate of $800- with an ARBR of $800-?

And that’s without going into how much easier it is to have the conversation with your clients around rising your realization rather than informing them on 1 July each year that you will be raising your rates by 10% again this year!

Alternatively, you can keep on driving for show and not worry too much about the dough you’re making.

‘Stupid is as stupid does’

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In the 1994 movie of the same name, Forrest Gump is asked:

“are you stupid or something?”

to which Forest replies:

“stupid is as stupid does”.

Some 20 years later (yes, it really has been that long!), in general parlance this phrase has come to mean that:

‘an intelligent person who does stupid things is still stupid’ – (Urban dictionary)

and I have to say that this thought went through my mind earlier this week when I read that a third of [UK] commercial firms are likely to raise their rates in a bid to boost their profits (Solicitors Journal 6 May 2015 – “Number of law firms planning to raise charge out rates increases“).

Leaving aside the issue of whether a direct raise in your rates will equate to increased profits (for example, the psychological impact of rising rates/budgets on fee earners with no increased salary (cost)) –  what in the world would make 26 (1/3rd) of so-called intelligent finance directors of the UK’s Top 100 law firms say “it is likely their firms will increase their charge out rates in order to improve profitability in the year ahead“?

As I have blogged countless times before (the most popular being: ‘Is it time for law firms to break with the RULES when looking at profitability?‘), hourly rates are but one of the metrics in calculating profitability. And it’s probably not even the biggest metric driving your firm’s partner profit levels, which almost certainly would be better achieved via an increase in your realised rate.

Putting this mathematically (admittedly not my strongest area), say my hourly rate is $100 and my realization rate is 90%, then I’m being paid $90-. Taking this forward I’ve decided to increase my hourly charge-out rate to $110-, but find that my realization rate has now fallen to 80%. If my maths is correct, I’m now being paid $88-.

In other words, in real terms, I’m losing money!

Don’t think this could happen? Then take a look at Charts 4 & 5 from the ‘2015 Report on the State of the Legal Market‘ published by The Center for the Study of the Legal Profession at the Georgetown University Law Center and Thomson Reuters Peer Monitor (at page 5)

chart 4

 

chart 5

Those charts don’t make for pretty reading.

So when, as the article reports:

“…firms realise this is not going to be an easy sell to clients who are likely to negotiate hard to keep fees down, so their approach to increasing charge out rates is likely to be softly softly, rather than gung-ho”

my response would be: “why bother?”.

Instead,

  • try keeping your charge-out rate the same over the next 12 months;
  • try not to give discounts;
  • try to increase your realisation rate (by 3 to 5 cents in the dollar);
  • try to reduce your lock-up days;

and see where you end up.

You may just find that has a better impact on your partner profitability numbers than the likely impact that is going to come your way when you go annoying and off-siding your clients with the almost obligatory 1 July 10% rate increase letter.

But I could be wrong…