Finance – Mark Gould…

Measuring performance and setting priorities

29 February 2016 Mark Gould4 Comments

Today is a leap day, a quadrennial adjustment of the calendar on which tradition dictates that women may ask men to marry them. (Of course, this is just a convention — nothing in reality prevents either gender from popping the question.) In that spirit, I want to take a look at a convention in law firms that could do with being upset — recording time.

This isn’t simply a plea to move away from time-based billing: that topic has been done to death by other commentators. In any case, I think clients are increasingly resistant to the idea to the extent that it has almost become the charging model of last resort rather than the starting point. No, I am more concerned about a figure that looms large in the daily life of almost every private practice lawyer: the annual chargeable hours target.

Even firms that have adopted alternative ways of billing clients still cling to timesheets. Their lawyers are expected to account for every six minutes of every day. (Even holidays — many time recording systems need to be told that a lawyer is not working.) Many of the same firms set annual targets for their lawyers — they must record a certain number of hours per year. I understand why this is important. Even when the link between time spent and the price of legal services is broken, firms still need to know what their input costs are in order to know whether the work is profitable.

I think the cost of this knowledge is too great. Although they are potentially useful to firms, these targets have a pernicious effect on lawyers’ behaviour, law firm culture, and client service.

Behaviour and culture

Although the point of recording time is to give the firm an idea of how much effort is being expended on client work (and other activities, so long as non-chargeable time is recorded too), many firms also use targets to inform other things, such as eligibility for bonus payments, suitability for promotion, and so on. As a result, lawyers prioritise meeting their annual targets above all else. Any work that cannot be attributed to a client file is therefore given a lower priority. Unless the firm explicitly elevates the priority of non-client work, perhaps by allowing work on specific internal projects to be counted towards the lawyer’s annual target, lawyers will naturally be reluctant to contribute to activities such as knowledge management.

Law firm culture is, in part, an accumulation of the way people commonly behave. As such, habitual prioritisation of chargeable work in preference to certain types of non-chargeable activities will naturally cause those activities to be considered less worthy. The personal financial preferences of time-recording lawyers become cultural norms. Worse than that, however, the act of recording time has come to signify importance within many firms. That is where the fee-earner/non-fee earner distinction arises. Firms that claim to deprecate the use of the term ‘non-fee earner’ will only succeed in changing their culture by removing fee-earners from the stage. If nobody records time, the most obvious distinction between lawyers and business services professionals is eradicated.

A fruit-based digression: customer focus

In my last blog post, I linked to and quoted from a fascinating piece by Horace Dediu on the way Apple appears to measure performance, and how that affects (and is affected by) the priorities the company sets. Dediu points to a difference between the way most businesses measure performance and the way Apple appear to do it. He argues that the norm is to depend heavily on easy to measure financial data:

These “financial” measures of success are considered prudent and optimized for return on equity (also known as the maximization of shareholder returns).

Unfortunately, Dediu argues, financial metrics prioritise some forms of information over others, to the extent that the wrong decisions might be taken in consequence:

The mass phenomenon of measuring the wrong thing because it’s the easiest to measure is called “financialization”. Financialization is the process by which finance and finances (rather than creation) determine company, individual and society’s priorities. It comes about from an abundance of data that leads to fixation on what is observable to the detriment of awareness of hazards or obstacles or alternatives. This phenomenon is more likely when the speed of change increases and decision cycles shorten.

By contrast with companies wedded to the need to maximise shareholder returns, Dediu notes that Apple puts the customer, rather than the company, at the centre of its decision-making processes. In doing so, it aims to make the best product it can for customers. The challenge is to assess how successful it is in doing that.

The idea that the purpose of the firm is to create and maintain customers is not new but it is relatively rarely practiced. The reason is that the data is harder to obtain. The data that comes from sales is crisp and concrete. The data about customers is muddy and soft. In a world where spreadsheets are used as weapons, the crisper the data, the better the ammunition.

Optimizing around customer acquisition rather than equity returns leads to a new set of metrics. What would these metrics look like for Apple?

The company publicly offers three separate sets of quantity of customers and quality of customers.

In terms of quantity we have:

Number of iTunes accounts

Number of iCloud accounts

Number of active devices

In terms of quality of customers we have:

Average selling prices for devices (as a proxy for willingness to pay)

Customer satisfaction (as a proxy for loyalty)

Services and accessory revenues (post-sales and recurring value)

Dediu then shows graphically what Apple’s performance over the last ten years looks like against those metrics. (Generally good.)

Client focus for law firms

There is no reason why law firms should not also consider themselves as client-focused. In fact, there is a good case for arguing that they should be more client-focused than a company manufacturing quasi-commodity technology products and services. Law firms’ dependence on basic financial metrics suggests, however, that they struggle to measure how well they perform from a client perspective.

Firms’ persistent emphasis on time recording may be the most significant factor working against proper client focus. In prioritising measurement of the time taken to perform tasks, rather than finding a way to assess their importance for clients, firms choose to elevate quantity over quality. Even when a firm has a good system for assessing client satisfaction, it is rare for that information to be integrated into decisions about individual lawyers’ progression or bonus. (And I suspect good systems for assessing client satisfaction are vanishingly rare in themselves.)

The leap-year challenge for law firms, then, is to consider what good qualitative measures of client service they might have or be able to generate, and to work out how those metrics could be used to supplant the outdated conventional measures of firm performance. In doing so, they should find improvements in lawyers’ openness to involvement in important practice support and development activities, in the firm’s culture, and in the quality and creativity of service provided to clients. I can’t promise that those improvements will lead to Apple-scale profitability, but other examples across the corporate world suggest that better performance flows more often from a customer focus than from a shareholder focus. In addition, firms would no longer need to invest in time-recording technology and the panoply of enforcement tools and processes that flow from them.

Pulling the right financial levers

9 October 2015 Mark GouldLeave a comment

One of the links I provided in my last post was to a Financial Times report from six months ago, “Professional services at heart of UK productivity problem”, which suggests that depressed productivity is a particular problem for services sectors:

Lawyers, accountants and management consultants lie at the heart of the UK’s productivity problem, explaining almost a quarter of a shortfall since 2008.

Financial Times research shows that the stagnation of productivity since the crisis is largely explained by just four sectors — professional services, telecommunications and computing, banking and finance and manufacturing.

Why might this be? The article’s authors suggest a couple of reasons:

Productivity in professional services has stalled for many reasons including corporate reluctance to fire staff even as business dried up in the recession and subsequent new hires taking time to become more productive.

And they also quote a view from the legal sector:

Stephen Denyer, head of City and International at the Law Society, said staff in law firms were spending more time than before on activities that were not “billable hours”, such as business development and compliance.

“You have to work harder to win each mandate, and a lot of time on compliance, the requirements not only of our regulator but also in relation to money laundering, sanctions, particularly for people doing international work.”

These are probably good explanations, but a much more thorough analysis was provided by Steven Toft for the UK Commission for Employment and Skills. In his piece, Toft concluded that poor productivity at the national level stemmed from poor performance in the workplace.

Much of the fall in productivity is due to what the ONS calls Multi Factor Productivity (MFP) or Total Factor Productivity (TFP):

Output growth which cannot be explained by increasing volume of inputs and is assumed to reflect increases in the efficiency of use of these inputs.

In other words, how resources like capital and labour are managed. As the Growth Through People report comments:

One big part of TFP is the ‘black box’ of the workplace, and how employers turn skilled workers and tools into products and services which customers value. We may have a more qualified and – if qualifications are of good quality – a more skilled workforce, but are those skills being used effectively? It seems that as world markets have become more difficult in the past decade, many of our work-places have struggled to adapt.

The inability to turn a highly skilled population into high productivity is a symptom of failure in the workplace.

By comparison with some enterprises, law firms derive much more value from their people. Without doing the comparative revenue per lawyer analysis that I described in my last post, it is impossible to be sure that law firm productivity is not stagnant. My suspicion is that even if the sector as a whole looks more productive, few firms stand out as particularly good performers. (Sadly, I don’t have access to the relevant data and I can’t afford to buy it at the moment.)

My conclusion comes in part from thinking about a very simple model of law firm operations. (Please excuse the very basic nature of the next few paragraphs. I find it helpful to go back to first principles.)

(In the background to this analysis is a continuing downward pressure on fees. One reason for productivity apparently being depressed is that, although output (if measured in terms of chargeable hours worked) may be constant, clients are no longer willing to pay the headline hourly rate for that work. The need to extract maximum value from each hour worked only reinforces the importance of increasing productivity or yield.)

At its most basic, a firm can be understood as a facility for producing legal advice, information or execution capability. It contains people who do those things in return for fees. There are a number of ways in which their output can be increased.

If there is still capacity for additional work, any new instructions (and the fees that come with them) go straight to the bottom line — all additional income increases profit and the profit margin.
If there is no additional capacity, new work will require additional people to do it. In this situation, additional work will not increase the profit margin, but it should increase the size of the firm’s profit.
In order to extract additional value when capacity appears to have been reached, a firm may insist on more intense production. If, for example, the current target for chargeable hours is 1400, the firm might push for a higher target of 1600 or more hours. (Information about the current range of hours targets in the UK has been collated by the Legal Cheek website.) A change such as this is unlikely to be possible in a short time period, and will almost inevitably come with a cost as salaries rise alongside the additional work requirement.
Firms can make changes to the fee-earning machinery. They can shift work from qualified lawyers to paralegals. They can move staff from high-cost centres like London to cheaper areas of the country. They can change their resourcing model to use more contract staff rather than permanent employees. If the value of the work produced does not change, any and all of these changes will shift the revenue per fee-earner equation in a positive direction for the firm. It will look more productive.
But each of these shifts (what Bruce MacEwen calls ‘labor market arbitrage’) is a one-off gain. Once work has been moved to paralegals and contract staff in a low-cost city, that tactic cannot be tried again. In effect it is a re-basing of the productivity curve, giving no recurring advantage to the firm. It is also a tactic that is easy to adopt, so it gives no firm a lasting advantage.
Looking to more long-term changes, a firm might turn its back on low-value work and build a capability to do higher-margin work. This is not an easy strategy, unless few other firms identify the same opportunity.
Real increases in productivity or yield will only come if firms find ways to generate more income from the same amount of fee-earner work.
Alternatively, continuing improvements to productivity and yield come from products or services that can generate income without incurring costs at the same time. At present, however they resource the work that they do, most firms incur salary costs at a similar rate to the income they generate (unless they run below capacity). Firms with products or services that ‘make money while we sleep’ (as a managing partner once described them to me) will produce income that goes straight to the bottom line once the investment costs of creating those products or services have been met.

Looking at these options, there are clearly limits to the power of firms’ business development (sales and marketing) or HR functions to improve the long-term financial health of the firm. They can affect work levels and resourcing (the first four bullet points), but they are unlikely to play a central role in shifting the firm’s focus (the last three bullet points).

To go back to my agricultural metaphor, the combination of successful sales/HR work is like a farmer buying a new field. The farm will generate more income with that field, and more profit, but overall profitability or yield is not changed. Real improvements in yield come from using the land more intelligently by developing better farming techniques or leveraging new technology to extract more value.

Similarly in law firms: changing the way work is done, the kind of work that is done, or the products and services the firm provides, is a job for those who understand the work best — together with those who can see into the future. In a law firm, those people should be in the leadership function together with knowledge leaders and (because that is the direction of travel for the foreseeable future) technology leaders.

Firms that really want to make lasting changes to their productivity beyond one-off improvements to process or labour market arbitrage and without overworking their staff, need to use their knowledge and technology teams better. If they continue to rely solely on BD and HR, their gains are more likely to be short-lived.

When firms turn to their technology and knowledge teams, they need to be sure that those teams are capable of providing the help needed. That will be the subject of the next post.

Spending time and money

23 April 2015 Mark Gould1 Comment

In my last post, I mentioned the stresses that a GC might be under and how that might manifest itself as a shortage of time. Something similar is at play when one considers financial constraints. Often those who have money to spend have very little or no capability to make more. Anyone who makes demands on people’s time or money needs to be aware of the limited nature of those resources, and what else is competing for them.

A number of thoughts flow from this observation, which may be useful for people offering legal and other services as well as those providing internal business support.

What do they get in return?

If you do something in the expectation that someone else will commit time or money to it (or both), they need to feel that they will get something in return. This is most obviously expressed in financial terms as a return on investment, but that is only the most tangible form. At the other extreme, broadcasters and the film and music industries (for example) create products that take time to consume and often have to be paid for. In return for investing their time and money in a film, TV programme, book, or album, the audience need to feel that their lives have been enhanced in some way. They need, in Lord Reith’s words, to be informed, educated or entertained.

Crucially, investing in one thing often excludes the possibility of investing in another. If I choose to watch Mad Men (as I do), I will spend at least 92 hours (and probably more) of my time doing so. Those 92 hours can’t be spent doing something else — I can’t read a book, do some work, or go for a drive at the same time. Likewise, the financial cost of acquiring the right to watch the programme (by DVD or pay-TV subscription) means that I have reduced my capacity to buy other things. The impossibility of spending twice has repercussions on both sides of the equation — for those spending time/money and those demanding it.

Sometimes people know what they get when investing in something. This may not be conscious — slumping in front of a mindless TV show with a glass of wine after a hard day’s work may seem worthless, but it provides a valuable opportunity to relax and unwind. Sometimes it needs to be explained what the return on investment might be. Time spent on marketing may feel like a waste, for example, but not doing it will almost inevitably lead to a drop in income.

By contrast, people seem to be pretty poor at evaluating investment choices. I have referred previously to the work of Dan Ariely and other behavioural economists on choice and different kinds of value. In particular, people overvalue things they already have compared to future goods. That generally makes it hard to persuade people to stop doing something inefficient and start doing something new and better.

Learning (or not) from past spending patterns

One significant consequence of the way we value our expenditure of time and money, and yet fail to understand its cost, is a tendency to misunderstand change. This may have an impact on sellers as well as buyers.

A good example of this can be seen in the music business. For decades, recorded music was a dominant form of entertainment. From the 1950s until well into the 1990s, significant amounts of people’s leisure budget would be committed to vinyl or (later CDs). As a result, some (by no means all) recording artists and others in the music industry became quite wealthy. The possibility of riches attracted some to the business. Now, with the growth of streaming services such as Spotify, people can listen to recorded music without having to own a copy. As a result, it appears that less money accrues to the original creators than they have been used to.

One response to this drop in income is to reject the whole model — to withdraw from streaming services altogether. Another is to claim that such services should recompense artists at a higher level than they do currently. I suspect that neither of those options will work.

The problem is that, in general, people just don’t have as much money to spend on recorded music as they did. It is rare now to see people regularly “buying two CDs, a DVD and maybe a book – fifty quid’s worth.” Instead they have to commit £20-40 per month on a mobile phone contract, £10 to Spotify, even more for cable TV and broadband subscriptions. There just isn’t the money available to go back to the old way of doing things. Artists demanding that the clock should be turned back are wasting their breath. The simple economic fact is that people don’t generally value music as much as they used to.

Something similar happens within organisations. Without improvements in profitability or increases in income, the amount of money available for investment is finite. When external advisers or internal support teams demand more, their demands will only be ignored. That’s why businesses hate it when legal costs overrun. It is difficult to ignore those demands for payment, but the fact that costs have escalated is a clear indication that the lawyers have failed to understand how the client’s business works. Historically, lawyers’ demands for sustained income have been much more difficult to ignore than recording artists. As new ways of providing legal support move to the mainstream, it will become increasingly easy for clients to choose cheaper (and often better) ways of resolving issues than using traditional law firms.

What’s coming next?

Some folk in the music business appear to have been caught unawares by the changes in the way that people consume their product, and the consequent impact on their income. In fact, services like Spotify were a natural result of developments that they tried to fight (such as illicit peer-to-peer services like Napster and Limewire) and changes in other industry sectors (such as the growth of smartphones and broadband internet services).

New ways of finding and consuming music showed customers how much easier it could be to listen to what they wanted — no need to go to a shop to buy a CD to play in an expensive player of some kind. They also introduced people to the idea that music could be cost-free, albeit illegally. Once those ideas became more mainstream (as ideas tend to), they became hard to rebut. On that analysis, Spotify is actually an improvement. The options were that artists would either not be reimbursed at all for their efforts, or be paid at a much lower rate than they would prefer.

Had musicians analysed the financial impact of novel areas of consumer spending, they might have realised that their command of a large proportion of that budget was threatened. It appears that few did. By contrast, the music labels and distributors did understand. They did deals with Spotify and the like, so that those services could flourish legally. Those deals had to be done against the background of the streaming services’ likely revenues from subscriptions and advertising, and were therefore informed by how much consumers were realistically going to spend on music.

It is fair to say that few people could have predicted precisely what would happen to the music industry. However, understanding what was going on in and around it should have led anyone to the conclusion that there would be less money available than there had been previously. I suspect that people are still spending as much time as before actually listening to music, so I can see how musicians may be aggrieved that listeners are getting more for their money than they did previously. That may just mean that the music industry was particularly lucky in the past and that luck has now run out.

There are lessons for other sectors where the pace of change has been a bit slower. Everything you do that costs someone time or money is contingent on them continuing to agree to that expenditure. Keep an eye on the things that might reduce their interest in the way you do things.

Don’t dismiss the upstarts competing directly for your work (even if they are doing so illicitly). The likelihood is that if people like what they do, it will form some part of the future.
Be aware of how your customers/clients are spending their time and money. If more interesting things are happening somewhere else, you need to move to be with them, whatever it costs you. The alternative is the equivalent of the £3 CD or the £5 DVD.
Consider the possibility that the riches of the past were abnormal, and that the future may be much leaner. Don’t depend on a return to good times.

Measuring the difference: law firm metrics

27 January 201527 January 2015 Mark Gould1 Comment

One reasonable response to my recent posts suggesting KM delivers most value when it acts as some kind of irritant to conventional law firm practices is to ask “how can one know when things have improved?”

I have tried answering a question like this before, but this time I want to approach from a different direction. Previously, I looked at how much a firm might reasonably invest in knowledge management (the input). This time, I am more interested in outcomes.

When considering law firm financial matters, my first call is usually to Bruce Macewen’s site. As expected, I was not disappointed. A commonly used public measure of law firm health is a simple one — profits per equity parter (PPEP or PEP). The legal media like it because it gives them a handy figure to build into headlines and league tables. But actually it tells us nothing meaningful — it is too easily gamed. Bruce dislikes it too, and in one article suggested a host of alternatives that firms could use for themselves.

On the quantitative side:

Revenue Per Lawyer

Compound annual growth rate (CAGR) of revenue over a multi-year period

Realization rates (implying, I would argue, clients’ perception of value-for-services-received)

Associate retention rates (or attrition rates, measured negatively)

Percentage of business from clients of long-standing duration (say, more than 3 or 5 years)

Percentage of all legal spend from top 10 (20/50/100) clients

On the qualitative side:

Client satisfaction

Lawyer morale

Commitment to and investment in professional development

Commitment to and investment in such things as diversity and pro bono

The quality of firms the firm takes lateral talent from and the quality of firms they lose lateral talent to

The quality of firms the firm wins assignments from and the quality of firms they lose assignments to

Quality and morale of professional and support staff.

Any one of these would be a good starting point for assessing the value of any activity within a firm. If one makes a change and then sees a shift in one or more of these measures, it is possible to ascribe the shift to the change. However, there are two very important caveats.

First of all, it is important not to cast any of these metrics as targets. Setting a target doesn’t help people understand what they should do to meet it (and also implies, rather rudely, that people aren’t already doing all they can to help the firm perform at its best).

Secondly, many of these performance indicators depend on a huge number of interrelated variables. Take the first, for example: revenue per lawyer. (I would prefer to measure this by reference to all employees, not just lawyers, especially as law firms come to rely increasingly on non-traditional roles for client service.) This is a metric approved by McKinsey, and is easily measured and reported. It makes particular sense in a business that depends on people to deliver a service. A large firm with significant fixed costs (buildings, insurance, technology and other infrastructure, for example) will find it hard to make a real change to this number without also affecting some of the intangible factors — client experience, staff turnover, etc. It would be foolish to hope that a single activity (whether that be better knowledge management or improved marketing) could be responsible for a real change in the firm’s financial health. Things are too messy for that.

So how should we approach the problem? This raises four questions for me:

Which factors matter most to the firm?
What variables might affect the selected metrics?
What does the firm know about those variables?
What can be done to improve things?

The first should be obvious. There is no point addressing revenue per lawyer (or profit per employee) if the firm is actually more bothered about its exposure to a small number of key clients than about its profitability at present. This is a strategic question, but I think few firms have such a clear view of their priorities without seeing a list such a Bruce’s of the issues that might concern them. Once they do, it is important to work out which factor is the most important — which will always command more investment than any other?

The second point is an expression of my second caveat above. Once we know what really drives the firm — what is its highest priority — we need to understand how performance in that area is influenced by activities, actions and culture within the firm as well as the wider environment. That might be possible as a desk exercise, but it is a task better done by engaging with a wide cross-section of the firm.

This is the third point — in most situations, the collective knowledge of the firm itself will give the best insight into how things are now and what might be possible in the future. That engagement could uncover knowledge about clients and their markets, about the firm itself and the people within it, and about infrastructural or other opportunities and challenges. Exposing this knowledge is something that should be at the heart of the firm’s knowledge activities. A survey won’t do — what people say when they mean what they say needs to be carefully uncovered and intelligently analysed.

Once there is a better understanding into the way things are, the firm can start to think about what activities and actions might change things for the better. Sometimes that will be an obvious choice, but often it will be necessary to test a number of different actions and see which ones make a lasting difference.

Sadly, many firms start with the fourth step. Worse than that, they invest significant sums in large-scale activities that they cannot then prove to have the benefits they expected. The result? At least, wasted time and money. At worst, disenchanted clients and people, to the extent that the firm risks collapse.

If you are interested in going about things the right way, using this four-stage process (or something tailored to your needs), please get in touch: I can help.