As we come out of the pandemic, firms are seeing demand increase and they are continuing to increase hourly rates. From the client perspective, the value gap between increasing rates and value for legal services continues. Clients have already been setting pricing expectations, especially with a volatile economy and rising inflation. As a result, law firms are writing off time as well as accounts receivable to meet client expectations post-pandemic. The question is whether the write-offs are mostly economic driven and/or separate and apart from write-offs associated with matter management and timekeeper performance. The direct impact of either case reduces overall realization, but what methodologies can be used to identify and improve the fiscal performance?
Realization is a valuable fiscal performance metric—although, from a process improvement perspective, the overall realization metric could also be defined as the degree of inefficiency in the current process for delivering legal services. Furthermore, the focus is not one of fiscal performance, but one of evaluating a current process that contributes to the fiscal performance—that is the differentiator. Whether initiated by the client or proactively/ reluctantly by the law firm, overall realization remains an efficiency metric that requires review and adjustment of the current process to improve fiscal performance.
There are two types of realization to consider. Billing realization is defined as fees billed divided by the value of the billable time worked. This metric defines how well the firm is converting billable time worked into billed value. Billing realization is the first line of defense. Firms want to be sure they are billing all their recorded time, where possible. If they are not billing the time, there could be many varied reasons. One of the most common and significant areas to consider is timekeeper time management, specifically in the areas of self-editing where timekeepers, for whatever reason, record less time than what was worked. While the time recorded may get billed to the client, the higher realization as a result leads to problems with process efficiency (including staffing decisions involving experience and expertise and the process used to deliver the services), timekeeper skills, and misleading metrics on pricing of the work, all of which significantly impact profitability. Firms can start by asking some basic questions: Does the firm have criteria for staffing matters? Are work/planning budgets considered? Is the firm supervising the matters properly? Is the firm leveraging technology properly? These are all questions relevant to maximizing efficiency of the current process in delivering work product.
Billed value is the product of demand (billable hours) and pricing (hourly rates). Like most metrics, they affect each other. For example, a law firm can have perfect overall realization, but that could be attributed to low billing rates resulting in lost revenues. On the other side, a law firm can have an overall realization rate of 80% due to ongoing large discounts on higher billing rates. One example is unintended and the other is planned, but both impact realization based on pricing decisions. Firms that notice similar trends should review their hourly rates to make certain they are consistent with the market and not indicative of other performance issues.
The second metric is collection realization, which is defined as fees collected divided by the value of the billable time worked. This metric defines how well the firm is converting billed value to cash receipts. Collection realization is a critical metric, but most firms focus on the billing realization. The rationale being, “Let’s nip the issue before sending the bill so we can get paid quickly.” While this is a great idea in theory, and is in line with best practices, we cannot ignore the collection realization side of the equation. As stated in a previous column, billing is an art and a science that includes regular communication with clients and setting proper expectations, up to and including the sending of the invoice. Deviations from this approach could result in greater client scrutiny of invoices and result in additional reductions, thus reducing collection realization. While firms can enjoy particularly good billing realization on the front end, further issues could manifest in a reluctance to pay for billed services and reduce collection realization. In either scenario—reduced billing or collection realization—the firm loses revenue and profit.
In summary, overall realization is important to the firm’s fiscal health and success. Some final points to consider for improving overall realization include:
- Establish guidelines for write-downs/write-offs, which include levels of firm management approval. Attorneys are less likely to regularly write down or write off time if there is an accountability factor to firm management or other partners.
- Refrain from discounting work on a regular basis with the mindset that it must be done to keep the client. The value proposition never goes away. Firms that believe they must discount their services regularly to get additional work should reexamine the client relationship. Repetitive write-offs averaging 10% to 20% monthly will impact firm profitability over the longer term. Unless there is a specific rationale, monetary or otherwise, that benefits the firm to continue this type of a relationship, the client relationship should be reassessed, and tough decisions may need to be made.
- Require all write-downs/write-offs of a certain amount to be discussed with the attorneys involved. Reduced billing realization could and would be improved if attorneys took the time to address the issues with the other attorneys, particularly new associates. Firms cannot correct a time management problem if it is not addressed with the attorneys in question. Have the conversations and monitor the performance.
- Brush off the aged accounts receivable reporting and collect the money! To better illustrate the impact of collection efforts, rank all aged accounts receivable from highest to lowest amount. You will note that a significant amount of your aged accounts due are under $10,000, or a composite of small balances. Reviewing aging buckets is critical, but to make the real impact, go for the low-hanging fruit first. Every dollar collected improves collection realization and profitability. The older monies collected fall right to the bottom line.
The father of process improvement, W. Edwards Deming, is often credited with saying “You can’t manage what you don’t measure.” Firms need to follow the “realization” of the efficiency metric and take steps to understand and minimize those inefficiencies when reviewing their time, billing and collections processes. Realization is only one component, but it is a suitable place to start.
Looking at the bigger picture, a better understanding of the pivotal metrics such as demand, pricing and realization, coupled with developing strategies for improvement, will yield increased revenues and profit.
