Firms urged to go beynd PEP and adopt quality and risk performance measures

Rubens: as the market and the demands on law firms shift, so too must the metrics

Large law firms need to embrace new ways to measure firm and partner performance as traditional methods – such as profits per equity partner – “can be irrelevant, encourage inappropriate behaviours, discourage innovation and tend to be short term in focus”, a leading law firm consultant has advised.

Giles Rubens, a principal at Fairfax Associates, said firms need both to improve the commonly used current metrics – which are largely concerned with operational management – and introduce new metrics “with a longer-term focus and which measure progress on key strategic priorities”.

The key changes required to the current metrics are moving from a focus on revenue generated to one on profitability and from a focus on partner personal performance to one that assesses each partner’s overall contribution, he said.

Mr Rubens said that rather than measuring matters primarily on their scale, based on the revenue generated, “it is profitability that really matters and the profit generated on two similar value matters can be vastly different”.

He continued: “While matter profitability is not a new metric, it remains a relatively under-used one, in part because of the perceived sensitivity of introducing it and in part because the methodology many firms have historically applied is not appropriate under certain circumstances.

“Particularly in the context of pricing and margin improvement, matter profitability is most effective when a notional salary is applied to partners to account for the cost of their time as a working lawyer. To include a partner’s full compensation can lead to misleading results.

“On the flip side, excluding partner compensation entirely is also likely to be inappropriate because it will make a matter largely undertaken by partners look far more profitable than one with a more balanced team.”

This approach will help firms make informed decisions concerning profit management and pricing and also allow them to set prices and manage matters more effectively on other than an hourly rate basis, he explained.

The second amended metric would be to look beyond traditional leverage – the ratio of associates to partners, or non-equity lawyers to equity partners – to take into account of modern business structures that also utilise “contract attorneys, legal assistants, technology, services provided by third parties, and other resources in order to compete effectively”.

Mr Rubens said that among the new metrics should a “risk index”, which measures the relative risk profile of a firm. The factors that could be included in this include:

  • Change in the net economic value of the firm based on the accrual balance sheet of the firm, including off balance sheet liabilities such as the net present value of unfunded retirement obligations;
  • Total liabilities as a percent of income;
  • For cash basis firms, percent of income attributable to a reduction in work in process and/or accounts receivables balances (so as to judge whether profit growth is a result of current activity or a one-time benefit);
  • Percent of income attributable to recurring clients of the firm; and
  • Dependency on a small number of significant clients – and linked to this, the extent to which major clients are institutionalised (clients of the firm) or anchored with individual partners and hence portable.

Mr Rubens also recommended a quality index. Though hard to measure, and requiring some subjective inputs, “it is nonetheless one of the most important metrics that firms should be focusing on”.

This could include the number of new matters opened for existing clients, the rate of change in the average size of the firm’s top 50 or 100 client relationships, the number and levels of the public rankings of the firm, and the results of client and staff surveys.

Mr Rubens concluded: “The old adage ‘You get what you measure’ is largely true in law firms. So as the market and the demands on law firms shift, so too must the metrics. Firms need to take a hard look at the metrics they use to measure performance and profitability and ensure that they remain meaningful and support the firm’s strategic aims.”

    Readers Comments

  • This is an excellent piece by Giles Rubens.

    It’s worth emphasising that – despite broad areas of similarity – the requirements of each firm are particular to its own circumstances. It’s vital therefore that firms should select key performance indicators with care, developing those which are most meaningful for their own businesses even if they don’t facilitate comparison in league tables with other firms.

    It is also worth noticing that different service lines, different business models even, within the same firm may require different KPIs to aid profit management and pricing.

  • Ashley Balls says:

    PEP has been a flawed measure ever since firms discovered HR ‘leverage’ and learned how to manipulate the measurement. Profit per lawyer is one of the only reliable profit metrics and only then if super profit is divided by the number of FTE practising certificates. Anther metric that is worth taking is effective charging rate. Again this established by taking the net fee income billed and paid over a finite period and dividing it by the number of FTE lawyers in a team, department or firm. The resulting realisation rate typically makes a mockery of hourly based fees budgeting schemes and ‘rack’ charging rates.

    Having been involved in a growing number of mergers, acquisitions and valuations of law firms the due diligence process is revealing when it comes to real operating metrics.

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