How to Navigate the Complexities of Creating a Productivity-Based Compensation Model for Your Law Firm
Unsurprisingly, the issue of compensation is a major focus area for management when running a law firm (or any business for that matter). This point often becomes particularly complicated for lawyers due to the unique complexities associated with the billing practices in most law firms. Because of this, establishing a sound measurement of productivity in the law office can assist twofold: not only does this allow you to appropriately allocate compensation, but it also provides invaluable information regarding the profitability of your business, as well as hard data which you can base decisions off of.
The way in which the legal industry defines productivity differs slightly from how others may describe the term. Specifically, when measuring your firm’s productivity, there are three important areas to evaluate:
- Rainmaking (a.k.a. the originating attorney who brought the case or client to the firm)
- Execution responsibility (i.e. matter owner, or the person responsible for overall efficiency, deployment of resources, and client communication)
- Contributions to:
- Billable hours
- Fixed-fee matters
- Contingency matters
- Unbillable time
The creation of a productivity-based compensation model involves several components. This data should be collected from a wide range of sources, and many of the most successful firms simplify this task by automating the process. Here are some of the initial steps a firm needs to take to build a successful compensation model:
First, you must ensure the following prerequisites are fulfilled. This requires:
- That ALL matter parties and roles are clearly defined
- That ALL time and costs are properly tracked by matter
- A history of properly used and timely pre-billing and billing processes
- Effective management of Accounts Receivable
- Up-to-date and precise accounting on both the firm and matter levels
Additionally, there are multiple variables involved in compensation which must be defined, such as the individual’s role, percentage allocation for each role, and whether the work being done is contracted by client or matter type.
If you think your firm might benefit from a productivity-based compensation model, there are a few items to check off the list prior to initiating the switch. In addition to fulfilling the prerequisites listed above, it is important that your firm supports:
- Integrated billing and accounting processes
- Ability to compute collected income per invoice, matter owner, timekeeper, etc.
- Ability to flexibly attribute discounts
- Ability to assign matter parties
- Ability to allocate distribution percentages at the matter level (if needed)
- Ability to handle fixed fee/contingency matters
So why do firms take the time to craft highly detailed compensation models? Utilizing a productivity-based compensation model is often an effective motivator. Not only does it invite new business into the firm, it also encourages that current cases be treated with urgency and diligence. That being said, there are also challenges associated with transitioning to a productivity-based model. Some common pitfalls to be aware of are:
- Unnecessary complexity when not using an automated system
- Segregated billing and accounting systems which can an incomplete picture
- Improperly calculating fees earned and not total payment
- Processing partial payments from clients
- Handling discounts
- Handling value-based pricing (i.e. fixed-fee) and contingency matters
In all of this, it is imperative to establish a transparent and objective calculation, so that all employees are treated fairly and feel valued. Often, firms will ask whether this calculation should be based on what has been billed or what has been collected. Generally, it is not best practice to apply a compensation model based on a utilization rate (i.e. what is billed), as adjustments and/or credits can affect these figures down the line. As a result, we recommend basing compensation on the realization rate (i.e. what is actually earned for a particular case).
For more information about navigating the complexities of creating a productivity-based compensation model for your law firm, view our full webinar, Understanding Productivity & Compensation Models.