Understanding Productivity & Compensation Models for Law Firms
Managing a law firm means running a business. It doesn’t mean that a law firm can be managed the same way as any other business. The ways a law firm can track productivity and build compensation models differ from that of traditional businesses.
The Complexities of Managing a Law Firm
Before understanding how law firms can effectively measure productivity and build compensation models, it’s important to understand the many complexities of managing a legal practice. On the surface, one may look at a law firm and think it’s simple. Lawyers render service for their clients and then they receive payment for their work.
Not so fast…
Complexities of Casework
First, there are the complexities of casework and the way in which everything must be tracked. When practicing law, everything must be traced back to the matter with which it is associated. This includes any related events, tasks, communications, and documents. The time spent on these items and activities contributes to how your firm measures productivity, is compensated and compensates the firm members involved with the matter. In situations where a firm is working for a flat fee, it is still important to track all of these items to ensure there is a proper return for the firm’s efforts.
Complexities of Legal Accounting
Unlike most other business accounting, legal accounting goes far beyond tracking internal expenses. Law firms need to track matter costs appropriately, manage client funds, and properly allocate invoice payments. Failure to appropriately manage these aspects of the business can result in ethics violations and severe penalties.
Complexities of Legal Billing
Billing clients for legal services is another thing that may seem simple on the surface but is not. Law firms need to be sure to track all billable activity, expenses, and matter costs. On top of this, they also need to be able to manage client retainer balances and partial payments.
Unfortunately, getting paid can sometimes be a difficult process. Different cases or case types can have lengthy timelines for getting paid by the client. For whatever reason, legal fees are often the last to be paid, judgments awards are often delayed, and moreover, clients may dispute different fees associated with the legal matter a firm is working on. Many times these complexities associated with collection can be dealt with through clear and effective communication. This includes making sure that all clients are billed in a timely manner and that the bills they receive are accurate to avoid any back and forth.
Why Should A Law Firm Measure Productivity?
Productivity is defined as the effectiveness of productive effort, especially in industry, as measured in terms of the rate of output per unit of input. Law firms should measure their productivity for the same reason any business should. It is a key measurement in understanding the profitability of the business.
Determining Utilization vs Realization Rate
Just like any business, law firms measure utilization rate as a percentage of time spent on projects for clients opposed to time spent on internal functions or downtime. This represents the firm’s time that clients are later billed for.
In addition to understanding a firm’s utilization rate, it is also important to understand realization rate. A firm’s realization rate measures the difference between the time recorded working on a matter for a client and what percentage of that time is going to be billed to and collected from the client.
Understanding a firm’s utilization and realization rates is virtually impossible without objective data from all parties working on the matter. This can go beyond members of the firm and include associate attorneys and firms as well. This information should include but may not be limited to:
- Financial Data
- Practice Area or Case Type
- Classification of Client Base
- Technology Used
- ROI of Various Expenses & Resources
Understanding Firm Productivity Goes Beyond Compensation
Undoubtedly, productivity can play a major role in deciding compensation related to a legal matter, but understanding a firm’s productivity goes far beyond compensation.
Many firms take on cases or matters with fixed fees or contingency fees. Regardless of how much time is spent on a case or matter, the firm is compensated based on performance or a set fee. In some instances, firms may not be compensated at all dependent on the outcome of the case or matter.
While understanding a firm’s productivity related to contingency or fixed fee matters may not directly correlate with compensation, it is important to understand how much time is spent on these matters. By tracking the time spent on fixed fee and contingency cases, firms will be able to understand the rate of productivity and the ratio of work to income earned on different case types.
Setting Up Productivity-based Law Firm Compensation Models
Law firms looking to set up a productivity-based compensation model need to utilize a comprehensive set of data that includes:
- The originating attorney who brought the case to the firm. This is also known as rainmaking.
- Execution responsibility, or the person responsible for overall efficiency, deployment of resources, and client communication.
- Timekeepers contribution to billable hours
- Contribution to fixed fee & contingency matters or unbillable time.
All this data can be collected from a wide range of sources. While this can be a daunting task, law firms who automate the process are much more likely to experience success. The following steps can assist a law firm in building a successful productivity-based compensation model.
- Ensure that all matter parties, roles, and responsibilities are clearly defined.
- Measure ALL time spent working on and costs associated with a matter. This should be done regardless of whether your activity is billable, related to administrative tasks, or for fixed fee work so that you are able to measure productivity.
- Utilize proper pre-billing and billing processes. It is extremely hard to compensate the appropriate parties based on collection if a firm doesn’t bill their clients or bills them ineffectively. It is important to apply all discounts on a timekeeper level and provide detailed invoices to ensure clients are not confused about what services they are paying for. In addition to this, it is also important that all clients be billed in a timely manner. The longer out bills are from when services were performed can create confusion for clients related to what they are being billed for. This will improve the speed at which clients pay their invoices.
- Effectively manage Accounts Receivable. Law firms need a solid process in place to collect accounts receivable. As AR ages and clients go longer without paying for services rendered by a law firm, the more difficult it becomes to collect. Many successful firms utilize retainers and evergreen retainers to solidify their AR processes. This process can be more easily managed through automated reminders from systems like CosmoLex and the personal intervention from members of the collecting firm.
- Keep all accounting up to date. Firm’s that keep their accounting up to date are ultimately more successful in creating effective compensation models and managing their business. Many jurisdictions require that all accounts are reconciled monthly, but it is best to perform these tasks on a daily basis. This will ensure that all of a firm’s finances are in order, instead of trying to go back and make sense of a month’s worth of transactions every 30 days.
- Appropriately allocate revenue before realizing income. When money comes into a law firm it doesn’t necessarily mean it’s income. In fact, when money first comes in, it most likely cannot be classified as income. All revenue that comes into a firm must be prioritized appropriately for a firm to remain compliant. There are three steps that must be met before any firm can realize any actual income. First, depending on the source, any liabilities that the firm has must be paid. In some situations, firms are required to reimburse any assets like advanced client costs before liabilities. After liabilities and client costs have been handled, the firm must address any hard or soft costs that are related to the legal matter that has been invoiced. It is only after these three requirements have been met that a firm can realize any income. While the prioritization of revenue allocation can be challenging for firms on its own, it has the potential to become even more challenging when you consider the fact that many legal invoices are paid in installments and not all at once. This is extremely important when building a compensation model for a law firm.
- Create a compensation model that allows flexibility to encourage growth. There are few law firms out there that aren’t looking to grow and build upon their existing business. Effectively managing compensation within a firm is paramount in growing their business. This means firms need to find tools that allow them to build flexible compensation models that can address a firm member’s ability to grow compensation-wise inside of the firm with little difficulty.
- Make record of the compensation model. At CosmoLex we work with a wide range of law firms that have unique compensation models. It can be difficult to implement a firm’s model inside of a practice management system when they have difficulty explaining it to themselves. For that reason, it is incredibly important that all firms have detailed documentation in place when it comes to their compensation model. Many firms will develop complex compensation models and think that they are doing what is right for all members of the firm, but complexity isn’t always a good thing. A simple-manageable compensation model could be just as effective as one that is complex.
Making Compensation Easy with CosmoLex
Throughout this whitepaper, we have provided information on tracking productivity and the steps associated with setting up an effective compensation model for law firms. Understanding these steps is often easier than accounting for them. This is where CosmoLex can come in and assist firms in making all this work.
Above anything else, it is extremely important that a firm has billing and accounting functions working together to carry out the steps mentioned above. CosmoLex integrates both systems so that they speak together and are always in lockstep with each other.
Addressing Variables Inside of Compensation Models
While an integrated system is important in setting up a compensation model and tracking productivity, there are other variables to consider.
The Individual’s Role
Compensation is tied to both rainmaking and productivity. An originating attorney who brings a client into the firm and works on a legal matter should be compensated for both. Timekeepers’ compensation rates rarely differ based on which matter they are working on, while matter parties such as originating attorney and responsible attorneys’ rates are to be specified for each specific matter. A solid compensation model should provide firm-wide and matter-specific settings. In CosmoLex this can be done when setting up a new matter.
Here is an example where a firm has elected the following default allocations in its global settings:
In this situation, for this specific matter, the allocation for the responsible attorney differs from the global default that had already been set up.
Variations by Client or Matter Type
Firms who successfully track their productivity and income by case type and client will begin to gain insight into the work that goes behind them. This often results in variations to their compensation models that suggest work in different practice areas or for different clients may call for different compensation rates. For this reason, it is important to have the matter level flexibility offered by CosmoLex.
Part of managing a law firm is keeping those who work for the firm happy. All members of the firm need to feel that they are being treated fairly or the firm will not get the most out of them, or even worse lose them. Setting up a compensation model that is based on objective calculations ensures that all contributors feel that they are treated fairly.
Automation Is the Key To Creating A Successful Compensation Model For Law Firms
If you have made it to this point you understand how complicated compensation models for law firms can be. Handling all the different steps and aspects of creating these models successfully is nearly impossible without the help of technology that automates many of these processes.