2012 Redwood Analytics® User Conference Analysis. Insight. Action. Profitability 101 What They Don’t Teach in Law Schools Chris Burgess Consultant, Redwood Analytics

2012 Redwood Analytics® User Conference Analysis. Insight. Action. Agenda Profit Drivers Hours Based Revenue Partner Comp Attorney / Client View Cost Basis Q&A

2 Looking at Profit The success of your firm cannot be assessed through hours or billings alone Profitability is the true measure of success It’s about more than just firm profit, or profits per partner

3 Profitability Drivers: Overview FeeCapacityRevenueContributionMarginOperatingProfitNetIncome Capacity DirectCosts O/H Investment costs 6. Client Investment Speed (Time Value of Money) 1. Standard Value of Production 3. Realization2. Utilization 4. Leverage 5. Margin Business Model of a Law Firm

2012 Redwood Analytics® User Conference Analysis. Insight. Action. Hours Based Revenue

5 Methodology Current month collections Less Current month expenses “Profits”  Matches firm’s financials  Lagging measurement  No client view Expected collections Less Matching time period expense Expected profits  Unfamiliar  Captures all profit drivers  Leading measurement  Client profitability Cash BasedHours Based

6 Methodology—Expected Collect Amount What has happened? – Discounting – Writeoffs What can happen? – At-risk WIP – At-risk AR

7 Bill Risk Collect Risk Writeoffs Expected Collect Amount Discounting Standard Amount Expected Collect Amount

8 Expected Collections— Forward Realization Curves

9 Expected Collect Amount ValueRate Value of standard (Hours worked X standard rate) $36,350,000$302 Discounting: hours & rate-$1,853,000-$15 Write-offs-$176,000-$1 Billable amount$34,321,000$286 FORWARD REALIZATIONS Bill risk adjustment *-$342,000-$3 Collect risk adjustment **-$1,345,000-$11 Expected amount$32,634,000$272 * Unbilled total: $1,995,445 ** Uncollected total: $4,237,212

10 WIP Losses Client discounts Alternate billing arrangements Written down hours Time never billed A/R Losses Bills never collected Write-offs Partial payments Zero payments Realizations

11 Intended vs. Effective Discounts Intended discountEffective discount

12 Direct Margin Expected amount Less: Direct costs Direct margin Equivalent to contribution margin or gross profit “Starting point” to view client profitability Includes all costs directly attributable to client

13 Net Margin Direct Margin Less: Indirect Costs Net Margin Captures all firm costs except: – Time Value of Money (TVM) – Discretionary attorney compensation Bonus Excess of partner cap

2012 Redwood Analytics® User Conference Analysis. Insight. Action. Partner Comp

15 Cost Methodology—Partner Comp No partner comp Clarity of “available” profits Client & partners’ profit linked Doesn’t encourage leverage Obscures intra-rank information Eliminates meaningful comparisons Fully loaded comp Includes leverage Aligns attorney comp with client base Eliminates arbitrary cap Partners’ work = unprofitable Defining result hampers analysis NoneFullyLoadedPartiallyAllocated

16 Cost Methodology—Partially Allocate Standards Maintain relative relationships Non-arbitrary approach Analytic clarity Approach Capped direct-cost rates Allocation to client Management excluded Bonuses excluded Fully loaded costs in model NoneFullyLoadedPartiallyAllocated Models: Simplified accurate view of reality

17 Partner Compensation Total Partner Compensation Arbitrary Comp Adjustment Management Comp Partner Cap – Comp Adj. PORTION OF PARTNER COMP ALLOCATED TO DIRECT COSTS

18 Partner Cap - Comp Adjustment

19 Leverage Shifting work down to lower-level timekeepers Firm source of profits other than partner work Enhances client profitability Enables “growing of the pie”

20 Real Life Leverage Hours WorkedLast Year %Current Year % Partner Other Timekeepers1577 All Work Attorney Titles Leverage7%32% Std Rate Std. Amt$111,605100%$108,209100% Direct Costs($120,074)-108%($21,693)-20% Direct Margin($8,469)-8%$86,51680% Indirect Costs($46,992)-42%(43,657)-40% Net Margin($55,461)-50%$42,85940% $98,000 more profitable No leverageSome leverage Less Revenue Less Cost

2012 Redwood Analytics® User Conference Analysis. Insight. Action. Attorney / Client View Cost Basis

22 Client/Attorney View Basis of Cost Allocation Indirect and Direct Cost Allocations Attorney View = Actual Hour cost basis Client View = Std Hour cost basis

23 Cost Allocation Basis Separates utilization Matter based profitability Focus on client/matter drivers, not work effort Includes utilization Attorney based profitability Individual performance focus Standard Hours Actual Hours “Cost rates” … the cost of a billable hour

24 Methodology—Profitability Dimensions Matter-based Attorney-based Client & matter Billing (responsible) attorney Area of law Arrangement DepartmentOfficeTimekeeper title & class Workingattorney Utilization Bridge

25 Profit Methodology Overview 3 key points 1.Cash vs. forecast cash Expected collect amount 2. Cost allocations Partner comp allocation Standardized actual hour costs 3. Attorney/Client View Addresses the impact of utilization

26 Conclusion—How To Effectively Use It Understanding the methodology is essential Methodology must be clearly communicated to key individuals True profitability analysis demands a holistic approach Monitor key drivers and identify areas of improvement and opportunity

27 Questions?