Budget season is nearly upon us, which means that legal professionals across the industry are currently looking hard at their spending, most likely defending existing investments and lobbying for new investments. However, as many of us know, making the case for investment in the firm can be particularly challenging.
It is difficult to escape the fact that driving profitability in a law firm (or any professional services firm) is intrinsically tied to the tight control and management of overhead expenses. To break down the profit equation, profit can be shown as:
Revenue= Hours Billed and Realized x Average Hourly Rate
Expense = Hours Worked x Hourly Cost + Overhead Costs
Profit = Revenue – Expense
 Ignoring AFAs for the purposes of this discussion.
It’s a pretty simple concept: as overhead expenses increase, profit drops. And make no mistake, any expense that doesn’t lead directly to billing a client is an overhead expense — including investments in research, tools, technology, and innovation.
That does not mean that all overhead expenses are bad — but it does mean that those expenses require justification. As an example, let’s assume the following:
- A firm’s corporate clients are pushing back on the prices for manual review of documents in an M&A transaction.
- A typical engagement for the firm takes 250 hours to complete the document review and the firm is only able to bill at $150/hour for those hours.
- The hourly cost (fully loaded) of the resources is $150/hour; on other duties they bill at $450/hour.
- The firm conducts 10 such deals each year.
If we do a bit of math with this example, we can calculate the marginal profit of this work as follows:
Revenue = 250 hours/engagement x 10 engagements x $150/hour = $375K
Expense = 250 hours/engagement x 10 engagements x $150/hour = $375K
Profit = $375K – $375K = $0
This is clearly not an advantageous scenario for the firm — and it’s actually worse than shown above, because those same attorneys could have potentially been billing at a higher rate on other duties. The revenue lost and opportunity cost of this work can be determined by calculating the revenue that would have been made at the regular billing rate of $450/hour.
Revenue = 2500 hours x $450/hour = $1.125M
Opportunity Cost = $1.125M – $375K = $750K
One can quickly see that the firm in our fictitious example is losing money because the document review work is a break-even effort. Now let’s think about how technology could impact this. What if the purchase of document review software for $100K/year could cut the time required by the attorneys in half? That would free up 1,250 hours (250 hours/engagement x 10 engagements x 50 percent) for which the firm could potentially bill out at the full rate of $450/hour.
Taking those assumptions, we can now calculate the impact to profit:
Revenue = 125 hours / engagement x 10 engagements x $150 / hour + 1250 hours x $450 / hour = $750K
Expense = $375K + $100K (for software solution) = $475K
Profit = $750K – $375K = $375K
This is a fictitious example, but one can see quickly how the math can work to support the purchase of a new technology solution. Realizing the potential value of a solution is just one piece of the puzzle; the process of communicating that value and driving the adoption of the solution within a firm is a very different story.
To get a more concrete sense of how this works in the law firm environment, I sat down with Steve Lastres, Director of Knowledge Management Services at Debevoise & Plimpton LLP, to get insight on how he’s pursued innovation projects.
As we have mentioned in previous articles, an important first step is evaluating your firm’s business priorities to ensure that a new tech solution fulfills a specific use case or adds demonstrable value to help provide better client service. For Lastres, that’s where the process begins. “With so many new innovation products in the legal market, the process starts with the Knowledge Management Services team carefully evaluating and reviewing tech tools where there may be a need or fit to improve the current process,” he said.
From there, Lastres’ team identifies a primary stakeholder — either the chair of the relevant practice group or other partner designee — to sit in on a demonstration of the tool to confirm he/she sees the value, followed by additional pilots for potential stakeholders to confirm that they also find the tool useful. If the tool passes muster, Lastres’ team submits a formal business case to the appropriate committees within the firm for review — but not before one more test.
“The next step is to arrange for a ‘Proof of Concept’ (POC) to confirm the product works as intended in our environment before committing to acquiring the tool,” said Lastres. “If there are tweaks or customizations that come to light during the POC, we can work with the vendor to fix any bugs or contractually obligate the vendor to enhance their tool as a prerequisite to negotiating an agreement.”
After the agreement is finalized, Lastres’ team creates a training and communication plan for the relevant stakeholders to learn how to use the tool and make sure that it is successfully adopted in practice. His team also communicates with its vendors to pass on suggestions for enhancement. Debevoise even has a “KMS Help Line” to provide users with constant support on all of its innovation tools.
While this may seem like a time-intensive process, the checks along the way are necessary to see through successful adoption and reap the benefits of an innovative solution across the firm. Even with a plan in place, innovators may still encounter challenges along the way.
“Lawyers by trade are skeptical and as a profession, lawyering is conservative,” said Lastres. “Therefore, you need to really understand how these tools work in practice and be able to demonstrate the ROI and articulate how the tool improves the existing workflow or process. Focus on what matters to law firm leaders: can the firm generate more revenue by adopting this tool, make lawyers more efficient, or provide better client service?”
Ultimately, the decision to adopt innovative tools typically lies in the hands of a key group of stakeholders within a firm. But with a clear understanding of a firm’s core capabilities, the partners’ priorities, and the firm’s areas of growth, would-be innovators can build a business case for adoption and help to usher in meaningful change.
May Goren Photography
Dean Sonderegger is Vice President & General Manager, Legal Markets and Innovation at Wolters Kluwer Legal & Regulatory U.S., a leading provider of information, business intelligence, regulatory and legal workflow solutions. Dean has more than two decades of experience at the cutting edge of technology across industries. He can be reached at [email protected].