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Key Financial Performance Measures
18 August 2014
KPMs – Then and Now
Presenter:
Mark Medice
Senior Director
Peer Monitor
Program
3
If the rate of change on the outside
exceeds the rate of change on the inside,
the end is near.
- Jack Welch
4 4 4
Themes in our Discussion - Industry
• Overall industry law firm demand remains flat, creating
pressure on firms to take market share from each other
• Demand continues to shift in-house and to LPOs
(especially for litigation)
• Bright spot for the industry has been the improvement
in transactional practices like corporate, M&A and real
estate, up over 4 percent as a group
• Change is happening but the debate rages about the
level and type (e.g., step-change, disruptive,
incremental)
5
KEY QUESTION
Is the current economic environment a
“blip” (a normal phase of the business
cycle) or a harbinger of more fundamental
and long-lasting changes in the
legal market?
6
Today’s Discussion
• Legal Industry Trends
• Basis for Change
• New Metrics
Legal Industry
Trends
8
-9%
-6%
-3%
0%
3%
6%
9%
Q1'07
2 3 4 Q1'08
2 3 4 Q1'09
2 3 4 Q1'10
2 3 4 Q1'11
2 3 4 Q1'12
2 3 4 Q1'13
2 3 4 Q1'14
2
Y/Y % Change
All Segments - 7-Year Pattern for Demand Growth
All timekeepers
Billable time type
9
-9%
-6%
-3%
0%
3%
6%
9%
Q1'07
2 3 4 Q1'08
2 3 4 Q1'09
2 3 4 Q1'10
2 3 4 Q1'11
2 3 4 Q1'12
2 3 4 Q1'13
2 3 4 Q1'14
2
Y/Y % Change
Rough timeline of
US Recession
All Segments - 7-Year Pattern for Demand Growth
Credit Crisis
All timekeepers
Billable time type
11 11 11
PERFORMANCE BY SEGMENT
12
2014 YTD Demand by Segment
-5% 0 5% Percentage Growth Scale
Mid-Size (-0.8%) Am Law Second 100 (2.7%)
Am Law 100 (-0.1%)
Note: Results for June YTD 2013, AL100 was -1.5%, AL200 -1.4%, Mid-Size -3.2%, with
all segments improving over prior year, while the second 100 continues the trend as
segment leader.
All timekeepers Billable
13 13 13
SEEPAGE
14 14 14
Firms Losing Share to In-house Resources
* 2012 ACC Census
45%
69%
35% 30%
40%
65%
28%
20%
Intellectual Property Litigation M&A Tax
Declining Workloads to Outside Counsel
2006 2011
Work traditionally handled by outside counsel is now staying and managed within the
corporate legal department. What work is being done in-house rather than with outside
counsel?
15
Overview of LPO Market LPO Market Size and Future Growth
$0.64
$0.85
$1.10
$1.43
$1.86
$2.42
$0.0
$3.0
2010 2011 2012 2013 2014 2015
Ma
rke
t S
ize
($
B)
Forecast
Source: The 2013 Legal Outsourcing Market Global Study & TR Strategy Analysis
Current LPO market represents only a fraction of potential market;
robust future market growth of 30% is expected through 2015
Current LPO Market Size
$400B
Global Legal
Services
Market
$20B
“Outsourceable”
Legal Work
$1.1B
LPO Market
LPO Market Growth
16 16 16
VARIABLE PERFORMANCE
17 17 17
1H2014 v 1H2013 Demand Growth by Firm
-20%
-15%
-10%
-5%
0%
5%
10%
1H'14 v 1H'13 1H'13 v 1H'12
Y/Y % Change
2013 Std Dev: 10.9% 2014 Std Dev: 7.1%
•56% firms in positive territory in 2014 compared to 37% in 2013
• 2.6 firms flipping positive for every negative in 2014
Note: Firms with positive growth are experiencing
average of 4.6% during 1H2014V1h2013 in contrast to
those in negative territory experiencing -5.5% All timekeepers Billable
18 18 18
PERFORMANCE BY PRACTICE
19
Proportion
All Segments Practice Demand
-10%
-8%
-6%
-4%
-2%
0%
2%
4%
6%
8%
10%
Tax Corporate(all)
RealEstate
Labor/Employment
Litigation PatentLitigation
Bankruptcy
Gro
wth
(%
)
Y/Y % Change
Q2'14 v Q2'13
3% 23% 6% 10% 31% 5% 2%
All timekeepers Billable time type M&A June: 5.8% // Q2: 1.4% // YTD: 3.7% (prop: 3%)
20
Proportion
All Segments Practice Demand
-10%
-8%
-6%
-4%
-2%
0%
2%
4%
6%
8%
10%
Tax Corporate(all)
RealEstate
Labor/Employment
Litigation PatentLitigation
Bankruptcy
Gro
wth
(%
)
Y/Y % Change
YTD June: '14 v '13
3% 23% 6% 10% 31% 5% 2%
All timekeepers Billable time type M&A June: 5.8% // Q2: 1.4% // YTD: 3.7% (prop: 3%)
21 21 21
TRANSACTION CONTINUED STRENGTH
22 22 22
1H2014 v1H2013 Demand Growth by Firm – Transactional
-20%
-10%
0%
10%
20%
30%
1H'14 v 1H'13 1H'13 v 1H'12
Y/Y % Change
2013 Std Dev: 9% 2014 Std Dev: 10%
•66% firms in positive territory in 2014 compared to 42% in 2013
• 2.4 firms flipping positive for every negative in 2014
Note: Firms with positive growth are experiencing average of 8.7% during
1H2014V1h2013 in contrast to those in negative territory experiencing -5.5%. All timekeepers Billable
23 23 23
1H2014 v1H2013 Demand Growth by Firm – Transactional
-20%
-10%
0%
10%
20%
30%
1H'14 v 1H'13 1H'13 v 1H'12
Y/Y % Change
2013 Std Dev: 9% 2014 Std Dev: 10%
•66% firms in positive territory in 2014 compared to 42% in 2013
• 2.4 firms flipping positive for every negative in 2014
Note: Firms with positive growth are experiencing average of 8.7% during
1H2014V1h2013 in contrast to those in negative territory experiencing -5.5%. All timekeepers Billable
•Similar to All Practices; demand in Q2 2014 was more muted than
Q1 2014.
•In Q2 2014 64% firms are in positive territory in 2014 compared to
55% in Q2 2013.
•1.4 firms flipping positive for every negative in 2014.
24 24 24
TOP PERFORMERS
25 25 25
2014 Top Performer Methodology
2010-2013 CAGR. Positive performance in all 5 metrics
1. Revenue per Lawyer
2. Gross revenue
3. Gross profit
4. Profit as a percent of revenue
5. Profit per partner
Developed a 5-variable matrix
– Scored each variable based on positive quintile performance
(scale of 1 to 5)
– Summed each firms to get a composite score
– Firms with a composite score in the top percentile determined
to be 2014 Peer Monitor top performers
Sample: 16 Top Performing Firms*
*7 of these firms (~45%) were in the 2013 Top Performing Firms sample (based on 2-years positive PPP performance above the
median.
26 26 26
Top Performer’s Early Findings
• They push rates harder even if they discount more.
• Their utilization levels are higher, especially at the
partner level.
• Their expenses are balanced to revenue, meaning they
are typically not lower than market averages, but are
balanced for revenue growth
– They make investments / revenue focused.
27 27 27
UTILIZATION
28 28 28
All Segments - Hours per Lawyer
70
80
90
100
110
120
130
140
150
Q1'05
2 3 4 Q1'06
2 3 4 Q1'07
2 3 4 Q1'08
2 3 4 Q1'09
2 3 4 Q1'10
2 3 4 Q1'11
2 3 4 Q1'12
2 3 4 Q1'13
2 3 4 Q1'14
2
Ho
urs
pe
r M
on
th
All Lawyers
Lawyers Only Billable time type
29 29 29
All Segments Hours per Lawyer
70
80
90
100
110
120
130
140
150
Q1'05
2 3 4 Q1'06
2 3 4 Q1'07
2 3 4 Q1'08
2 3 4 Q1'09
2 3 4 Q1'10
2 3 4 Q1'11
2 3 4 Q1'12
2 3 4 Q1'13
2 3 4 Q1'14
2
Ho
urs
pe
r M
on
th
Equity Partners Non-Equity Partners Associates
Of Counsel Sr/Staff Attorneys All Lawyers
Lawyers Only Billable time type
32 32 32
REALIZATION
33 33 33
All Segments Realization against Standard
82%
83%
84%
85%
86%
87%
88%
89%
90%
91%
92%
93%
94%
Q1'05
2 3 4 Q1'06
2 3 4 Q1'07
2 3 4 Q1'08
2 3 4 Q1'09
2 3 4 Q1'10
2 3 4 Q1'11
2 3 4 Q1'12
2 3 4 Q1'13
2 3 4 Q1'14
2
Billing Collection
Lawyers Only Billable time type
1.1% Gap
3.0% Gap
1H 2014 All Segment Collected Rate Growth 2.7% and 5.5% for Q2 2014 v Q2
2013
35
-9%
-6%
-3%
0%
3%
6%
9%
12%
15%
18%
21%
Q1'07
2 3 4 Q1'08
2 3 4 Q1'09
2 3 4 Q1'10
2 3 4 Q1'11
2 3 4 Q1'12
2 3 4 Q1'13
2 3 4 Q1'14
2
Rolling 12-Month (Y/Y % Change)
Direct Overhead
All Segments - Expense Growth (Total)
Basis for Change
37 37 37
A HARBINGER OF FUNDAMENTAL CHANGE
• There is mounting evidence that we are seeing a
fundamental shift in key aspects of the traditional law
firm model.
• This change was not caused by the current downturn,
but it has been accelerated and exacerbated by it.
• The cause of the change we are seeing was the
essential unsustainability of the old law firm economic
model.
38
DRIVERS OF LAW FIRM PROFITABILITY
Leverage
Rates
Realization
Expense Management
Profitability
Productivity
39
DRIVERS OF LAW FIRM PRODUCTIVITY
Leverage
Rates
Realization
Expense Management
Profitability
Productivity Productivity: •Declining steadily since the late
1990’s.
•Driven by associate pushback to
unsustainable billable hour require-
ments.
•Aggravated by a “seller’s market”
for talent that drove up salaries as
productivity declined.
40
DRIVERS OF LAW FIRM PROFITABILITY
Leverage
Rates
Realization
Expense Management
Profitability
Productivity
Leverage: •Struggle to maintain leverage as:
•Firms hired more associates
to make up for declining produc-
tivity and
•Firms made partners at a faster
pace than the firms were growing.
•Most firms sustained or grew their
leverage but at a very high cost.
41
DRIVERS OF LAW FIRM PROFITABILITY
Leverage
Rates
Realization
Expense Management
Profitability
Productivity Realization: •Dropping fairly steadily in years just
prior to downturn.
•Reflected increasing client demands
for discounts and resistance to
“premium” arrangements.
42
DRIVERS OF LAW FIRM PROFITABILITY
Leverage
Rates
Realization
Expense Management
Profitability
Productivity Expenses: •During years prior to downturn,
expenses grew at a much faster rate
than inflation.
•Principal driver was rapidly escalating
associate salaries – followed by space
and technology costs.
43
DRIVERS OF LAW FIRM PROFITABILITY
Leverage
Rates
Realization
Expense Management
Profitability
Productivity X
X
X
X
44 44 44
LOSS OF RATES AS A RELIABLE DRIVER OF PROFITABILITY
• Prior to the recession, firms were raising rates at a clip
of 6-8% per year – well ahead of annual inflation rates.
• Had firms not been able to drive these rate increases,
the economics of the “boom years” would have looked
very different.
• Partly as a result, the overall costs of legal services
grew exponentially – ultimately to a point that strong
client resistance became inevitable.
45 45 45
Percentage Change in Legal Market Revenues vs. Inflation (1999-2008)
Source: U.S. Census Bureau: Service Annual Survey and U.S. Bureau of Labor Statistics
46 46 46
A BUYER’S MARKET FOR LEGAL SERVICES
• For the foreseeable future, we are likely to have a
buyer’s market for legal services in which clients
increasingly focus on overall value.
– Little tolerance for “routine” rate increases.
– Expanding use of competitive proposal processes.
– For billable hour based matters, increasing demands for
discounts, blended hourly rates, capped fees, multi-year fee
arrangements, etc.
– Expanding use of alternative (non-hourly based) pricing
arrangements.
– A growing determination to bring the economic interests of the
client and the law firm into better alignment.
47 47 47
INCREASED FOCUS ON EFFICIENCY
• Clients will be increasingly focused on
considerations of efficiency and cost effectiveness.
– Prime evidence – growing willingness of many clients to
“disaggregate” legal services.
• Firms will need to respond by implementing new
models for –
– Pricing legal services
– Designing and managing better legal work processes
– Recruiting, managing, and retaining professional talent and
– Partnering with other service providers to improve efficiency
in service delivery.
48 48 48
NEED TO REDEFINE “COMMODITY” WORK
• The new models may require firms to re-think their
willingness to undertake “commodity” work.
• Client focus on efficiency, combined with increasingly
sophisticated technology, may well force a redefinition
of “commodity work” – and underscore the importance
of all firms being able to deliver more standardized
work products along with their more specialized
services.
49 49 49
NEED FOR STRONG LEADERSHIP
• The need for strong and insightful leadership in law firms has never been greater.
• The world has changed. Focus on growth and expansion that drove law firm strategic and management decisions for the decade preceding 2008 has been replaced with a different imperative – the necessity of focusing on efficiency in the delivery of legal services.
• Adapting to this change will require significant shifts in law firm culture and a fundamental reorientation in the way law firm leaders think about their businesses and their roles.
New Metrics
51
THE NEED FOR BETTER PERFORMANCE
METRICS
52 52 52
MEASURING AGAINST THE NEW MODELS
• If “what gets measured gets done,” the change in law
firm models that we predict over the next few years will
necessitate new measurement tools to help law firm
leaders (as well as their clients) judge the performance
of lawyers and their firms.
• It will take time for new metrics to be developed and
adopted across the market, but some firms have
already begun experimenting with a variety of tools that
show promise.
53 53 53
Chart 11 Current and Possible Future Performance Metrics
A number of the metrics that we list
as “possible future” measurement
tools are already being used in
several firms and by banks,
consultants, and other service
providers to the legal market.
54 54 54
Measurement Categories
• Firm Performance
• Expense Management
• Practice Management
• Partner Performance
• Client Development/Market Strength
• Balance Sheet/Risk
• Management and Leadership
55 55 55
Firm Performance
Movement towards organizational efficiency and better asset management
measures that consider returns relative to risk
Possible Future Metrics Drivers of Change Today’s Key Metrics
•Profits per Equity
Partner
•Profits per Partner
•Revenue per Lawyer
•Profitability Index
•Leverage
•Changing leverage
models
• Increased
transparency of law
firm financials
•External ownership
•Multidisciplinary
practice
•Profit per Employee
•Matter Profitability
•Return on Capital /
Return on Equity
(accrual basis)
•Risk-adjusted
performance
•Profit in excess of
partner “salaries” /
Profit per Share
•Value of Income
Stream
56 56 56
Expense Management
Pressure to reduce costs in short term and improve cost-structure long term to
account for efficiency and returns
Possible Future Metrics Drivers of Change Today’s Key Metrics
• Expenses per Lawyer
• Staffing Ratios
• Functional Expenses
per Lawyer
• Changes in staffing
models
• Adoption of more
systematic
procurement models
• Outsourcing of
substantive legal work
• Efficiency Index
• Return on Assets
• Employees per $
Million
• Compensation per $
Million
57 57 57
Practice Performance
New pricing models and greater accountability at matter / practice Level
Possible Future Metrics Drivers of Change Today’s Key Metrics
•Fees & Growth
•Realization
•Utilization
•Leverage
•Matter Profitability
•Alternative pricing
•Performance
pressure
•Matter Contribution
to Profit / Margin
•Practice Contribution
to Profit
•Profit per Practice
Member
•Profit per Employee
•Market Share
•Extended Leverage
•Profit Contribution
by Client Decile
58
Partner Performance
New pricing models and increased need to maximize firm performance
Possible Future Metrics Drivers of Change Today’s Key Metrics
•Originations
•Working Attorney
Fees
•Realization
•Billable Hours
•Leverage
•Alternative pricing
•Performance
pressure
•Staffing model
changes
•Profit per share of
practice managed
•Total profit of work
originated/managed
•Unit cost of work
originated/managed
•Client satisfaction
Rating
•Employee
satisfaction Rating
•Cross-selling /
Cross-working
59 59 59
Client Development / Market Strength
Shifting power balances and more savvy consumers of legal services
Possible Future Metrics Drivers of Change Today’s Key Metrics
•Client Turnover Rate
•Client Diversification
Index (e.g., percent
of revenue produced
by top 10 clients)
•Fee Growth
•Realization
•Originations
•Pricing pressure
•Client retention
issues
•Use of “dual-
counsel” situations
• “Brand” Strength
•Wallet Share for
Target Clients
•Growth in Share for
Target Clients
60 60 60
Balance Sheet/Risk
Changing partnership models, industry consolidation
Possible Future Metrics Drivers of Change Today’s Key Metrics
• Capital per Partner
• Debt per Partner
• Debt / Equity Ratios
• Debt / Net Fixed
Assets Ratio
• Changes in staffing
models
• Lower risk tolerance
of banks
• Increase in capital
needs as to fund
investments
• Value Index / Firm
Valuation
• Return on Capital
• Risk Index (use of
debt, capital,
performance over/under
market, etc.)
61 61 61
Management & Leadership
Acceleration towards more sophisticated management needs & smarter
approaches to managing human capital
Possible Future Metrics Drivers of Change Today’s Key Metrics
•PPEP Growth
•Fee Growth
•Turnover
•Firm rankings
•Continued industry
consolidation and
competition
•Smarter approaches
to measuring and
deploying human
capital
•Market Share
Growth
•Leadership Index
•Client Satisfaction
index
•Return on Human
Capital
•Employee
Satisfaction Index
•Management Value
Index (“value” /
“cost”)
62 62 62
MEASURING AGAINST THE NEW MODELS
• Going forward, measuring the health and effectiveness
of law firms will require the use of several new
measurement tools for both financial and non-financial
performance assessment.
• One of the serious misuses of metrics in the past few
years has been over reliance on PPEP as the defining
index of a firm’s value and quality.
• In the future, more flexible and comprehensive tools will
be required.
