Is realization all it’s cracked up to be as a law firm performance metric? Calibrate Managing Director David Schaefer recounts a parable.
Shortly after New Year, three Managing Partners of AmLaw 200 firms go to their favorite watering hole to celebrate their firms’ performance for the prior year.
They all had record years in revenue and profits and, after a few drinks, started to get into the weeds as to who managed the past year the best, going through all the usual metrics for firm performance.
When the topic of realization came up, the first MP, with the second-best improvement over the prior year, said that realization improved a couple of points to 98%; the second MP, who had the best improvement over the prior year, said that realization also improved a couple of points to 78%; and the third MP, who had the least improvement over the prior year, said that realization was relatively steady at 90%.
It was not long before the first and second MPs concluded that it was a toss-up between them as to who was the best manager and that the third MP was not in the discussion.
A patron, sitting within earshot, smirked and muttered under his breath, but just loud enough for all the MPs to hear, “It’s conversations like this that led me to believe that lawyers should not be running law firms.”
The MPs, incredulous at the patron’s insolence, but curious about the remark, asked the patron what made him such an authority. Upon learning that the patron is a former COO of an AmLaw 100 firm, the MPs asked for his two cents as to who did the best job.
In any given year, there will be a number of drivers at play that affect realization for a law firm.
Among the more common are:
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- the supply and demand curve for legal services
- where the practice mix of that firm falls within that curve
- billing rates relative to the competition
- leverage, billing and collection discipline
- client relationship management
Also, in a favorable environment for law firms, there will be little to no push-back on billing rates and more law-firm leverage over clients’ requests for discounts.
There are three fundamental problems with using realization as a primary law firm performance metric:
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- Clients are not buying hours
- Not all hours billed are equal in value
- Billing rates in most firms are largely divorced from the cost of delivering legal services
Realization used to be a reliable indicator of good management when:
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- legal fees were not a meaningful line item on a clients’ P&L
- law departments did not challenge or have the authority to challenge law firm billing rates and fees
- there was little to no transparency as to the billing rates and fee structures among law firms
- it was assumed that most legal services had to be bespoke
- alternative fee arrangements were largely the province of plaintiff’s firms in tort litigation
- project and process management were the province of manufacturing businesses
- RFPs for legal services were limited to government work
But all that was several decades ago.
This is not to say that realization has no place in making evaluations with respect to gauging how well a firm, a department, a practice group or even a partner’s practice is performing, especially if it is chronically low or declining. But there are many other factors at play.
So back to the bar…
The COO turns to the first MP, the one with the 98% realization.
“Twenty-plus years ago you’d be canonized as law-firm leader of the year. Today, and in this environment, I would have the following concerns. First, I think it’s more likely than not that your billing rates are too low relative to your market position. This means that you left a lot on the table. Given your apparent prioritization of realization, I would surmise that many, if not virtually all, of your partners have resisted increases to billing rates so as to keep realization high. Finally, if that’s true, it is likely that the goal of 100% realization has been incorporated into the behavior of all timekeepers and therefore they are likely under-recording their billable time from time to time so as to appear to be uber-efficient and short circuit any reason to write off their time before it is billed and any argument by the client that the invoice should be discounted because of excessive time.”
The COO then turns to the second MP, the one with 78% realization and the best improvement over the prior year.
“Very impressive to rack up those profits with that realization. Your lawyers must have been working their tails off. Since this level of realization does not appear to be an aberration, then you may have some significant issues to address. If your billing rates are not too high on a practice-by-practice basis, then there may be significant issues with leverage, project and process management and billing and collection discipline. If your billing rates are too high relative to your practice areas or clients, then it might be steep discounts to get business. Not unusual, but then there may be an issue of a relatively high attorney expense relative to the revenue and a slippery slope to keep growing revenue.”
The COO finally turns to the third MP, the one with 90% realization and the least improvement over the prior year.
“Ninety percent realization should put your firm at the top in that statistical category. High realization coupled with high and consistent results year over year strongly suggests that it’s not likely that there are any major operational issues to address. In my view, the best managers are those that get the most out of what they have on a consistent basis. Therefore, my vote is that you’re the best among your colleagues.”
The third MP thanks the COO, the first MP remarks that the COO is smug and arrogant, and the second MP offers the COO a job as CEO of his firm.
About the Author
David S. Schaefer is a Managing Director with Calibrate. A former Managing Partner of an Am Law 100 law firm, David advises law firm leaders and COOs on how best to align the practice of law and business of law to best push forward a firm’s culture, vision and strategy.
