Practice Management: Leverage Your Way To Better Profits

Unleashing the Power
In essence, leverage in a law firm is the ratio of paralegals, associates and other non-owner fee earners to partners (or shareholders). In a firm with seven associates and three partners, the leverage would be 2.3, which is generally considered to be highly leveraged. For a firm with 10 associates and 10 partners, the leverage would be 1. 

Here, it’s important to note that as the leverage decreases, a greater percentage of the firm’s net income must go to partners to maintain or increase their income. Take the following examples:

FIRM A: (Highly Leveraged) Firm B: (Barely Leveraged

2 Partners 10 Partners 

Gross Revenues: $10 M Gross Revenues: $10 M

Net Income = 25% Revenues: $2.5 M Net Income = 50% Revenues: $5M

Each Partner Income: $1.25 M Each Partner Income: $500,000

Source: Law Practice Today

The Impact of Low Leverage
In an eye-opening white paper from Edge International, consultant Sean Larkan shows how low rates of leverage have a marked impact on law firms and their clients. For example, with fewer attorneys to delegate work to, partners are forced to work longer hours and place their focus on billable matters — and less on building long-term business. “Partners are forced to do work that would normally be delegated down to the lowest competency level. This may mean higher write-offs, where certain types of work do not justify high rates, and unhappy clients.” 

Clients don’t fare much better in Larkan’s view. “They pay higher rates for work that used to be delegated … but that is now performed by partners or more senior lawyers, presumably at higher rates. They may also develop concerns that the firm is not providing for future continuity and succession for partners and their work.”

Put the Right People to Work
Seen this way, the path to profitability becomes clear: leverage your work. Send as much work as possible to higher margin associates. Yet, you’ve got to use the right associates. Very ‘young’ associates generally don’t generate enough revenue to create profits. As Tobe Brown, former director of the Utah State Bar, notes in his popular law blog: “The sweet spot for profit comes from experienced associates or other non-partners, whose revenue-to-cost ratio is high.”

In his breakthrough book Identifying Profits (or Losses) in the Law Firm, Robert J. Arndt makes the distinction that even a highly leveraged firm can generate more income for the equity partners as long as associates at the lowest levels are working at their highest productivity. The key, he explains, is to manage your payroll correctly while continuing to bring in work. 

Understanding the “New Leverage”
It’s important to understand that leverage does not simply mean throwing warm bodies into the mix. Before they are profitable, new associates typically require several years of development. With this in mind, some firms are looking at levers other than non-equity workers. These include:

Action Steps
Leverage takes many forms. But at its core is the understanding that tasks should be performed at their cheapest, most effective level of timekeeper. When the entire firm — from associates to senior partners — fully understands the implications of leverage, there is serious potential for improved profitability. Just as important, properly employing leverage can also lead to lower costs of service for clients.

To that end, consider these three steps for building a culture of leverage:

If you have questions about leverage or any other aspect of practice management, please feel free to give us a call.  Our team of highly trained and experienced consultants has a passion for helping our professional clients find ways to better manage the business of their practices.