By Shawn Lehocky and Bryan Reilly
Contingency law firms are businesses. They’ve always been, and they need to be run like one.
Not having any sense of which aspects of your firm’s marketing and intake operations are working as intended is no way to run a business.
A profitable business is a growing business. But how can contingency firms know, at any given time, whether they are profitable?
Even if the equity partners of a contingency firm fancy themselves as members of a noble profession and not owners of a business, if they don’t run their firm effectively or delegate that task to a qualified colleague, they won’t be able to make payroll or invest in their clients’ matters, and most importantly, they won’t have a law firm that’s open for business to serve their clients. Those equity partners owe it to their clients and colleagues to keep their firm open by keeping it profitable.
As the chief executive officer and the chief financial officer of the largest workers’ compensation and disability law firm in Pennsylvania, we feel that same responsibility. We owe it to our clients, staff, and attorneys to keep our firm running and profitable. We do that in part by having access to data that shows us how well our firm is doing financially at any moment in time. That data will tell us if our law firm is running at a profitable clip, and if so, how profitable it is. After all, our firm cannot fight for our clients if it is no longer in business.
Naturally, our desire to see a snapshot of our firm’s profitability at any given time begs a number of questions. What metrics do we need real-time access to so that we can see our firm’s profitability at any given time? What is the relationship between each of those metrics? What data would we need in our accounting, practice management, and client relationship management systems to feed those metrics?
The role of key performance indicators at law firms
In business jargon, the metrics we’re in search of would be considered “key performance indicators,” or KPIs.
A KPI is a quantifiable measure of performance, tracked over time, providing objective evidence of progress or the lack thereof. It measures what needs to be measured in order for progress to be made. It serves as a guide for everyone in a business who needs and wants to make better decisions. A KPI can be an early indicator of future revenue and profit. For example, if you know that for every ten prospective clients, you will on average engage three clients whose matters will each yield your firm on average $7500 in fees, you can predict how much revenue your firm will bring in based only on how many prospective clients you have at any time.
Law firms of all types should be profit-generating entities. They can and should benefit from the use of KPIs just like other businesses do. By using KPIs, firms can assess how well they are performing against measurable goals. They can determine who in the firm is responsible for its successes or failures. And they can track specific results over time, particularly a firm’s advertising, marketing, and intake efforts, making it easier to predict which efforts will work in the future.
Sometimes, KPIs will vary from law firm to law firm. A volume personal injury law firm may consider the number of calls from prospective clients to be a KPI. A catastrophic personal injury firm may consider the number of referral sources who referred the firm a case within the last 90 days to be a KPI. An immigration boutique might consider the number of downloads of a foreign language e-book or brochure to be a KPI.
But other KPIs should be universal. All law firms can benefit from knowing what their average fees are for particular types of matters, along with the number of matters coming in from referrals, web searches, social media, and other sources. The “win rate” of its attorneys would be helpful to track too.
The single equation you can manage your contingency law firm with?
For some time now, we have been working on what we believe is the holy grail for managers of contingency law firms: a single equation that brings together many of a firm’s most important KPIs and which outputs a number that gives those managers a snapshot of how their firm is doing financially with respect to the firm’s net income.
After much trial and error, here is our current iteration of that equation:
Prospects x Contact % x Qualified % x Retained % x Fee Generating % x Average Fee – (Fixed + Operational Expenses) = Net Income
Each variable represents a key metric that can be used to plan, predict, and determine the future revenue and profitability of a firm:
- the number of prospective clients,
- what percentage of those clients have been contacted,
- what percentage have been qualified as potential clients,
- what percentage have been retained,
- what percentage have fee-generating matters, and
- the average fee generated, minus the firm’s fixed and operational expenses.
Here’s an example of how the equation might look for a relatively new solo contingency firm:
52 (prospects) x 85% (Contact %) x 45% (Qualified %) x 75% (Retained %) x 80% (Fee Generating %) x $5000 (Average Fee) – $35,000 (Fixed + Operational Expenses) = $24,670 (Net Income)
The equation provides a result that tells arguably the most important story possible for a law firm—its estimated net income. That in and of itself is an important feature of the equation.
However, that is only one piece of important information the equation provides. In addition, the equation’s variables interact with each other in the form of ratios to tell their own stories that can uncover weaknesses in a firm’s marketing and intake processes, as well as its delivery of legal services.
In addition to the results from the equation, here are five ratios involving the equation’s variables that contingency firms should pay close attention to:
1. % Qualified / Prospects. Casting a wide net with advertising and marketing to bring in a high volume of prospective clients may be beneficial to contingency firms in some ways and will be expensive in others. But most firms will only want to bring in prospects who actually need their services, and whom the firms have the desire and ability to serve.
Each firm should have a set of basic qualifying questions to determine whether a prospect should move forward through the firm’s intake funnel and ultimately speak with an attorney. This ratio helps a contingency firm determine whether its advertising and marketing are attracting the right kind of prospects for its firm, and whether its intake efforts are effective in qualifying prospects.
2. % Retained / % Qualified. By indicating what percentage of qualified prospects actually sign on as clients, this ratio shows a contingency firm’s closing rate. This ratio will make it clear whether a firm’s intake team is doing its job, and whether the staff members or lawyers the firm deems are its “closers” are actually closing new clients.
3. % Fee Generating / % Retained. This ratio measures the quality of a contingency firm’s inventory and will help explain whether it is qualifying and retaining the right cases. If it is, this number should be high. This number will never be 100% because there will be natural attrition of clients no longer interested in pursuing a claim, passing away, or otherwise no longer capable of representation, as well as the (hopefully few) client matters for which there is no recovery. That said, a 100% ratio should always be the goal. If a contingency firm thinks its ratio seems low, that is an indication that it is accepting too many low-quality cases. This results in the unfortunate reality of paying operating expenses and investing in litigation costs that will never generate a return.
Managers of contingency firms should focus their efforts on continuously increasing the total fees per case by pursuing aggressive strategies to maximize the value of each case. At contingency firms, a client’s interests are generally aligned with those of the firm. For that reason, maximizing case value is almost always in the best interests of both a client and a firm.
4. Operational Expenses / Fixed Expenses. Every contingency firm should have an annual budget made up of fixed expenses like rent and variable expenses like advertising. Firm managers should be aware of their firms’ expenses and consistently evaluate them. Further, if revenue does not meet expectations, they should know the variable expenses they can reduce to maintain their profitability goals. Firm managers should also manage the return on these expenses by identifying whether incurring particular expenses can lead to more profitability—and then adjusting that spending accordingly.
5. Net Income / Revenue. Sometimes, a significant amount of gross revenue earned from fees does not flow down to net income. This ratio measures a combination of a contingency firm’s front-of-the-house expenses, operations expenses, financial discipline, and reinvestment levels.
The systems behind the equation
Building this equation and sourcing its inputs has major implications for a contingency firm’s data gathering and information systems.
To track these KPIs, a firm should create internal management dashboards with the KPIs in mind. To the extent possible, the dashboards should have automation built in to avoid human error. “Garbage in, garbage out” is inevitable if the data gathering and information systems powering the equation are ineffective.
Additionally, when building additional reports based on the dashboards, managers should always ask themselves: “What question are we trying to answer?” They should then work backward to make sure they are pulling data that answers that question.
The equation can do a lot—but not everything
There’s one caveat to the equation. It can alert law firm management to a developing problem or successful endeavor, but it may not be able to pinpoint the root cause of the problem or success. It can only provide the general direction to go in order to investigate further.
In the equation, there is a relationship among the variables, but each needs to be evaluated independently. It is generally best to work your way through the client acquisition pipeline, starting at the top. Each variable downstream is largely contingent on variables before it. Problems at the beginning of the pipeline get magnified as they work through the system.
For example, a contingency firm might notice that its % Retained / % Qualified ratio, which represents the percentage of prospects who retained the firm out of the number of qualified prospects, had increased over the past year. This metric would indicate that something had changed, but it could not tell what caused the change. The data could only direct the firm’s operational team to where to look.
The team could find, for example, that the conversion rate increased in cases where the firm brought in a name partner to close a prospect or that in certain cases, bringing in a diverse team of partners and associates led more prospects to retain the firm. Or, as we just alluded to regarding working your way through the pipeline, perhaps the firm is simply doing a better job creating more effective marketing that attracts better prospects, or perhaps the firm is doing a better job contacting prospects.
Additionally, it is helpful to compare problematic statistics to historical data, to the extent the latter is available. For example, if a contingency firm’s retained percentage has historically been 75% with a standard deviation of +/- 5%, and in the current month it is 60%, that is an indication that something in the system MAY be wrong. This type of benchmark is good for quickly identifying anomalies and pointing management in the direction of the likely source of a problem.
Putting the equation to work
Interestingly, any one of the equation’s variables can sink a contingency firm, no matter how well the other parts of the business may be operating.
For example, consider expenses. A contingency firm could have the best “front of the house,” turning a solid percentage of possible cases into fees. But if the firm’s expenses are out of whack, the firm gains nothing from those cases and may actually lose money.
Alternatively, a contingency firm could bring in prospects with high-quality cases, convert them at a high rate to actual clients, and turn the work into fees. But if the firm has the wrong lawyers or staff handling the cases and does not receive full value from them, it could be leaving additional revenues (and profits) on the table.
Every aspect of a contingency firm is connected: from marketing, to intake, to delivery of legal services. Contingency firms must not lose track of that and must have feedback loops from every department represented by the variables in the above equation for it to serve its purpose.
In addition, every variable in the equation needs to be vigilantly monitored. All relevant departments in a contingency firm should be unified in looking at the equation’s comprehensive KPIs and taking action based on what they show.
If that occurs, this equation may truly be the single equation you can manage your contingency law firm with.
(We love talking to other law firm executives and equity partners about how they can better manage their law firms by more closely tracking KPIs and implementing the above equation. If you are interested in learning more about either, please contact us. We’d love to chat.)
Shawn Lehocky is the chief executive officer of Pond Lehocky Giordano LLP. Bryan Reilly is the firm’s chief financial officer. They can be reached at firstname.lastname@example.org and email@example.com, respectively.
Reprinted with permission from the January 14, 2022 edition of The Legal Intelligencer © 2022 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited, contact 877-257-3382 or firstname.lastname@example.org.