Why is “Profitability” So Important?

Aderant Think Tank

Why is “Profitability” So Important?

If you had to choose one metric that reflected your firm’s overall health, would it be revenues or profits? Firms often make the mistake of focusing just on revenues, operating under the assumption that greater revenue means greater profitability when, in fact, their profitability is the key metric.

Why do revenue totals receive so much attention? According to Edge International Consultants, revenue is simply easier for firms to calculate. And with so much emphasis placed on “recorded billable hours,” firms fail to look at the bigger picture. Edge notes that “These measurements fail to disclose the true profitability of the practice, which is ascertainable only by going beyond hours or billings or receipts to include costs allocated to the revenue source.”

Interestingly, the latest Am Law 100 statistics show that the top-grossing firms in the U.S. are now targeting profits, leading to increases in efficiency and cost-cutting. The April report indicated that “In response to [the current] business climate, firms have, in general, taken two important strategic steps since 2008. First, they’ve slowed or reduced their head count growth… Second, firms have reduced their ownership class. Forty-five firms had smaller equity partnerships last year than in 2008.”

Businessweek also reported that “Per-partner profits, a crucial measure of a firm’s performance, have been under pressure since the financial crisis. But firms whose lawyer head count, including partners, dropped in 2013, in most cases saw a rise in per-partner profits.” The consultant quoted in the story aptly referred to this trend as a “flight to cost-effectiveness”.

Recently the ABA’s Law Practice Magazine published The Law Firm Profitability Issue, which provided a useful roadmap for firms seeking to shift their focus from revenue-centric thinking. They argued that “In contrast to times past, lawyers and law firms need to become more efficient to remain competitive. It behooves lawyers to improve their practice management, accomplish more work in a given time and do a better job in the same time. This can be accomplished using technology more efficiently, such as developing systems to retrieve and use prior work product.”

The issue highlighted the key areas for increasing firm profits, including increased marketing, avoiding trouble clients, utilizing alternative fee arrangements, getting your clients to cover your client-related expenses, and investing in new systems, methods and technology. When considering AFA’s, taking time to understand the cost of an engagement is key: “Data mine your files. Your most valuable tool in establishing what the appropriate fee should be is the information in the files and bills of similar prior projects.”

Finally, higher profitability can even lead to happier partners. The latest MLA Partner Compensation Survey found that while firm size had little bearing on compensation satisfaction, “partners at firms with higher PPP generally were more likely to classify themselves as Very Satisfied”.

Put simply, profitability is all about the “bottom-line”: your revenues minus costs and expenses. When you make a serious commitment to promote both the growth side of your business while also acknowledging the importance of managing costs, you will create a strong foundation for your firm that can weather just about any future calamity.

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