Think Tank: How Law Firms are Using Business Intelligence to Improve Profitability

Business Intelligence

Think Tank: How Law Firms are Using Business Intelligence to Improve Profitability

What should legal services cost on a per square foot basis? That’s the sort of pricing pressure a real estate development client once placed on a large law firm – and amazingly the firm was able to accommodate the client.

Real estate clients just “think” in terms of square footage and in that industry, pricing often varies by volume. As a result, the client couldn’t understand why legal work for 4,000 square foot building was priced the same as for a 400,000 square foot building, according to a case study published in CIO Magazine.

The law firm used business intelligence (BI) software to analyze internal data and acted to develop a remarkable solution.  The law firm found “while there was risk of underpricing large buildings, the deal volume in small buildings offset that risk for the law firm. The result made per-square-foot pricing possible.”

“The challenge for law firms is how to best accommodate the demand for AFAs to remain both competitive and profitable. “

That case study stems from 2008 – a year that marked what many believe to be the onset of the “new normal” in the business of law.  The new normal has been underscored by the rise of alternative fee arrangements (AFAs) and undeniably, the use of AFAs has grown slowly but surely ever since.

The most recent annual study by HBR Consulting, for example, found of the 275 corporate legal departments surveyed, 85% are currently using AFAs.  Moreover, this legal pricing trend shows no signs of slowing as the same survey also found 80% want to do more AFAs next year.

The challenge for law firms is how to best accommodate the demand for AFAs to remain both competitive and profitable.  This is driving a need to analyze existing data in law firms in order to make more intelligent business decisions.

Indeed, as a recent Aderant white paper titled, Actionable Intelligence:  Successful BI for Law Firms, noted: “Law firms have more data than ever about their businesses, but effectively using that data to make quick, proactive and strategic decisions has proved more challenging.”

Consequently, many law firms – like the very forward thinking example above – are increasingly turning to BI tools to glean such insights.   In fact, market research stemming from ILTA suggests about half of all firms are using BI. As the chart in the aforementioned white paper illustrates, adoption of BI in law firms has been a slow and stated increase over roughly the same period of time.

What is Law Firm Business Intelligence?

According to Gartner, an IT consultancy, BI is defined as follows:

“Business intelligence (BI) is an umbrella term that includes the applications, infrastructure and tools, and best practices that enable access to and analysis of information to improve and optimize decisions and performance.”

In law firm circles, the definition is similar, although slightly more refined for the subtle but important nuance of the legal community:

“BI solutions combine software applications and business analysis content, drawing on best practices, enabling firms to better manage their performance and improve their bottom line. In simple terms, BI is an enabler for better strategic decision-making.”

So in unpacking these definitions a bit, this means providing law firms with access to insight they might not otherwise have discovered – actionable information on which a firm can act. Business intelligence tools help law firms, especially the financial department where the data responsibility usually rests, surface previously unobserved trends.

A Tale of Two Partners and Profitability

I’ve seen, first-hand, BI tools reveal a difference between revenue and profit margin of two partners with similar books of business.  Partner A has generated and collected annual fees totaling $4.1 million with a net profit of 20%.  That’s a healthy margin until the firm realizes Partner B has collected fees of $4.3 million with a net profit of 54% – or more than double the profitability of Partner A.

Why the difference?  There could be several factors at work.

One factor could be simple leverage – shifting work down to the lowest cost timekeeper – where Partner B is simply using less expensive people. Second is the amount of time required to generate $4 million in revenue – meaning that Partner A may have needed significantly more billable hours to produce that revenue than Partner B.

This is the backstory to law firm profitability that business intelligence can surface.  Here we’ve compared books of business for two partners based on revenue – and the variability that profit margins can play once the cost-basis is considered.

The epiphany for many partners is that billing more hours doesn’t always mean more profit.  This is because every hour that a firm produces has a cost – yet most firms don’t look at things this way.

The implications of this sort of insight are enormous when a firm is considering how to grow profitably.  More importantly, it demonstrates the value of BI far beyond just pricing.  BI enables law firms to transition from a reactive to a proactive financial analysis environment.

How are Firms Using BI for Profitable Insight?

As most law firm CFOs can attest, the finance department gets multiple ad hoc requests for information. BI helps meet these requests by augmenting and simplifying the ability to access, analyze and publish data available from a time and billing or a case management system.

Accessing this data used to require highly technical resources to map or reconcile data.  Law firm-specific BI software eliminates this requirement and means a non-technical resource, like a financial analyst, has access to previously untapped law firm data.

Similarly, fulfilling these requests used to take days or even weeks.  For example, it entailed considerable time to massage spreadsheet data into a report to send to partners.  BI tools designed around the needs of a law firm can dramatically improve efficiency and shorten the cycle time from request to publication down to hours or even minutes.

Typically, I see law firms segment the output of BI into three primary categories rendered in the form of a dashboard. Those categories are as follows:

1) Firm-wide business intelligence.  While dashboards can vary widely from firm to firm based on strategic initiatives, these often include visualizations of various inventory and production metrics broken down by category. Sometimes this is segmented by client or by billing partner, and other times by department or industry.  Often it is closely tied to utilization and realization rates to understand the financial effects of both.

2) Individual partner intelligence.  BI tools can easily publish metrics to analyze an individual’s book of business.  I see partners comparing their current statistics to target metrics for hours, billings and collections among others. Sometimes this will include profitability metrics or cross selling metrics with all data designed to help a partner understand his or her contributions to the firm.

3) Client-specific intelligence. Time and again we’ve seen attorneys running into a client meeting with a need for client-specific data. The status of open invoices, the pace of work for that client, and the categories of work being performed are all prime examples.  This type of business intelligence allows partners to be better prepared for that client conversation – and empower them with the information they need to earn more work.

Intelligence is, by definition, a collection of information of value. In the business of law, that value is determined by whether or not a firm can take action.  It’s one thing to know the realization rates, but quite another to understand why the firm is earning these rates.  The former is useful, but the latter is actionable.

Surely no law firm sets out or aspires to price legal services by the square foot.  Yet if a client inquires and the firm has the data to determine if it is achievable, then that business intelligence becomes a competitive advantage – and ideally a profitable one.

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