Think Tank: How Law Firms Can Reboot Business Intelligence to Improve Profitability

Business Intelligence

Think Tank: How Law Firms Can Reboot Business Intelligence to Improve Profitability

By Maria E. Mangubat, Spotlight Product Manager, Aderant

The catch-phrase, “actionable business intelligence”, gets tossed around haplessly in legal circles.  The result has diluted the meaning to the extent BI has become synonymous with reporting.

There is nothing inherently wrong with reporting.  Reporting is a powerful feature of business intelligence software that law firms can use to understand what happened with their business.  The operative word here is “happened.”

Examining things that have happened is an investigation.  It looks backward over events and facts in the past to piece together a puzzle.  This is an important distinction because in a puzzle, as Malcolm Gladwell wrote in his book, What the Dog Saw, all of the pieces already exist, as they just need to be assembled in the proper order to see a complete picture.

This is what reporting does for a law firm.  It provides metrics, in this case profitability metrics, such as profits per partner (PPP), over a period of time that has already occurred.  There’s no action a law firm can take to influence metrics already reported except to learn for future reference.

By contrast, truly actionable intelligence is forward-looking.  It is both predictive and prescriptive. All the pieces do not yet exist.  The goal here is to assemble what pieces of information do exist, and fill in the gaps with trends, experience in the case of software, and data, in order to make a prediction: given the current course and speed, this is where the individual, team, or firm is headed.

The difference here is that intelligence is actionable.  A law firm can take an action that can influence the metrics that will eventually be reported.

The Problem of Profitability Reporting in Context

The distinction between reporting and intelligence becomes important in the context of law firm management.  Many of the firms we speak with use a monthly reporting dashboard with the following client profitability metrics:

Summary of ACME Corporation for Q4 2016:

  • Hours Worked: 1600
  • Standard Amount: $400,000
  • Fees Billed: $200,000
  • Fees Collected: $600,000

The issue is none of these figures are related. The standard amount represents the value of the 1600 hours worked in Q4, the fees billed are from work performed in Q3, and the fees collected are from work performed in Q2. These numbers are a snapshot of the law firm’s past, not a glimpse into the future.  This does not provide the information a partner needs to understand a) the status of the client today, b) where it will be tomorrow and c) what action they can take today to improve future probability.

On the other hand, if we start by looking at what was worked for Acme Corporation in Q4 and analyze what has happened to that work throughout time, we gain a different perspective.

Summary of ACME Corporation for Q4 2016:

  • Hours Worked: 1600
  • Standard Amount (of Work): $400,000
  • Billed Amount (of Work): $300,000
  • Collected Amount (of Work): $60,000

In Q4, the firm worked 1600 hours for Acme Corporation and valued that work at $400k.  Of that $400k standard amount, the firm has billed $300k and collected $60k.  With this data, the billing partner can act knowing that $100k in WIP needs to be billed and $240k in AR needs to be collected.  In a few months after the partner has taken action, we can expect to see this work fully realized.

Another distinction between reporting and intelligence can be seen in the prevalence of cash-based profitability analysis at law firms.  Why is this happening?   It’s because most firms use cash-based accounting.  This is a logical choice for accounting purposes.  No services firm wants to recognize revenue and incur the tax liability until it’s been collected.

However, for business intelligence purposes, it’s not ideal.  This is because cash is based on collections, and there is a lag between when something was worked and when the value of that work is collected resulting in a mismatch of revenue and expenses.  The cash-based view reports what’s already happened.  There’s very little a law firm can do with cash-based reports today to affect the outcome tomorrow.   On the other hand, an accrual-based view of profitability uses forecasted collections to predict the future profitability of work allowing the firm to take corrective action before it’s too late.

The distinction between reporting and BI is important because many law firms use profitability analysis, a form of business intelligence, according to the 2017 Law Firms in Transition Survey by Altman Weil.  More specifically, 52.5% of law firms use profitability analysis to improve profits, and 41.5% say that analysis has led to significant improvement.

Two insights can be derived from this statistic.  First, nearly half of all law firms don’t conduct profitability analysis and have much to gain by starting.  Second, for the other half that does profitability analysis, switching to an accrual methodology can improve profits even more significantly.

Three Ways a Proper BI can Improve Profitability

This all sounds great, but what does this mean in practice?  It means BI can predict, based on history and trend lines, what’s going to happen next.  This is actionable because a partner still has time to change the outcome.  Some examples include the following.

1) Right-size law firm leverage.

Based on forecasted collections, BI predicts a client account is going to miss a set profitability target for the month. With this intelligence, a partner can reduce costs by pushing more work to associates, or assigning a more senior attorney to boost efficiency, for example.

2) Improve Work In Progress processes.

A client team has unbilled work on a client account.  Based on the client’s history, BI forecasts the work won’t be billed for another 180 days and will likely be rejected.  With this prediction, a partner can initiate the pre-bill process.

3) Adjust utilization.

Two associates have the same compensation and target hours.  Associate A bills more hours than the target, while associate B bills fewer.  On paper, the actual cost rate (compensation divided by hours worked) of associate A is less, while it’s more for associate B.

What happens next is this actual cost rate is then used to calculate client profitability at the firm. The result?  The client accounts utilizing associate A look more profitable than others.

It could well be that associate A is highly efficient or alternatively, associate A always seems to require more time to get the same workload done. These are questions law firm leaders would want to consider. BI software, will use a target cost rate, based on an accrual model, and surface these discrepancies for a resolution that’s in the best interest of the firm.

Traditional Friction Points for BI in Law Firms

A discussion on the application of BI usually uncovers the central reasons why BI has been relegated to reporting rather than intelligence.  Typically, there are two reasons we hear routinely from clients: a) we’ve always done it that way and b) there’s a natural human resistance to change, especially when it involves compensation models.

In many cases, the primary law firm proponent of BI has long since changed roles, jobs or even firms.  The person tasked with the role today may have missed the initial business case for why the software was implemented, or why certain metrics were chosen. The fact that it could affect compensation makes it easier to maintain the status quo.

Yet the business of law has changed.  Competition and pricing pressures are the driving forces behind law firm operational efficiency.  A proven way to uncover new efficiency is to look forward to what is possible, as opposed to reporting on what has happened.

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