Practice Management

Leverage and the impact to per partner profits is a topic that has shown up as being positive in some surveys and negative in others.  Bruce MacEwen cites a study in an entry titled "Leverage: Friend or Foe? (Or Noncombatant?)" that shows a drastic disparity between firms with high leverage and those with low leverage, the latter being more profitable.  The results of the Juris Law Firm Economic Surveys of 2006 and 2007 show the opposite:  those with higher leverage had higher profit margins.

Which is correct?  Does higher leverage help or hurt law firms?

The answer is yes to both.  In order for a firm to profit from leverage, you must first attain maximum utilization of associates.  Stated simply, increasing the associate to partner ratio without first making sure that your associates are too busy to take on additional work will not lead to increased profits.  Instead, you will be absorbing others' work and that will lower your bottom line.

For firms who have good leverage and high profitability, associates are more fully utilized.  For example, in the graph below, associate utilization is 90% for the top quartile of firms based on per partner income (1,800 billable hour standard. source: 2007 Law Firm Economic Survey by LexisNexis).  In the 2nd quartile, associate utilization is only 83%.  For the 3rd and 4th quartiles, associate utilization is a mere 71% and 72% respectively.  There is a clear link to increased associate utilization and profitability.

So when can having lower leverage increase profitability?  Ostensibly, a firm adds associates when you have work to give them.   However, if you aren't adequately utilizing the attorneys already on staff, higher leverage can hurt you.  Firms who have low leverage but high profits likely have partners who bill much more than their associates.  If more work was passed to the underutilized associates, the firm would have a period of lower profits per partner since net hourly rate would decrease. 

Other firms who have both low leverage and high profits could be targeted litigation firms who win large awards or there is a culture of lateral hiring of client-rich partners.  Or they could be partner-heavy "boutique" firms whose owners are work hoarders with higher than average rates.  That formula seems to work well when their market is underserved.  These type firms also typically have much lower receivables as well which helps cash flow and ultimately per partner draws.  However, these type firms aren't well suited for personnel growth and more times than not operate from an "eat what you kill" operational environment.  This environment, also called a "warlord" or "star-based" approach,  makes proper management of the firm next to impossible.  This approach is not sustainable in the long run and the firm is held captive by those stars until they ultimately leave, often creating a financial crisis.

Changing headcount or billable hour leverage isn't easy.  For mid-sized firms, shifting work from partners to associates is a painful and possibly dangerous proposition.  The partners work themselves to the point of exhaustion but are chained to the routine and income generated.  Giving work away is tantamount to giving away their practice.  It doesn't make sense and without full participation and a commitment to marketing, it can backfire and hurt profits.  It just seems too risky.

Unless, of course, it isn't about your practice but the firm's practice.  If the focus is on the firm rather than the individual partner, then attaining the right leverage for maximum profit AND growth makes more sense, even if not a painless implementation.  Once the firm is committed to increasing leverage, then steps can made through annual goal setting to meet the ultimate ratio desired.  Tracking tools can be used to measure performance.

Tom Collins has written some excellent pieces on leverage, including "Handling the Complexities of Law Firm Leverage", "Billable Hours vs. Head Count Leverage in Law Firms", and "Why Law Partners Hoard Work?".  

The lesson is that increasing leverage for leverage's sake is not wise.  It has to be part of business-building, so you need good "rainmakers" and a lot of work.  To make leverage work for you, you must plan.

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