Measuring Up
by Barbara Lewis MBA and Dan Otto MBA

In a book that’s topping the best seller list, Leadership by Rudolph W. Giuliani, former mayor of New York City, details his quest to measure critical aspects of the City’s cumbersome and sometimes antiquated departments.  Most people in Los Angeles may be familiar with Giuliani’s CompStat program, adopted by the New York Police Department, which current Los Angeles’ Chief William J. Bratton spearheaded when he was the NYPD Chief of Police in the mid ‘90s and which he has introduced in Los Angeles. 

Giuliani embraced the “Broken Windows” theory promulgated by James Q. Wilson and George L. Kelling, which links broken windows to increasing crime.  The Mayor inherited a city so rife with crime that corporations and residents were moving out at an alarming rate, which undermined the tax structure.  Recognizing that it’s the small offenses that breed major crimes, Giuliani set about tackling the minor transgressions first.  However, he had to measure criminal statistics that could gauge the success of his programs and that could predict criminal activity.  Enter CompStat, one of many programs designed and developed by the various departments in New York City.  Each program has hundreds of daily, weekly and monthly metrics that track and monitor key statistics.   Frequent, oftentimes daily, reports reflect results with ultimate accountability resting with one individual.

One of 592 statistics measured by the City’s Department of Corrections was the amount of candy and cigarettes purchased at the prison stores.   Prison personnel noticed that when candy and cigarette purchases doubled, a riot might be in the planning stages, since prisoners were stocking up anticipating a lockdown.  So when sweets and smokes disappeared from the store shelves, reinforcements arrived and cells were searched…averting the riot.

Whether in government or business, critical statistics can measure success and predict actions that can provide guidance.   In law firms, partners should track and monitor a number of important statistics in the areas of finance, personnel, operations and marketing that will reflect success and highlight areas for improvement.

The beginning of the year is a good time to analyze the last few years’ numbers as the benchmark and then set goals for the 2003 statistics.  Numbers paint the picture.   The financials are the first place to start if you want to develop a measurement system.  In addition to the basic metrics of revenue, expenses and profits, the profit margin is important, but oftentimes overlooked and unknown. 

The profit margin (revenues minus expenses divided by revenues) is an average of 33 percent among law firms in the United States (before partner draw) and can be as high as 65 percent among small law firms.  Most firms should target the 33 percent margin or above.    

Yet certain firms don’t know their margins and others chase revenues with no regard to the profit margins.  One firm that calculated its margin at 10 percent discovered that it was operating inefficiently with no standards and procedures.  After three months of developing standardized procedures, the profit margin soared to 38 percent.  But only after the profit margin was measured did the firm realize that improvements were necessary.

Expense measurement as a percentage of total revenues and as a growth trend is important.  While most firms track total expenses, certain firms don’t analyze line items as a percentage or trending of expenses.  Unless measured on a monthly basis and then compared to law firm averages, past firm performance and budgeted amount, expenses can runaway without much notice.  The Internal Revenue Service, Dun & Bradstreet and other sources provide law firm statistics to which you can compare your firm.    

Developing a budget for expenses and then tracking expense variance is the best way to determine if expenses are suddenly out of line.  The firm that noticed office supply expense spiking in September asked employees not to outfit their children’s desks and backpacks with firm supplies.  Without monthly monitoring, they wouldn’t have been able to recognize and curtail the abuse. 

Revenue can be measured by matter, referral source, industry of client, amount by client, originating attorney, department and many other ways.  When one firm discovered a huge jump in revenues from a specific industry and matter type, they decided to alter their focus in an effort to capitalize on the trend.  Revenues sorted by referral source can indicate where clients are originating and may point the direction for new marketing efforts.  When one firm tracked client source, they discovered that speaking at a specific conference each year yielded at least one client.  They redoubled efforts to ensure that they continued to be invited as speakers.

Analyzing clients by amount of revenue can unveil some good information.  When a mid-sized firm’s analysis indicated that 50 percent of their revenues was less that $1,000 per client, they recognized the high costs they were incurring by working with small clients.  Each client needed a file opened, handholding, and several invoices on the same matter along with collection calls, since the small clients historically had balked at the fees.  Further analysis revealed the firm’s theory of small clients growing into large clients was incorrect.  Instead, the small clients left the firm after an average of three years…probably searching for another law firm that was less expensive.  This type of client was squeezing the firm’s profit margin.  The solution was to accept clients with a minimum projected fee of $2,500 and a retainer of 50 percent.  If the client objected, then the firm recognized that there might be collection problems in the future.

Accounts receivable is a critical barometer to monitor.  Calculating the average number of collection days gives you a benchmark for future tracking.  To determine the average number of days it takes you to collect on your invoices, calculate your total outstanding accounts receivable (less current A/R) and divide by current month’s billings (or a 12-month average billings), and then multiply that amount by 30. 

A high number of collection days indicates that the firm is “loaning” money to its clients who are not paying in a timely manner.  Keeping collections under 45 days is healthy.  The goal should be to continually drive down this figure.   By tracking this amount, you can monitor your progress in achieving your goal. 

Personnel ratios are valuable statistics to monitor.  Since salaries represent the largest expense in most businesses, it’s the area where improvements can be made.  Generally, employees don’t complain that they have too little work.  However, it’s not unusual to hear that they have too much work, especially if the workload has increased recently.  Figuring out how many employees to hire should not be left to the employees’ whining.  Instead research personnel ratios such as the number of staff to timekeepers, the number of associates to partners, etc.  Theses figures will provide general guidelines, although the ratios can vary by the type of practice.  

Measuring the level of task performed by each employee is critical for improving profits.  The secretary who was typing all day 15 years ago, today has much less computer work, especially if the attorney is computer literate.  Consequently, some secretaries are doing more filing and clerical work – tasks that could be performed by a lower salaried employee.  Employing secretaries for these types of tasks drains profits from the firm.  Other firms recognize that secretaries are performing lower level tasks and train them as paralegals.   Running timesheets for all employees to determine the level of tasks they perform and then making adjustments in “who does what” can dramatically increase profits. 

Much of the measurement task can be time-consuming unless databases and spreadsheets are used.  With a little programming, most software programs can be linked to databases and spreadsheets, which will automatically calculate the statistics.  With some additional programming, those statistics can be converted to colorful graphs that reflect trends and indicate areas for improvement.

Any objective can and should be measured.  Even a public relations objective as elusive as increasing visibility in the business community has its metric.  The firm can conduct a visibility survey prior to beginning a PR campaign to assess how well-nown the firm is in the community.  The same visibility survey can be conducted two years later to measure the results of the campaign.

Mayor Rudy Giuliani’s record in reducing crime and improving other areas in New York City is admirable.  He identified the goal, determined what needed to be measured to monitor the achievement and then devised the metric.  Any law firm can make enormous strides in much the same way.  A strategic planning session can help in developing the firm’s goals for the next few years and in designing the key measurements that will indicate if the firm is accomplishing its objectives.