Rethinking ROI

There is an excellent article detailing some common errors of large law firms on LLRX: Rethinking ROI by John Alber (Bryan Cave LLP).

Albers main statement is that effective measures linked to core business goals and client work can save huge sums of money.

"Knowledge management projects undertaken based on good intentions alone can succeed only by accident. Success is far more likely if projects are undertaken with specific, measurable goals in mind."

But rather than using traditional but abstract ROI measures, John Alber suggests measures such as leverage, effective rate and profit component. He goes on describing how firms spend millions on either buying or building large scale systems without measures, based on good intentions alone.

"I believe that the very first step in any knowledge management initiative should be to acquire or create the tools necessary to measure the relative success of such an initiative. Such tools, if selected or constructed correctly, will do far more than merely measure the success or failure of a knowledge management tool suite. They can provide law firm owners with key information about their core business activities."

He then goes on and shows that simple ROI calculations provide anything but a statement that is logical and valuable. Instead of these ROI calculation he suggests to build measures at least around three core components:

(1) Leverage
(2) Effective rate delivered to the client, and
(3) Profit component

Leverage

There are may ways to measure leverage. Perhaps the simplest entails creating a ratio of partner hours to non-partner hours. You can add many subtleties to this calculation, but the net result is still to determine the effectiveness with which work in a particular group is moved to younger or less experienced lawyers.

At first blush, high leverage sounds like a bad deal for clients. However, in a well-managed firm, quite the contrary should be the case. If associates and young partners are well-trained and provided with tools that make it possible for them to accomplish expert work to high standards of quality and to do so sooner than is the case at peer firms, clients benefit by having a larger pool of talent available to do their work. They also benefit by getting a lower effective rate for the work they have done (because of the lower cost of younger lawyers).

Effective Rate

Effective rate is an average of all hours billed to a client. To calculate it, simply divide total fees by total hours on an engagement or for work done by a particular group across engagements. If you agree to a blended rate when serving a client and you do a good job of managing the engagement, then the effective rate ought not to be higher than the agreed blended rate.

Profit Component

When an engagement is concluded (and probably before), it makes some positive or negative contribution to the profits of a firm. Allocate that on a partner basis, or a matter basis or a group basis, and you have a profit component. This can be roughly equivalent to calculating earnings per product or per business unit in a publicly held corporation. Doing it successfully requires the ability to allocate costs very precisely. For example, if you want to look at the profit component for a group of lawyers using a new knowledge management tool, you will have to track costs across all the matters on which they use the tool and then arrive at a profit component for the group. That can be difficult, both technically and culturally (firms have to decide whether they want to know profit components by group).

To read the full article, please go to LLRX: Rethinking ROI