Ark Conference--The Economics of Law and the Future of Legal KM

I'm here at the ARK conference in New York.  It is quite well attended.
Toby Brown is giving the keynote, "The Economics of Law and the Future of KM."  I am live-blogging so there may be typos.

Toby challenges core principles of KM.  He wants us to do KM differently, where KM might be focused better.

Toby moved away from KM in his career when AFAs started to come up. He gave it up.  KM "came back to him" as he knew it would, as it underlies much of alternative fee arrangement work.

He started an AFA peer group about a year ago, initially with five people.  Now there are almost 120, and they've added legal project management into the mix.  The group's purpose is to increase professional development, have good conversations, and work with the vendors in the space.  Contact him to sign up.

What keeps law firm leadership up at night?  It's the economics.

Many people at law firms don't understand economics (this gap is his first challenge to KM).  How are people at our law firms going to understand and come to a clear definition of what is profit?

What is profit for a law firm?

Definitions of gross margin, contribution, and net margin go to what kind of behavior we are trying to motivate among the partners.  What's motivated partners in the past is hours and rates.

What drives profit?

We know what drives law firm profits--rates, realization, productivity and leverage.

Rates

Raising rates 1% typically rates profitability around 2% where realization is 90-110%.  The cost rate is hidden.   The cost rate (for non-partners) is the expenses (salary, rent) per timekeeper divided by a target annual hours (typically a rate change is around 50-80%).

Realization

A 5% discount will typically drive down profit 10% or more.

Discount, writedowns, writeoffs are three cuts at realization, each of which needs to be tracked differently.  Discounts typically reflect market prices; writedowns might reflect inefficiencies in work; and writeoffs reflect inability to collect.  KM should think about getting the firm to clearly differentiate between them and to track them separately.

Productivity / Utilization

Number of effective hours per timekeeper (billed and collected).   As hours go down, costs per hour go up.  Cost rates have less of an impact.

"The rule of three" is that the first third is compensation, the second third overhead, and the third third is profit.

Leverage a/k/a "The great equalizer"

Leverage is ratio of partner time to that other timekeepers (market standard might be around 25%).  The net margin for partners is typically negative.  This is not a bad thing as it shows that the other timekeepers are making profit that pays the partners.

Who is generating the highest net margin?

If you're leveraging well, you're moving the work down to the lowest appropriate level of staff.

What's happening with these levers?

Rates used to go up 8-10% per year.  These days increases are around 3-4%.
Realization has dropped from around 96% to 86% and dropping.
Productivity has dropped around 10%

Leverage--Most firms are overlawyered in the partner ranks.

Toby sees the legal market as competitive rather than a "buyer's" market.  He doesn't see the shift as a pendulum swing that will swing back.  We've cut costs and mitigated somewhat the usually run  in rates.    Rate increases have a delayed effect.

Demand for 2012 was up just about 1%, essentially flat.  Large law firms increased spend on technology and other matters around 6% with projects like Windows 7 and Office 2010.

bHe sees a huge opportunity.   This is not rocket science.  If we drive down the cost of providing legal services we can maintain profitability and provide work for less.

A lot of products and services will meet these needs, and some of them are KM driven.

LSA can read and analyze time entries and programatically put time entries on them (I've seen this product and I believe that it is able to task-code with somewhat more than 85% accuracy).

Sky Analytics provides analytics on billing information.  Initially they were working for law departments.  It can also look at the phases of work and identify the staffing by phase. It can identify timekeeepers repeatedly billing 8 hours a day or working on a lot of weekends.

Another KM opportunity is monitoring.  Compare how you said you were doing with how you did.

KM classically has been about documents and people.  This will turn KM more towards money, staffing, process, and other things it hasn't focused on to date.

Another KM opportunity is reviewing scenarios and identifying profitability for different phases of work.

Partners don't understand leverage and how increasing leverage can increase the firm's profitability and net margin.  This itself is a KM opportunity.

Basic KM tools can be put in place to share information about profitability.

The Finance people may feel threatened by KM efforts.  They are getting asked for more and more different reports and are underwater.   They need KM but may have a hard time getting out of their blinkered approach.

Redwood Analytics, Aderant, Data Fusion, and others can't present the phase/leverage/staffing information in a usable way.

Tom Baldwin--we need to connect the dots between our efficiency tools and the "soft spots" pointed out by finance and profitability analysis.

Finance people can spot the problems, KM can provide solutions