METRICS! WE DON’T NEED NO STINKIN’ METRICS (PART III)

When I first wrote about the financial operating performance metrics that make up LawBall in Metrics! We Don’t Need No Stinkin’ Metrics and Metrics!  We Don’t Need No Stinkin’ Metrics (Part II), I did so with illustrations for 2 real firms, both Texas-based, which I called “Firm A” and “Firm B.”  The information as to lawyers, partners, revenue, and profit in those illustrations was from The American Lawyer and The Texas Lawyer for operating years 1991 and 1996 and The American Lawyer for the operating year 2005. With the recent release of the AmLaw 2007 survey (2006 operating information), I thought it might be interesting to update the information for Firm A and Firm B and to see how the firms faired in 2006 in comparison both to one another and to the 6 firms that each finished 1st in at least one of the LawBall metric categories as I mentioned in the immediately preceding posting.  Since the tabular presentation of the information is long and narrow, I’m placing it to the side of this narrative in hopes that it will make it easier to follow.  But, since the tables still may be difficult to read within the blog, clicking on the tables should open a larger version; and, I’ve attached a copy as a *.pdf document in the right-hand margin under the category “Posting Attachments” as “Legal Industry Metrics Example 2006 Updated Information.”   

When we last left Firms A and B, Firm B had narrowed its return on equity (ROE or profit per partner) gap with Firm A from 1991 to 1996, primarily on the strength of improving its margin.  But over the ensuing 9 years, Firm A left Firm B in the figurative dust even though Firm B’s revenue had grown at a higher 9-year compounded annual growth rate (CAGR) through 2005 than, and its financial leverage had grown to exceed, Firm A’s.  By “drilling down” into the margin, asset turnover, and financial leverage components of ROE, some of the reasons for this relative financial performance disparity surfaced, including Firm B’s deteriorating margin and its faster lawyer (or asset) growth rate (which contributed to Firm B’s slower growth in asset turnover). 

We also saw a similar pattern with respect to return on assets (ROA or profit per lawyer).  ROA is a good measure of the efficiency with which a business allocates its resources, as it eliminates the effects of financial leverage on operating results.  Just as with ROE, Firm B narrowed the ROA gap from 1991 to 1996.  But by 2005 Firm A’s ROA also had left Firm B in the figurative dust.  Firm A’s profit growth and its asset turnover growth both exceeded Firm B’s CAGR.  Firm A’s 9-year CAGR for cost per lawyer was lower than Firm B’s; and, Firm B’s 9-year CAGR for its cost per lawyer even exceeded its asset turnover (revenue per lawyer) CAGR.   As result, Firm A’s ROA grew from 1.4232 times that of Firm B in 1996 to 2.0957 times in 2005.  The relative disparity between the firms’ 2005 ROE (2.0192) was slightly less than that of the firms’ 2005 ROA due to Firm B’s relative financial leverage improvement during that 9-year period.

How did the 2 firms do in 2006?  Firm B narrowed the ROE gap slightly and closed the ROA gap a little more.  Firm B’s 1-year CAGRs (from 2005 to 2006) for its revenue, profit, and asset turnover were 5.94%, 6.38%, and 8.70%, respectively.  Firm B’s costs per lawyer grew at a 1-year CAGR of 8.46%, which was just a hair below its asset turnover CAGR and lead to a slight margin improvement.  Firm A’s 1-year CAGRs for its revenue, profit, and asset turnover were 4.31%, -1.64%, and 2.10%, respectively.  Firm A’s costs per lawyer grew at a 1-year CAGR of 7.44%, which was a troubling 5.34% higher than its asset turnover CAGR and lead to a margin decrease from 47.84% to 45.11%.  Firm B’s ROA grew at a 1-year CAGR of 9.15%, while Firm A’s ROA fell -3.73% as a result of its margin decrease. Firm B’s ROE grew at a 1-year CAGR of 6.38%, compared to Firm A’s 5.29%, with the narrow change in ROE compared to ROA being driven by Firm A’s 9.37% increase in its financial leverage while Firm B’s leverage decreased -2.54%.  A disturbing point for both firms from their 10-year CAGRs:  their cost per lawyer grew at a faster rate than did their asset turnover (revenues per lawyer).  For Firm A, the “negative spread” was -.39%, while for Firm B it was a more significant -2.02%.

The illustration’s “what if” examples show if Firm B had managed its growth in lawyers to the same 10-year CAGR as Firm A, while still achieving the financial leverage it actually achieved, the improvement in its asset turnover would’ve led to a 2006 ROE that was $98,106 better than it achieved; or if Firm B had managed its margin so its actual decline over the 10-year period had been only to the average margin it experienced from 1991 to 1996, it would’ve led to an ROE that was $108,414 better than it achieved; or if Firm B had managed it costs per lawyer so that it’s 10-year CAGR had been Firm A’s 5.29% instead of its own 7.50%, it would’ve led to an ROE that was $126,177 better than it achieved.

For those of you with savant-type mathematical leanings, I thought you might enjoy a comparison of Firms A and B’s metrics to that of Skadden, Arps, Slate, Meagher & Flom; Wachtell, Lipton, Rosen & Katz; Wilson Elser Moskowitz Edelman & Dicker; Gordon & Rees; Stevens & Lee; and Wiley Rein, as well as to the aggregate top 200 metrics that were included in my last posting.  Here’s the comparison:

(A copy of the comparison is included in the *.pdf attachment.)  While Firm A’s metrics compare favorably to the aggregate top 200 in costs per lawyer, margin, asset turnover, ROA, and ROE and lag only in leverage, Firm B’s metrics compare favorably only in costs per lawyer and lag behind in margin, asset turnover, ROA, leverage, and ROE.  In my prior assessment of Firm B based on its performance through 2005, I said that my “best guess” was that the requirements necessary to service Firm B’s business became much more standardized and took less complex problem solving.  But, instead of managing its mix of assets and pricing to reflect that change, Firm B focused on raising its rates as high as it could.  It probably lost business as a result, while at the same time growing its number of lawyers.  It likely got lulled into a false sense of security because its revenue and profit both grew; it didn’t actively manage its business through the ROE component operating levers; and it didn’t realize that its costs per lawyer were growing at a faster rate than its revenue per lawyer or that its ROA was anemic.  Its performance in 2006 hasn’t changed my “guess.”