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Key Financial Performance Measures

18 August 2014

KPMs – Then and Now

Presenter:

Mark Medice

Senior Director

Peer Monitor

Program

3

If the rate of change on the outside

exceeds the rate of change on the inside,

the end is near.

- Jack Welch

4 4 4

Themes in our Discussion - Industry

• Overall industry law firm demand remains flat, creating

pressure on firms to take market share from each other

• Demand continues to shift in-house and to LPOs

(especially for litigation)

• Bright spot for the industry has been the improvement

in transactional practices like corporate, M&A and real

estate, up over 4 percent as a group

• Change is happening but the debate rages about the

level and type (e.g., step-change, disruptive,

incremental)

5

KEY QUESTION

Is the current economic environment a

“blip” (a normal phase of the business

cycle) or a harbinger of more fundamental

and long-lasting changes in the

legal market?

6

Today’s Discussion

• Legal Industry Trends

• Basis for Change

• New Metrics

Legal Industry

Trends

8

-9%

-6%

-3%

0%

3%

6%

9%

Q1'07

2 3 4 Q1'08

2 3 4 Q1'09

2 3 4 Q1'10

2 3 4 Q1'11

2 3 4 Q1'12

2 3 4 Q1'13

2 3 4 Q1'14

2

Y/Y % Change

All Segments - 7-Year Pattern for Demand Growth

All timekeepers

Billable time type

9

-9%

-6%

-3%

0%

3%

6%

9%

Q1'07

2 3 4 Q1'08

2 3 4 Q1'09

2 3 4 Q1'10

2 3 4 Q1'11

2 3 4 Q1'12

2 3 4 Q1'13

2 3 4 Q1'14

2

Y/Y % Change

Rough timeline of

US Recession

All Segments - 7-Year Pattern for Demand Growth

Credit Crisis

All timekeepers

Billable time type

11 11 11

PERFORMANCE BY SEGMENT

12

2014 YTD Demand by Segment

-5% 0 5% Percentage Growth Scale

Mid-Size (-0.8%) Am Law Second 100 (2.7%)

Am Law 100 (-0.1%)

Note: Results for June YTD 2013, AL100 was -1.5%, AL200 -1.4%, Mid-Size -3.2%, with

all segments improving over prior year, while the second 100 continues the trend as

segment leader.

All timekeepers Billable

13 13 13

SEEPAGE

14 14 14

Firms Losing Share to In-house Resources

* 2012 ACC Census

45%

69%

35% 30%

40%

65%

28%

20%

Intellectual Property Litigation M&A Tax

Declining Workloads to Outside Counsel

2006 2011

Work traditionally handled by outside counsel is now staying and managed within the

corporate legal department. What work is being done in-house rather than with outside

counsel?

15

Overview of LPO Market LPO Market Size and Future Growth

$0.64

$0.85

$1.10

$1.43

$1.86

$2.42

$0.0

$3.0

2010 2011 2012 2013 2014 2015

Ma

rke

t S

ize

($

B)

Forecast

Source: The 2013 Legal Outsourcing Market Global Study & TR Strategy Analysis

Current LPO market represents only a fraction of potential market;

robust future market growth of 30% is expected through 2015

Current LPO Market Size

$400B

Global Legal

Services

Market

$20B

“Outsourceable”

Legal Work

$1.1B

LPO Market

LPO Market Growth

16 16 16

VARIABLE PERFORMANCE

17 17 17

1H2014 v 1H2013 Demand Growth by Firm

-20%

-15%

-10%

-5%

0%

5%

10%

1H'14 v 1H'13 1H'13 v 1H'12

Y/Y % Change

2013 Std Dev: 10.9% 2014 Std Dev: 7.1%

•56% firms in positive territory in 2014 compared to 37% in 2013

• 2.6 firms flipping positive for every negative in 2014

Note: Firms with positive growth are experiencing

average of 4.6% during 1H2014V1h2013 in contrast to

those in negative territory experiencing -5.5% All timekeepers Billable

18 18 18

PERFORMANCE BY PRACTICE

19

Proportion

All Segments Practice Demand

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

Tax Corporate(all)

RealEstate

Labor/Employment

Litigation PatentLitigation

Bankruptcy

Gro

wth

(%

)

Y/Y % Change

Q2'14 v Q2'13

3% 23% 6% 10% 31% 5% 2%

All timekeepers Billable time type M&A June: 5.8% // Q2: 1.4% // YTD: 3.7% (prop: 3%)

20

Proportion

All Segments Practice Demand

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

Tax Corporate(all)

RealEstate

Labor/Employment

Litigation PatentLitigation

Bankruptcy

Gro

wth

(%

)

Y/Y % Change

YTD June: '14 v '13

3% 23% 6% 10% 31% 5% 2%

All timekeepers Billable time type M&A June: 5.8% // Q2: 1.4% // YTD: 3.7% (prop: 3%)

21 21 21

TRANSACTION CONTINUED STRENGTH

22 22 22

1H2014 v1H2013 Demand Growth by Firm – Transactional

-20%

-10%

0%

10%

20%

30%

1H'14 v 1H'13 1H'13 v 1H'12

Y/Y % Change

2013 Std Dev: 9% 2014 Std Dev: 10%

•66% firms in positive territory in 2014 compared to 42% in 2013

• 2.4 firms flipping positive for every negative in 2014

Note: Firms with positive growth are experiencing average of 8.7% during

1H2014V1h2013 in contrast to those in negative territory experiencing -5.5%. All timekeepers Billable

23 23 23

1H2014 v1H2013 Demand Growth by Firm – Transactional

-20%

-10%

0%

10%

20%

30%

1H'14 v 1H'13 1H'13 v 1H'12

Y/Y % Change

2013 Std Dev: 9% 2014 Std Dev: 10%

•66% firms in positive territory in 2014 compared to 42% in 2013

• 2.4 firms flipping positive for every negative in 2014

Note: Firms with positive growth are experiencing average of 8.7% during

1H2014V1h2013 in contrast to those in negative territory experiencing -5.5%. All timekeepers Billable

•Similar to All Practices; demand in Q2 2014 was more muted than

Q1 2014.

•In Q2 2014 64% firms are in positive territory in 2014 compared to

55% in Q2 2013.

•1.4 firms flipping positive for every negative in 2014.

24 24 24

TOP PERFORMERS

25 25 25

2014 Top Performer Methodology

2010-2013 CAGR. Positive performance in all 5 metrics

1. Revenue per Lawyer

2. Gross revenue

3. Gross profit

4. Profit as a percent of revenue

5. Profit per partner

Developed a 5-variable matrix

– Scored each variable based on positive quintile performance

(scale of 1 to 5)

– Summed each firms to get a composite score

– Firms with a composite score in the top percentile determined

to be 2014 Peer Monitor top performers

Sample: 16 Top Performing Firms*

*7 of these firms (~45%) were in the 2013 Top Performing Firms sample (based on 2-years positive PPP performance above the

median.

26 26 26

Top Performer’s Early Findings

• They push rates harder even if they discount more.

• Their utilization levels are higher, especially at the

partner level.

• Their expenses are balanced to revenue, meaning they

are typically not lower than market averages, but are

balanced for revenue growth

– They make investments / revenue focused.

27 27 27

UTILIZATION

28 28 28

All Segments - Hours per Lawyer

70

80

90

100

110

120

130

140

150

Q1'05

2 3 4 Q1'06

2 3 4 Q1'07

2 3 4 Q1'08

2 3 4 Q1'09

2 3 4 Q1'10

2 3 4 Q1'11

2 3 4 Q1'12

2 3 4 Q1'13

2 3 4 Q1'14

2

Ho

urs

pe

r M

on

th

All Lawyers

Lawyers Only Billable time type

29 29 29

All Segments Hours per Lawyer

70

80

90

100

110

120

130

140

150

Q1'05

2 3 4 Q1'06

2 3 4 Q1'07

2 3 4 Q1'08

2 3 4 Q1'09

2 3 4 Q1'10

2 3 4 Q1'11

2 3 4 Q1'12

2 3 4 Q1'13

2 3 4 Q1'14

2

Ho

urs

pe

r M

on

th

Equity Partners Non-Equity Partners Associates

Of Counsel Sr/Staff Attorneys All Lawyers

Lawyers Only Billable time type

32 32 32

REALIZATION

33 33 33

All Segments Realization against Standard

82%

83%

84%

85%

86%

87%

88%

89%

90%

91%

92%

93%

94%

Q1'05

2 3 4 Q1'06

2 3 4 Q1'07

2 3 4 Q1'08

2 3 4 Q1'09

2 3 4 Q1'10

2 3 4 Q1'11

2 3 4 Q1'12

2 3 4 Q1'13

2 3 4 Q1'14

2

Billing Collection

Lawyers Only Billable time type

1.1% Gap

3.0% Gap

1H 2014 All Segment Collected Rate Growth 2.7% and 5.5% for Q2 2014 v Q2

2013

35

-9%

-6%

-3%

0%

3%

6%

9%

12%

15%

18%

21%

Q1'07

2 3 4 Q1'08

2 3 4 Q1'09

2 3 4 Q1'10

2 3 4 Q1'11

2 3 4 Q1'12

2 3 4 Q1'13

2 3 4 Q1'14

2

Rolling 12-Month (Y/Y % Change)

Direct Overhead

All Segments - Expense Growth (Total)

Basis for Change

37 37 37

A HARBINGER OF FUNDAMENTAL CHANGE

• There is mounting evidence that we are seeing a

fundamental shift in key aspects of the traditional law

firm model.

• This change was not caused by the current downturn,

but it has been accelerated and exacerbated by it.

• The cause of the change we are seeing was the

essential unsustainability of the old law firm economic

model.

38

DRIVERS OF LAW FIRM PROFITABILITY

Leverage

Rates

Realization

Expense Management

Profitability

Productivity

39

DRIVERS OF LAW FIRM PRODUCTIVITY

Leverage

Rates

Realization

Expense Management

Profitability

Productivity Productivity: •Declining steadily since the late

1990’s.

•Driven by associate pushback to

unsustainable billable hour require-

ments.

•Aggravated by a “seller’s market”

for talent that drove up salaries as

productivity declined.

40

DRIVERS OF LAW FIRM PROFITABILITY

Leverage

Rates

Realization

Expense Management

Profitability

Productivity

Leverage: •Struggle to maintain leverage as:

•Firms hired more associates

to make up for declining produc-

tivity and

•Firms made partners at a faster

pace than the firms were growing.

•Most firms sustained or grew their

leverage but at a very high cost.

41

DRIVERS OF LAW FIRM PROFITABILITY

Leverage

Rates

Realization

Expense Management

Profitability

Productivity Realization: •Dropping fairly steadily in years just

prior to downturn.

•Reflected increasing client demands

for discounts and resistance to

“premium” arrangements.

42

DRIVERS OF LAW FIRM PROFITABILITY

Leverage

Rates

Realization

Expense Management

Profitability

Productivity Expenses: •During years prior to downturn,

expenses grew at a much faster rate

than inflation.

•Principal driver was rapidly escalating

associate salaries – followed by space

and technology costs.

43

DRIVERS OF LAW FIRM PROFITABILITY

Leverage

Rates

Realization

Expense Management

Profitability

Productivity X

X

X

X

44 44 44

LOSS OF RATES AS A RELIABLE DRIVER OF PROFITABILITY

• Prior to the recession, firms were raising rates at a clip

of 6-8% per year – well ahead of annual inflation rates.

• Had firms not been able to drive these rate increases,

the economics of the “boom years” would have looked

very different.

• Partly as a result, the overall costs of legal services

grew exponentially – ultimately to a point that strong

client resistance became inevitable.

45 45 45

Percentage Change in Legal Market Revenues vs. Inflation (1999-2008)

Source: U.S. Census Bureau: Service Annual Survey and U.S. Bureau of Labor Statistics

46 46 46

A BUYER’S MARKET FOR LEGAL SERVICES

• For the foreseeable future, we are likely to have a

buyer’s market for legal services in which clients

increasingly focus on overall value.

– Little tolerance for “routine” rate increases.

– Expanding use of competitive proposal processes.

– For billable hour based matters, increasing demands for

discounts, blended hourly rates, capped fees, multi-year fee

arrangements, etc.

– Expanding use of alternative (non-hourly based) pricing

arrangements.

– A growing determination to bring the economic interests of the

client and the law firm into better alignment.

47 47 47

INCREASED FOCUS ON EFFICIENCY

• Clients will be increasingly focused on

considerations of efficiency and cost effectiveness.

– Prime evidence – growing willingness of many clients to

“disaggregate” legal services.

• Firms will need to respond by implementing new

models for –

– Pricing legal services

– Designing and managing better legal work processes

– Recruiting, managing, and retaining professional talent and

– Partnering with other service providers to improve efficiency

in service delivery.

48 48 48

NEED TO REDEFINE “COMMODITY” WORK

• The new models may require firms to re-think their

willingness to undertake “commodity” work.

• Client focus on efficiency, combined with increasingly

sophisticated technology, may well force a redefinition

of “commodity work” – and underscore the importance

of all firms being able to deliver more standardized

work products along with their more specialized

services.

49 49 49

NEED FOR STRONG LEADERSHIP

• The need for strong and insightful leadership in law firms has never been greater.

• The world has changed. Focus on growth and expansion that drove law firm strategic and management decisions for the decade preceding 2008 has been replaced with a different imperative – the necessity of focusing on efficiency in the delivery of legal services.

• Adapting to this change will require significant shifts in law firm culture and a fundamental reorientation in the way law firm leaders think about their businesses and their roles.

New Metrics

51

THE NEED FOR BETTER PERFORMANCE

METRICS

52 52 52

MEASURING AGAINST THE NEW MODELS

• If “what gets measured gets done,” the change in law

firm models that we predict over the next few years will

necessitate new measurement tools to help law firm

leaders (as well as their clients) judge the performance

of lawyers and their firms.

• It will take time for new metrics to be developed and

adopted across the market, but some firms have

already begun experimenting with a variety of tools that

show promise.

53 53 53

Chart 11 Current and Possible Future Performance Metrics

A number of the metrics that we list

as “possible future” measurement

tools are already being used in

several firms and by banks,

consultants, and other service

providers to the legal market.

54 54 54

Measurement Categories

• Firm Performance

• Expense Management

• Practice Management

• Partner Performance

• Client Development/Market Strength

• Balance Sheet/Risk

• Management and Leadership

55 55 55

Firm Performance

Movement towards organizational efficiency and better asset management

measures that consider returns relative to risk

Possible Future Metrics Drivers of Change Today’s Key Metrics

•Profits per Equity

Partner

•Profits per Partner

•Revenue per Lawyer

•Profitability Index

•Leverage

•Changing leverage

models

• Increased

transparency of law

firm financials

•External ownership

•Multidisciplinary

practice

•Profit per Employee

•Matter Profitability

•Return on Capital /

Return on Equity

(accrual basis)

•Risk-adjusted

performance

•Profit in excess of

partner “salaries” /

Profit per Share

•Value of Income

Stream

56 56 56

Expense Management

Pressure to reduce costs in short term and improve cost-structure long term to

account for efficiency and returns

Possible Future Metrics Drivers of Change Today’s Key Metrics

• Expenses per Lawyer

• Staffing Ratios

• Functional Expenses

per Lawyer

• Changes in staffing

models

• Adoption of more

systematic

procurement models

• Outsourcing of

substantive legal work

• Efficiency Index

• Return on Assets

• Employees per $

Million

• Compensation per $

Million

57 57 57

Practice Performance

New pricing models and greater accountability at matter / practice Level

Possible Future Metrics Drivers of Change Today’s Key Metrics

•Fees & Growth

•Realization

•Utilization

•Leverage

•Matter Profitability

•Alternative pricing

•Performance

pressure

•Matter Contribution

to Profit / Margin

•Practice Contribution

to Profit

•Profit per Practice

Member

•Profit per Employee

•Market Share

•Extended Leverage

•Profit Contribution

by Client Decile

58

Partner Performance

New pricing models and increased need to maximize firm performance

Possible Future Metrics Drivers of Change Today’s Key Metrics

•Originations

•Working Attorney

Fees

•Realization

•Billable Hours

•Leverage

•Alternative pricing

•Performance

pressure

•Staffing model

changes

•Profit per share of

practice managed

•Total profit of work

originated/managed

•Unit cost of work

originated/managed

•Client satisfaction

Rating

•Employee

satisfaction Rating

•Cross-selling /

Cross-working

59 59 59

Client Development / Market Strength

Shifting power balances and more savvy consumers of legal services

Possible Future Metrics Drivers of Change Today’s Key Metrics

•Client Turnover Rate

•Client Diversification

Index (e.g., percent

of revenue produced

by top 10 clients)

•Fee Growth

•Realization

•Originations

•Pricing pressure

•Client retention

issues

•Use of “dual-

counsel” situations

• “Brand” Strength

•Wallet Share for

Target Clients

•Growth in Share for

Target Clients

60 60 60

Balance Sheet/Risk

Changing partnership models, industry consolidation

Possible Future Metrics Drivers of Change Today’s Key Metrics

• Capital per Partner

• Debt per Partner

• Debt / Equity Ratios

• Debt / Net Fixed

Assets Ratio

• Changes in staffing

models

• Lower risk tolerance

of banks

• Increase in capital

needs as to fund

investments

• Value Index / Firm

Valuation

• Return on Capital

• Risk Index (use of

debt, capital,

performance over/under

market, etc.)

61 61 61

Management & Leadership

Acceleration towards more sophisticated management needs & smarter

approaches to managing human capital

Possible Future Metrics Drivers of Change Today’s Key Metrics

•PPEP Growth

•Fee Growth

•Turnover

•Firm rankings

•Continued industry

consolidation and

competition

•Smarter approaches

to measuring and

deploying human

capital

•Market Share

Growth

•Leadership Index

•Client Satisfaction

index

•Return on Human

Capital

•Employee

Satisfaction Index

•Management Value

Index (“value” /

“cost”)

62 62 62

MEASURING AGAINST THE NEW MODELS

• Going forward, measuring the health and effectiveness

of law firms will require the use of several new

measurement tools for both financial and non-financial

performance assessment.

• One of the serious misuses of metrics in the past few

years has been over reliance on PPEP as the defining

index of a firm’s value and quality.

• In the future, more flexible and comprehensive tools will

be required.

63

Questions / Discussion Mark Medice Senior Director Peer Monitor

412-203-2155 mark.medice@thomsonreuters.com