Managing human capital through numbers

Human capital is the largest asset of any law firm, yet far too many firms leave its management solely in the hands of human resources. By managing the numerical aspects of human capital, the finance function has a critical role to play in bolstering the firm’s employer value proposition.

By Michael Roch and Karen MacKay, Kerma Partners

Human capital is the largest asset of any law firm, and the ability to attract, develop, engage and retain top talent is increasingly recognised as the key to competitive advantage. Unfortunately, as we work with law firms in Europe and North America, we find that the financial-management function is often too narrowly focused on providing detailed financial data in accordance with traditional accounting principles, leaving human-capital management to human resources.

Managing the numerical aspects of human capital can provide firms with information that can measure the return on investment of HR programmes, improve the employer value proposition in an increasingly competitive talent market and get the attention of the partners who hold the purse strings.

The best managed firms separate the management accounting from the external financial-reporting function to maximise the value that finance departments can bring to the management table. Even where this is not so, accounting and human resources can begin to think beyond their traditional boundaries and to increase their collective value to the organisation.

Every employee has a lifecycle in the firm; in the case of fee earners, the three phases of this life cycle are as follows: The acquisition of talent (ie, recruiting, orientation and initial on-the-job training); the retention of talent (engagement, social networks at work, appropriate and increasingly challenging work assignments, continuing legal education, professional development and on-the-job training); and, finally, managing the departure of talent. Each of these phases means an investment for the firm that must be managed and maximised to support and enhance the firm’s employer value proposition in the long term. Assisting management in this effort is one of the most important ways in which a law firm financial director can add tangible value in the long term.

Managing the acquisition of human capital

Many firms consider recruiting costs an expense that hits this year’s income statement: a cost containment exercise. They typically capture only out-of-pocket costs, such as travel and accommodation for on-campus recruiting or, in the case of laterals, the headhunter’s fees. Depending on the jurisdiction, some firms also include bar admission courses, salary of trainees and any tuition reimbursement costs.

These out-of-pocket costs are peanuts when compared to the investment of time spent by recruiting partners and associates interviewing at the office or on campus, as well as time spent for developing and delivering induction and professional-development programmes and for on-the-job training.

Some firms encourage their lawyers to track time spent on recruiting, training and mentoring. However, these efforts often fail to produce meaningful data because time recorded as mentoring and recruiting is not valued or rewarded in most firms’ performance and compensation criteria. Also, most firms don’t have a budget of time value to be spent on recruiting and on-the-job training against which the time investment is measured.

For management purposes, however, we propose capitalising these out-of-pocket costs plus the time value of the fee earners’ time (partners and associates) at the cost rate of these individuals – without allocating an overhead component in this calculation. This capitalised cost is then amortised over the firm’s average retention duration (ie, the average time a fee earner stays with the firm). Firms of any size may attribute these costs by practice group and amortise these costs over that group’s retention duration – the prerequisite being of course that improving retention is a defined goal in the group and part of the performance criteria for its leader.

There are two important benefits to this approach. First, focusing on the total cost invested in the acquisition of human capital helps management justify additional investments in systems and structures to improve skills acquisition and workflow, and reduce partner time required for on-the-job training. Second, tying the amortisation rate to a practice group’s actual attrition penalises the profitability of departments with short retention times and rewards those with longer ones.

Keeping score on the recruiting investment on a per timekeeper basis also provides a good firm-wide indicator of whether the firm is making the required investment: Are costs per timekeeper decreasing because the process is being managed more effectively, or is the recruiting task relegated to senior associates or junior partners because the senior partners (who presumably will be more expensive given our calculation above) do not see it as part of their role?

This is not to say that out-of-pocket costs should be ignored altogether. If the usual cash recovery analysis is done on an accrual basis and includes out of pocket and time value, the firm can measure the effectiveness of a group’s integration efforts: The shorter the number of days, the better the group’s processes for training new attorneys and integrating laterals into the processes and working culture of the firm.

Engaging and retaining new generations

Almost every managing partner we speak with cites ‘intergenerational issues’ as a top concern. The leading firms have come to understand that the baby boomer generation (those born between 1946 and 1960) value work and money more than time off and life balance, and current compensation systems have evolved to meet their needs. Generations X (1960 to 1975) and Y (1976 to1995) value time, balance and skills. The younger generations are loyal to their skills, not to the firm. Your firm’s employer value proposition must connect to their goals. These younger lawyers make career decisions as part of a spectrum: “Will this job/firm contribute to my advancement, my skills, my future opportunities – why should I work here and how long will I stay?” Most firms, faced with an ever-decreasing talent pool, have to find convincing ways to answer these questions candidly or risk higher turnover, higher costs, and loss of prestige and market share. Thus finding ways to measure and manage this information should be a key priority for directors of finance.

Reviewing the number of hires, departures and promotions over time will begin to build a story that can be used for recruiting and marketing purposes and for leadership development initiatives. Track this by practice group and make the information available to firm leadership.

Most finance directors view these types of analyses, however, to be the job of human resources because often the key benchmarks are non-financial in nature. This view is outdated. Finance and human-resources directors should collaborate, establish benchmarks and develop and manage financial and non-financial key-performance indicators (KPIs) that help drive the firm’s specific goals and communicate improvement.

This is one of the most important things law firm financial and HR directors can do together to protect their firm’s employer value proposition.

Managing departures

Well run firms are rigorous about performance management resulting in terminations; however, most firms do not actively manage planned attrition or use it to their advantage. A recent study published by the Gallop organisation sites 12 critical factors that impact employee engagement. Among them is having “co-workers that are committed to doing quality work”. Managing performance is all about demanding and supporting quality. When firms tolerate mediocrity, the result is disengagement of the firm’s key players.

We believe that for most firms with over 100 lawyers, attrition of between ten per cent and 16 per cent a year is healthy. Practice groups with lower turnover may not be managing performance and may be creating the fat belly of senior associates that will never make partner. At its worst, this leads to discontent among the A-players below and above the bulge group.

This is not an attractive value proposition to future associates.

Finance directors can help their colleagues in human resources and practice group leaders to identify trends, set stretch goals of key indicators and measure results of initiatives, thus helping the managing partner to drive changes in behaviour.

Welcome to our alumni

A few noteworthy firms have done a very good job of managing performance while feeding their alumni network strategically. A lawyer who departs for the in-house department of a client or to chief-legal-officer role at a Fortune 500 company will – unless he is disgruntled – be a great source of business for the firm. A lawyer who leaves to join an investment bank can be both a potential referrer source and a resource to the firm’s clients. By collaborating with human resources to index the level of position to which an associate or partner departs, the finance director can do his or her part in continuously improving a firm’s alumni network. In addition, this information can be used to encourage people to stay longer and leave later by strategically placing them into corporate and other legal roles that are opportunities for the alumnus and for the firm.

The bottom line

In order to maximise their competitiveness in the long term, law firms must manage their human capital in a way that supports their strategy and their employer value proposition. This is just as important as managing the firm’s short-term profitability to ensure that the partners take home a draw that is sufficiently large to retain them. The way to do this is for the finance director or controller to collaborate with human resources and to think beyond the scope of typical financial reporting. Together, they can provide firm leaders with KPIs that relate to both short and long-term success.

Michael Roch, JD, CPA, MActg is the lead author of Financial Management for Law Firms (published by Ark Group). He can be contacted at michael.roch@kermapartners.com.

Karen MacKay, MBA, CHRP advises professional service firms on all aspects of the management and development of their professional talent. She can be contacted at karen.mackay@kermapartners.com.

BOX OUT: Key financial-performance indicators for human capital

Firms that view human capital as an asset first, and an expense second, measure most commonly the following indicators:

Partner and employee turnover, measured both by headcount and by turnover costs. Turnover costs would include at least recruiting costs, termination expenses, costs of client-retention efforts; other firms also include the costs of initial under-productivity associated with lateral hires (both at the partner and associate level);
Days in recovering recruiting costs. Recruiting costs can be measured in terms of days required to recover a fee earner's recruiting costs. The shorter the measurement period is, the better the firm's processes for training laterals and business-case procedures for hiring laterals. Our informal research across the clients we have worked with shows that an associate, on average, requires at least an 11-month period before their recruiting and direct costs are recovered in cash terms by fee-earning activities, that is before a lateral becomes profitable on a net basis;
Per capita annual cost of training. Measured also across partners, associates, management and staff, this number shows over time whether the firm is investing more or less. Useful are comparisons across firms; in the absence of reliable information, published financial statements of service providers at least will serve as a benchmark;
Per capita costs of internal communications. These measurements, and their changes over time, go hand-in-hand with the annual cost of training. Partners and employees alike can only understand what they have to do to succeed if there are clear standards and those standards are clearly communicated by senior management. All partners, associates and staff must live and breathe the firm's strategy. A firm that does not spend time or cost on managerial communications will not be able to get the buy-in necessary from its staff;
Per capita costs of support programmes. The same applies for internal support programmes. While this sounds of dubious value to some, the firms that have the highest amount of employee loyalty have support programmes in place, the availability of which is actively broadcast and the use of which is encouraged by senior management. For instance, psychological support in the form of a hotline is not only useful for stressed professionals, but an increase in utilisation (measured in the aggregate; these types of lines should always be anonymous) gives a clue as to the human capital's morale and can serve as a precursor of higher future staff turnover. In addition, we continue to be amazed how few firms have on-site nurseries;
Cost data by demographics. Most US firms generally keep demographic data. Just the distribution of partners, associates and staff across age, gender, law schools and other aspects of their background can show whether the firm is in line with the times in encouraging a broad range of backgrounds. Collection of cost data related to hiring, retention and turnover across such demographic data also yields helpful insights as to where the firm may wish to focus its future human-development efforts. Of course, the benefit of maintaining this data needs be balanced against potential litigation risks associated with managing based on such data.
Non-financial key performance indicators, which are beyond the scope of this report, would include average absenteeism, number of applicants for lateral partnership or employment with the firm, and employee satisfaction. It is desirable that these types of data are not only viewed historically and projected into the future, but also compared across the market.

This is an extract from Financial Management in the Legal Profession, which is published by Ark Group and co-authored by Michael Roch. For further information about this 100-page report, or if you would like to purchase a copy, please contact Adam Scrimshire on +44 (0)208 785 5914 or at ascrimshire@ark-group.com.