Simon McCrum is the author of The Perfect legal books trilogy…
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In this excerpt from The Perfect Legal Business, Simon discusses the importance of gross margin to a law firm.
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There is a universally recognised number that is used the world over to measure the profit-making efficiency of a business or part of a business. It is called Gross Margin. It is a single number expressed as a percentage. It allows you to compare the profit-making efficiency of a global business to that of a small local business. Businesses the world over are obsessed with it. It drives all that they do.
But do you know your Gross Margin? Possibly not. It does not feature heavily, if at all, at most law firms.
For us as a profession, billing is everything. Turnover! That completely obscures any understanding of a team or a firm’s profit. It’s also not a good instrument to drive change and business improvement.
The teams’ Gross Margins and the firm’s overall Gross Margin do often appear on the printouts that the Finance team prepare and publish every month, but they’re hidden amongst thousands of other numbers about billing rather than being the compass and the engine room of the business.
So, what is Gross Margin, what is needed to get it to improve, how do we get our people to do those things, and what is the Team Leader’s contribution here?
If you want to work out how much profit (which is different to cash, of course) a team makes in £ Sterling, you can simply deduct their salaries from their billings. That gives you their Gross Profit – in £ Sterling. It doesn’t take account of central costs and overheads that the business incurs, like rent, rates, gas, electricity, and so on. The aim is to see how good a team is at making profit, out of which profit those central overheads are then paid. I don’t include those overheads when I’m trying to see how good a team is at making profit.
But here, we aren’t interested in Gross Profit, measured in £ Sterling – we aren’t looking here at actual profit but at the team’s profit-making efficiency. Hence, we need to move on to a second calculation, which starts with the Gross Profit that you have just calculated.
If you divide the team’s Gross Profit (£) by the team’s billings (also £), and multiply the answer by 100, you arrive at the team’s Gross Margin, which is expressed not in £ but as a percentage.
The Gross Margin shows you what percentage of a team’s billings exceed the salaries that have been paid up to that point in the financial year to generate those billings. It is a measure of its profit-making efficiency.
And what should a team’s Gross Margin percentage be? Higher! That really is the answer. Whatever the Gross Margin is at the moment, the Team Leader’s role is to influence – in the right direction – either or both of the only two factors that can make the Gross Margin go up (i.e., to get billings up, or to get salaries down).
“But what if one team’s Gross Margin is a lot higher than another team’s?” I’m often asked. That’s always going to be the case. It’s not a comparison you should make – it’s irrelevant. We need to ascertain a team’s Gross Margin not so we can compare one team to another. Rather, we use the figure so that we can compare a team this month to the same team last month. The strongest and best-performing team in The Perfect Legal Business model is not the team with the highest Gross Margin. It is the team whose Gross Margin improves month after month after month.
Looking at the calculations we’ve just been through above, you can see the only two factors that can impact Gross Margin are (1) the billings of the team, and (2) the salaries of the team. The Team Leader has to drive billings up, or they have to drive salaries down. The latter can have a small and slow effect on the team’s Gross Margin. The former can have a huge and rapid effect on it.
In a nutshell, the Team Leader’s main role, therefore, in The Perfect Legal Business, is to drive the team’s billings up. And that is done by all the ways we examine in this book – having only good people in the team, Pride in Pricing, good Utilisation by the lawyers (chargeable hours), good Realisation levels by the lawyers (no write-offs), adhering to the Service Pledge, and having the right team structures in place so that file storage is avoided.
And, of course, profit is something that exists only on paper until bills are paid – the Team Leader’s job is forever to be the cash policeman, too.
I suspect that if the Team Leader kept the “crown jewel” that is the team’s Gross Margin to himself or herself, it’d be a bit like pushing a rock up a hill in the dark. Far from keeping it secret, therefore, I advocate that ownership of a team’s Gross Margin is passed to the whole team. They then see it as a measure of their own collective business efficiency, and they will hopefully adopt the team-like behaviours and priorities necessary to get the Gross Margin up – particularly if those behaviours are enshrined in the firm’s reward and promotions apparatus.
Where a firm goes on a business-improvement journey, a team’s Gross Margin can improve in Month #1. That of all teams can. The Perfect Legal Business constantly uses this measure of business efficiency to make sure that it doesn’t slip in any quarter, or – if it does – that the Team Leader quickly takes remedial action.
The Perfect Legal Business, therefore, works hard – through its Team Leaders and through the performance of its people – to drive profitability on every case and in every team. It also ensures that all profitability is turned into cash.
But if we stopped there, all we’d have is a business that dealt well and profitably with any case that came in.
There’s a final piece to The Perfect Legal Business jigsaw. For, just as one case completes, another is needed. The final difference between the Perfect Legal Business and an imperfect one, is where the Perfect Legal Business looks as a priority to find those new cases.
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