Small Firms, When to Hire New Staff?

This is part of my series where I try to help anonymous strangers on Reddit (as u/AgileAtty). You can find the original post here. There was a follow-up question in the comments which I also answered in part 2 of this thread.

It’s understandable that you’d want a “rule of thumb” for this question, but the reality is that you are growing beyond rule of thumb management strategies. Warning: long post ahead.

TL;DR It’s time to put on your Excel pants and level up your business maturity by using data to make these decisions.

The Three Core Systems

The first thing to understand is the three core systems that make a law practice (or any business) work: The "getting the work" system, the "doing the work" system, and the "getting paid" system. It is helpful to think of each in turn.

The "Getting the Work" System (Marketing & Sales)

You say “we are filing more cases than ever and everyone is busy, including myself.” That’s a great early indicator that your getting the work system (marketing & sales) is working reasonably well. But do you know why?

Hopefully you have some of this already, but you need to where your leads are coming from, and what’s the quality of leads from each source. You need to know your funnel(s), and your conversion rate for each stage of each funnel. And you should have increasingly good data that tells you which levers you can pull to change the quality and/or quantity of your leads, and how to improve your conversion at each funnel stage.

As a quick aside, it is possible to solve for your feeling of overburden just by changing your sales and marketing behavior: Take a smaller number of better cases. Whether or not this is your only strategy, it probably should be a component of what you do. Look at your case load over the last year or so, figure out what are the aspects of an “A” case, a “B” case, etc., and then stop taking anything below a B.

The "Doing the Work" System (Delivery)

Next up is your doing the work system. Here too, you need to be looking at data to drive your decisions. I’d start with three workflow metrics:

1. What is your current number of open cases? 
2. What is your arrival rate each month (the end of your getting the work system and become active matters)? 
3. What is your departure rate each month (matters that are closed, paid, and buttoned up in your systems)?

Your feeling of overburden is tied to the number of open cases in your system. Those are the balls in the air that your firm is juggling. If that number goes up (without adding resources), then your overburden will grow. If that number goes down, you will feel relief. That’s where the other two numbers come in. If your arrival rate exceeds your departure rate, that means your open cases are rising (and your overburden is growing).

The other thing to keep track of in your doing the work system is average lead time: how long does it take each case to move from arrival to departure in your workflow? Don’t overthink it at first: just take the duration of each case you’ve closed in the past X months and average them. Eventually you may want to track separate lead times for different case types or different outcomes, but the overall number is enough at first.

The main thing to know about your doing the work system is that your throughput speed is a function of your lead time and your arrival rate (this is an actual formula knows as Little’s Law). If your current lead time is 270 days, but you can get that lead time down to 255 days, then your firm will be able to handle 15% more cases each year (and, assuming no drop off in case quality, make 15% more in top-line revenue).

How, then, can you increase your throughput speed? There are three primary options. One I mentioned already: throttle your intake by taking a fewer number of better quality cases. Another is what you wrote this question about: add resources to your team — that can work, but it's your most expensive option. The third is to examine your workflows to identify places where work is getting stuck, and then make efforts to increase the flow at those sticking points. Putting your work on a kanban board is a great way to see where your bottlenecks are.

My guess, based on my experience, is that your work is getting stuck in at least one of three places:

• Final close out, where the case is pretty much done but you haven’t closed it out in your systems,
• Internal quality assurance (QA), where someone on your team has done a thing but is waiting on you or another senior resource to make sure it is ready to go out the door, or
• External dependencies, where your team has done all you can do but you’re waiting on some external party — the client, medical records, the insurance company / OC, even the court — to do a thing before the case can move forward.

This reply is already crazy long so I won’t go into strategies for each, just know that there are things you can do at any of those bottlenecks to speed them up without necessarily adding members to your team.

The "Getting Paid" System (Finances & Profitability)

With respect to the getting paid system, this is really a placeholder for broader financial discipline. With contingency practices, the act of actually getting paid isn’t as much of a challenge as it can be with other types of firms. What you need to know is how much of that money is flowing through to firm ownership; your profitability.

For some reason lawyers often don’t think of profitability the same way other business owners do. In most businesses, there are two profitability calculations: gross profit and net profit.

Gross profit is your top-line revenue minus cost of goods sold (COGS), which typically includes things like the cost of raw materials, direct labor associated with producing the good (or service), and direct overhead (expenses you only incur because you are producing that widget). For contingency practices, direct labor may be the only component of the COGS calculation — there aren’t really any raw materials, and you get to recoup most direct overhead expenses outright.

That means you need to be able to express your labor costs in a way that is useful for calculating gross profitability. Typically that means your workers’ fully-loaded salary (including benefits, etc.) expressed hourly.

Don’t overthink it — just plug it into a formula and use it. For example, if you pay a paralegal $75k/year, plus they cost you another $10k in benefits, their fully loaded salary is $85k/year. Divide that by 2080 working hours in a year and you come up with an hourly cost of roughly $41/hour.

Hopefully you are doing some rough time tracking on your cases even though you’re a contingency shop (it doesn’t need to be 6-min increments for these purposes, 0.5s are plenty). That way you can easily calculate gross profitability when you settle (or win) a case. What’s more, you probably get to fully recoup expenses so really your only component of COGS is your direct labor costs.

• Settlement Amount: $90k
• Fee to firm: $30k
• 100 paralegal hours @ $41 hourly cost: $4,100
• 75 attorney hours @ $100 hourly cost: $7,500
• COGS = $11,600
• Gross Profit = $18,400
• Gross Margin = 61%

(Another aside: don’t try to finesse your employee costs by saying “well they are 75% direct labor and 25% internal cost.” If you’ve hired them to work cases, allocate 100% of their salary to COGS. The only exception might be how you allocate your own costs since you have significant overhead responsibilities. Probably go with 50/50 for yourself).

Gross profit is really the only calculation you need to be making on a case-by-case basis, and even then you don’t care about individual cases so much as your average across all cases in a given time period. This average will include cases you lose or don't settle, meaning you have negative gross profit on that unit.

I won’t go as deep on net profit, but that is when you take gross profit — across all of your cases in a time period — and subtract your other business expenses for that same period. Accountants call that your sales, general, and administrative expenses, or SG&A. This is where you total up your marketing expenditures; all of the software you use; the cost of employees like receptionists, bookkeepers, or firm administrators (probably also half of your salary); insurance; rent; bar dues; and other overhead.

Ultimately, your net profit is what you get to take home as a business owner at the end of the year (or whatever time period you choose), assuming you don't reinvest it in improving the business.

When should I hire... ?

Getting back to your question: When to hire…? You hire staff when you know, from looking at your numbers, that it will be profitable to do so, and that you have exhausted less expensive options for improving your firm’s profitability.

That means you’ve looked at your "doing the work" system and can tell from your numbers that it is running reasonably efficiently. If you have bottlenecks in that system, it is almost always less expensive to engage in process improvement to unblock those bottlenecks than it is to throw another FTE into the mix. (Full disclosure — I am a process improvement guy).

It also means you’ve looked at your getting the work system and know for sure that you have the potential sales volume to support your new resource. And, again, that you’ve exhausted other strategies — you may be better off moving your practice up-market than driving for higher volume.

It all ties back to financial discipline. What most business owners want is more profit. You can get this by increasing your profit margin or by increasing your volume of already profitable unit sales. Or both. But volume for volume’s sake is not a direct path to profit.

Take the time to determine your profit goals, then form a strategy to meet those goals. This is not a “rule of thumb” exercise.

Note: Be sure to see my answer to a follow-up question in part 2 of this thread.