Walker Clark Worldview

With so many smart people who make their livings by intellect and analysis, why do so many law firms have so much difficulty with profitability?

I think it is because they don’t know where to look, or how deeply to probe, for the causes of poor financial performance.  This is why even in good times, some law firms — particularly small and midsize ones — struggle to remain profitable.

Law firm profitability is different.  Some traditional accountants — even ones who are experienced in other professional services businesses  — tend to overlook or minimize the special factors and forces that must be understood and addressed in order to improve the profitability of a law firm or of a particular practice in the firm.

You can’t take a generic profitability analysis, cross out the words “accounting firm” or “architecture firm” and write in “law firm.”

To be fair, there are a lot of excellent accountants and other financial specialists who understand this. I have had the great professional pleasure to work with a number of them. Not surprisingly many of them have in-house law firm experience.

Our firm’s experience advising hundreds of law firms and specialized practice groups throughout the world has confirmed the classic “six drivers of  profitability,” which have the greatest impact on the profitability of a professional services firm:

• Price
• Productivity
• Realization
• Cost management
• Fee earner compensation
• Leverage

This is nothing new. These apply to most professional services firms.  However, in most law firms these six factors interact in ways that can be subtly, but profoundly, different from other professional services. Someone who does not understand the practice of law might not notice these subtleties. Here are five of the more frequent examples:

• The price sensitivities and quality expectations in different types of legal services
• The nature of the various constituencies and business sectors in the firm’s client base
• The seniority, market reputation, and equity interests of the owners of the firm, who usually also are expected to produce a disproportionate amount of the fees
• The availability of partner capital to respond to short-term cash-flow issues or to take advantage of investment opportunities
• The degree to which a practice area or service line is heavily dependent on the management of sophisticated intellectual capital

From a profitability perspective, most law firms actually compete in a number of economically distinct legal markets, not just one. This is why a “one size fits all” profitability strategy — particularly dramatic ones such as across-the-board cost cutting or massive redundancies — might produce desired results in one practice area, but sometimes also can be impotent or even counterproductive in others.

Even the smallest law firms are very complex, sophisticated business entities.  The causes of problems in financial performance frequently can be found and understood only by drilling deeply into the operations, client base, and professional culture of the firm.  There is seldom an easy, quick fix to chronic profitability problems.

Norman Clark

What can law firms expect in 2010? Here are two points to factor into your planning for the new year.

• Most of the world will see economic recovery in 2010. Most Latin American economies will recover to, and surpass, 2008 performance — especially in GDP growth. We also expect to see recovery by the end of the year in every other region of the world. Recovery will be significant and sustainable, even in the United Kingdom and the European Union; although it might not be until 2011 that some national economies see a return to 2007 levels of performance.
• The picture is not as optimistic for the United States, however, where business failures and personal bankruptcies are likely to continue at record levels. Recovery in the U.S. will also be hampered by the dysfunctional economic policies of the Obama government, and its stubborn failure to acknowledge candidly and address honestly the issues that have decayed the foundations of the American economy and the American political system over the past 30 years.

What will this mean for law firms?  The answers will be highly firm-specific and will vary by jurisdiction, law firm specialty, and size.   There are four issues, however, that I am hearing discussed frequently among our clients and professional friends in law firms worldwide:

• Profitability.  Small and midsize corporate and commercial firms in the United States will continue to struggle with profitability issues, particularly on the revenue side.  Cash flow and management of working capital will continue to be problems for many firms.  We also expect to see continued business failures, downsizing, and partner departures, especially in local firms with fewer than 50 lawyers.
• Outsourcing.  There will be a renewed interest in outsourcing of administrative, marketing, and some lawyer functions in order to control costs.  Some of these efforts will work very well; others will be disappointing.
• New players in the international market.  2009 was a year of retrenchment for large international law firms.   In 2010, we expect to see a renewed interest in carefully selected international expansion. Look for some significant international law firm mergers, some of them involving firms that have not previously been considered to be major international players. We also expect to see regional firms, particularly those based outside North America, enter the international market.
• Quality assurance. There will be renewed interest in the quality of client service and in the efficiency of internal client service operations, not only as competitive advantages but also to reduce operating costs.

These are not the only things that we expect to happen in law firms in 2010, but they are interesting examples how progressive law firms are planning their responses to the economics of 2010, as we perceive them now.

Norman Clark

In my discussions recently with Walker Clark clients who are midsize law firms, I have noticed two interesting priorities emerging in the business plans for 2010. These are not the only profitability tactics that law firms are thinking about for next year, nor are they necessarily the most important. However, it is possible that your law firm might be overlooking them.

1.  A client-supportive approach to collections

A large portion of our law firm clients are ending 2009 with the biggest accounts receivable in their history, as well as record high percentages that are more than 180 days old.  Rather than write off the fees — and also write of the clients who owe them — some firms are taking the initiative to offer to compromise the overdue fees by 50% or more, in return for a payment plan to settle the account by the end of 2010. They are also offering the overdue clients significant discounts as an accommodation to help the client survive hard times.

This makes good sense. It is not in a law firm’s interest to have clients go out of business. Instead of being yet another financial wave that threatens to capsize the client’s ship, law firms should become part of the client’s damage control team. Sure, the law firm will be giving up some possible revenue; but it is money that it probably never would have collected.  In return, the law firm is receiving priceless client loyalty in the future.

Support, not shame, is the more effective collection technique.

2.  Renewed interest in outsourcing

In 2010 many midsize law firms will be taking a hard look at the costs of functions that have traditionally been in-house, such as IT and network administration, marketing support, project management, and translations. They are beginning to discover that the total cost of some of these functions — especially those with significant lawyer involvement — has become unacceptably high, while delivering only marginal quality and value to the client. These firms are trying to discover the true costs of these functions, which often include items that do not appear in the financial reports, such as the value of fee earner time and the rework caused by inadequate quality assurance.

Outsourcing will not make good business sense in every case. Substantial improvements can sometimes also be made through process reengineering. However, I expect to see outsourcing of more internal operations and tasks as part of the cost management tactics of many small and midsize law firms, especially in markets where fee income has not recovered to pre-2008 levels.

Norman Clark

National Law Journal has a short, interesting post on-line this morning: “Slight boost seen in number of part-time attorneys.” To quote the pertinent facts:

The percentage of attorneys working part time ticked up slightly in 2009, despite fears that the unstable economy would prompt fewer people to seek reduced-hours schedules.

According to the latest statistics from the National Association for Law Placement (NALP), the percentage of part-time attorneys at law firms grew from 5.6% in 2008 to 5.9% in 2009.

What surprises me is that the numbers are not higher — especially in the United States, where the “true” unemployment rate (“official” unemployment + unemployed people whose benefits have expired + people who are “underemployed” in part-time jobs that are insufficient to keep them out of poverty) is approaching 50% in some metropolitan areas. Many young lawyers are desperate to find any work that they can get, preferably in their profession.

What also surprises me is how many law firms appear to have completely overlooked part-time lawyers as a readily available, low-cost, high-yield resource, particularly in practice areas that are currently producing uncertain flows of new legal work.

Having a group of part-time attorneys with well-rounded professional knowledge and backgrounds, who are also available on relatively short notice, could make a big difference  in measurable financial terms and competitiveness for new work. Part-time staff can also ensure that the firm has the basic service-delivery resources that will be needed when the economy enters a sustained recovery.

Walker Clark, LLC, advises our clients to consider using  part-time lawyers and paralegals. We also help our clients to set up flexible plans and systems to recruit, manage, and incorporate these valuable “just in time” resources into their business plans and legal staffing. For more information about how we can help, contact me by email by clicking on this link or via our website.

Norman Clark

One of the first targets in law firms for the cost-cutter’s ax is often marketing-related travel, such as meeting distant prospective clients and attending conferences. A study published today by The Economist, demonstrates how mindless slashing of travel budgets could make things worse.

A post on The Economist’s business travel blog, “Gulliver.” reports on a study by Oxford Economics, a business management consultancy, on the return on investment in business travel. The research found that:

• Overall, every dollar spent on business travel produces $12.50 in additional revenue and $3.80 in additional profits.
• Meetings with customers produce the best return of all: ranging from $15 to $20 per dollar spent.
• Even the frequently maligned conference produces a return of at least 4-to-1.

We might live in a virtual, global marketplace; but successful marketing and business development still requires the personal touch.

Quoting from the report:

According to business travelers across all industries, 25% of existing customers and 28% of revenue could be lost to competitors if customers were not met in-person. This risk appears to be most acute within the manufacturing sector, where 36% of customers and 38% of revenue could be lost to competitors”

This does not mean that every boondoggle is a potential profit center. However, law firm partners and marketing professionals should resist the temptation to slash travel budgets that have specific goals and reasonably likely outcomes.

Remember the words of Geoffrey Chaucer, written more than 600 years ago in The Canterbury Tales:

Nigh and Sly beats Fair and Square who isn’t there.

Norman Clark

The decision by London-based Freshfields Bruckhaus Deringer not to cut salaries of its U.S.-based associates reflects a type of strategic thinking that is badly needed during an economic crisis.  

One of the principal reasons for Freshfields’ decision was the fear of an exodus of associates to other top-shelf New York firms, as well as long-term disadvantages in recruiting the best young legal talent. We can debate whether such fears are realistic; but the instructive point is that a major firm has resisted the temptation to go after a big cost-cutting target.

Our firm uses case studies as a central feature of our Core Business Skills Development curriculum.   Consider this excerpt from a case study from Understanding Law Firm Economics.  It is based on our observations during the 2001-2002 recession.  It is a good example of how a chain-saw approach to cost cutting can make things much worse.  All of the events described took place during a period of less than 18 months.

As the recession extended into its second and third quarters, and fees began to decline, the firm calculated that they could save more than $500,000 by firing 15 junior clerical staff.  Most of these worked in the firm’s high-volume collections and trademarks practices.  

The staff cutbacks created a minor “avalanche,” as five more senior staff also departed the collections and trademarks practice within the first four months.  The firm did not conduct exit interviews, but one of the senior staff told colleagues that he was leaving because “the ship is sinking.”  These senior staff were essential and had to be replaced, with overtime, temporary staffing, and replacement costs totaling more than $60,000.  This was an unexpected and unbudgeted cost.

The collections and trademarks departments tried to work more efficiently with fewer staff.  As the recession deepened, the trademarks workload decreased slightly, but the demand for collections services increased.  The overworked “survivors” had to work faster and longer as they struggled to handle the work left behind by their fired co-workers.  Staff from other departments were temporarily assigned to try to respond to short-term surges in workload, particularly during the last ten days of each month.  

Despite these efforts, processing times for client matters and response times to client inquiries began to lengthen.  The two practices also experienced an average increase of 20% in recorded time arising from the need to correct an increasing number of errors.  Of course, this rework could not be billed, as the clients would have justly refused to pay for it.  

The clients began to notice that something was wrong.  Client dissatisfaction and fee disputes increased sharply approximately four months after the cutbacks.  By the end of the fiscal year, the firm had lost $1,000,000 in potential fees; and fee disputes had increased the average fee payment time for the two departments from 58 days to 147 days.  

The staff cutbacks had other impacts.  Absenteeism increased in the two departments, resulting in more than $20,000 in overtime and another $35,000 in temporary staffing costs in the first year alone.  These costs were unplanned and unbudgeted.

The firm “saved” $500,000, but its failure to anticipate and manage the risks of its cost-management scheme cost the firm more than $1.1 million  for a net loss of more than $600,000.  This does not include the intangible negative value of the long-term damage to the firm’s reputation among collections and trademarks clients, declining staff morale, and increased potential losses due to fee disputes.  The partner who manages the trademarks practice is rumored to be in negotiations to join the firm’s arch-rival.

This is not a time for panic disguised as “bold, decisive action.” Instead, law firm leaders and managers should consider the long-term consequences of cutting staff or other operational costs.  For every dollar, euro, or pound that is saved, there will usually be a long-term cost that must be considered, but is too often overlooked or not understood.  

Norman Clark