The subtleties of law firm profitability
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
Tags: cost management, fees, partners, profitability