Walker Clark Worldview

On Monday 14 June 2010, I had the privilege of moderating a panel discussion about the adoption of a business approach to law firm strategy.  This was part of the very successful Managing a Modern Law Firm conference, organized by the Law Firm Management Committee and the Latin American Forum of the International Bar Association, and was held in Buenos Aires.

As part of my comments, I discussed three general lessons that many law firms worldwide have learned from the economic crises in 2008-2009 (and continuing into 2010 for some countries).

1. The need to be alert to emerging economic and geopolitical trends before they arrive in the form of a crisis
2. The need for a more intense focus on profitability, particularly with respect to lawyer productivity and efficiency
3. The need for fully-informed business decisions, based on facts, not hunches or hopes.

Norman Clark

Once upon a time, only 15 years ago, law firms could learn many valuable lessons from all aspects of the Toyota management model. Toyota showed us how to identify and focus on our core business, understand how internal business systems operated, and — above all — the importance of quality management. Law firms that adapted principles of total quality management from Toyota and other leading Japanese companies saw remarkable improvements in client satisfaction and long-term profitability.

Now Toyota has another important lesson for law firms everywhere — the importance of not sacrificing quality to profitability and growth. To do so is a fool’s choice, as the recent Toyota debacles demonstrate. For every thousand dollars saved by cutting corners on quality assurance, a business can ultimately lose millions of dollars in customer goodwill and market reputation.

An article in this morning’s Washington Post provides interesting insights about what happened inside Toyota to produce the recent quality fiascos. As Blaine Harden points out in his article “‘Toyota Way’ was lost on road to phenomenal worldwide growth,” the blunders were not isolated mistakes, but the natural result of a long-term deterioration in the quality mind-set that accounts for much of Toyota’s success in the 1980s and 1990s.

But now, as the company recalls millions of flawed cars around the world, there is an expert consensus that growth itself derailed the Toyota Way, blurring its focus on quality, thinning its stable of expert mentors and undermining its capacity to respond to consumer complaints.

This one paragraph presents an excellent checklist for law firms of any size:

• As your law firm has grown, have you blurred your focus on consistently delivering “best-in-market” levels of professional quality and client service? Quality assurance is not “nice to have” or a sideline. It should be at the core of your operations.
• Are you making a serious resource commitment to quality assurance? Quality assurance is more than having “spell check” on your computers. It requires probing into the operations of your firm to identify and prevent the causes of errors, rather than trying to catch them and fix them after they happen.
• How do you respond to client complaints? The real test of a law firm’s commitment to quality is not their slogans, but how they respond to client complaints. Unfortunately, most law firms do not have any systematic procedure to address client complaints, but instead rely on crisis-to-crisis damage control, which is much more expensive and usually much less effective.

Harden’s article also reminds me of something that a senior partner in a large, international law firm in London told me about 12 years ago, as his firm was embarking on a campaign of dramatic international expansion:

No matter how big we get, we still get only one chance to get it right with our client.

Norman Clark

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

During the past eight years, my colleagues and I in Walker Clark, LLC, have had the privilege of working with some of the most successful law firms in the world.  We have also had the challenge of advising law firms who want to turn around chronic disappointing performance.

One of the common elements in both types of law firms is performance objectives.

Successful law firms typically use them. Unsuccessful firms usually do not.

Properly managed performance goals produce clear, measurable benefits to a law firm’s financial performance and market reputation. These usually include:

• Higher fee revenue per lawyer
• Lower operating costs
• Improved quality assurance
• Higher lawyer and staff morale
• Lower lawyer and staff turnover rates

The bottom line is the bottom line: substantially improved and sustainable profitability.

This is why I continue to be amazed by otherwise intelligent, sophisticated law firm partners who say that individual performance goals, and the ongoing coaching and feedback that are needed to make them work most effectively, are a waste of time. This curious, old-fashioned notion is refuted by the real-world experiences of progressive law firms that have introduced performance objectives and manage them well.

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

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

This has been a rough year for many law firms. Managing partners continue to tell me about the worst cash flow problems since their respective firms began, and which do not show signs of improving before the second quarter of 2010. Others are still trying to adjust to new economic conditions that show signs of becoming permanent realities.

What should be the top management priorities for law firms between now and the end of their current fiscal years? What would produce the best return on the investment of time, attention, effort, and resources?

Let me suggest one action that every law firm should consider as a possible high-priority management action between now and the end of the year.

Understand the forces that drive your firm’s profitability.

Your law firm’s profitability is a unique mixture of a variety of forces in the market, in the client base, and inside the firm.  Understanding these forces is not an arcane or complicated process. It is essential, however, if you want to sharpen the focus of management attention on those factors that really will make a difference for your firm. Many firms spend far too much time and money chasing the latest legal management fad, only to learn that it had little value for them.

Because law firms have profound differences in culture, structure, and operations, there is no universal formula or methodology that will produce accurate, reliable results for every firm. Walker Clark, LLC, for example uses a variety of analytical methodologies, each one tailored to the specific characteristics and circumstances of the law firm.

This is not an arcane, complicated, or expensive process. For some law firms, however, it will be essential to plotting and following a course to economic recovery. For firms that have weathered the Great Recession well, it can be a high-yield investment in building on the firm’s strengths and improving its financial and market position even more.

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