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

Every law firm managing partner should feel good about starting the new year with a business plan that has already been approved by the owners of the firm.

Unfortunately, most law firms do not meet the “first day of the year” deadline with their business plans. In fact, a surprising number of law firms operate without a business plan at all. I personally think that this is as risky as setting sail on rough seas without a chart or compass; but, whether I approve or not, this is a reality for many law firms.

The most common reason for not having a business plan is the time required to produce a well-informed, carefully-considered one. “I need to spend my time performing, not planning to perform,” one managing partner recently told me.

There is an alternative to making it up as you go along. For some law firms, it might produce better results to wait until the end of the first month — or even the end of the second month–  before you finalize your business plan for the year. Aside from guaranteeing that you will get at least one or two months right, you might have a better understanding of:

• The factors that shaped your performance in the previous year. Sometimes these are not fully apparent until after you close the books. In some law firms that I have advised as much as 50% of the firm’s fees were not collected until the final three months.
• The factors that are beginning to affect your performance in the new year. Most law firms experience revenue decreases and cash flow issues in the first one or two months of the new year. January, in particular, can be the least productive month of the year. If it takes four to six weeks for your firm to get back into “high gear,” it might be wise to wait and see how the firm is actually functioning in the new year before finalizing your business plan.

Above all, deferring the final approval of the business plan until the second month of the new year can relieve the normal year-end pressures that consume so much time at the end of the old fiscal year.

“Wait and see” business planning might not work for every firm. For firms that already are usually on schedule with their business planning, deferring the final approval of the plan by one or two months might not add very much value. However, for firms that have chronic difficulty with formal business planning, this alternative might be a less stressful alternative that can produce equally good — and perhaps even better — results.

Norman Clark

We are now in the last two weeks of 2009, which, for many law firms, means the last two weeks of the fiscal year.

It is not too late to make significant improvements in your firm’s profitability for 2009, even at this last minute.

Focus on collections.  This money is already yours.  Other than the cost of a telephone call, the added fee revenue is pure profit.

Here are four tips:

1. Pay close attention to unpaid expense reimbursements. Even if the client is unable or unwilling to pay the fee, you can appeal to the client’s sense of fairness by asking the client at least to pay the expenses that you or your partners have already spent on the client’s behalf.
2. Offer to settle accounts receivable that are more than 180 days old at a deep discount, provided that you receive payment by 31 December. Your probability of ever collecting these balances without compromise has already fallen below 50%. Moreover, a substantial percentage of your long-overdue balances are probably from relatively small accounts.  You can possibly write off as much as 50% without a significant negative impact on overall profitability.  Why not take what you can get this year, rather than carry forward an account that will probably never be paid in full?
3. Offer an end-of-the-year rebate for all accounts receivable.  For example, if the current fee balance is received by 31 December, you will apply a rebate equal to payment of 5% or 10% against the next invoice in 2010. Although this will reduce your revenue a little in 2010, it could make a significant difference by the end of this year.
4. Pay special attention to clients that are having cash-flow problems or other financial difficulty.  Ask them to make a significant partial payment by the end of the year and a commitment to a payment plan in 2010.  In return, agree to write off a significant portion of the total balance — perhaps as high as 30% or 40% — if they complete the payment plan as agreed. You know (or, if you are doing your job properly, should know) which clients are in financial trouble. Most of them will respond positively and will also become more loyal to your firm.

These techniques work. Most clients see these as favors from you, not just last-minute bill collecting. They also can put a significant amount of additional profits into each partner’s pocket.

Norm Clark

National Law Journal has a very interesting piece on-line this morning, “Billing Out of the Box,” by Sheri Qualters.  It describes some of the creative approaches that small and midsize law firms are taking to revising their fee structures to meet clients’ economic realities in hard times.

There are two interesting points that I need to be make:

1. It is not about price competition. It is very significant (and adds a lot of credibility to the piece) that  NLJ  does not prattle on about how small law firms must try to remain competitive by charging the lowest price in the market.  A reasonable fee only keeps your firm in the market.  It does not create competitive advantage.   All it takes to lose the “low price” competitive advantage is for a competitor to charge one dollar less.  Moreover, such a race to the bottom is usually suicidal for small and midsize law firms.
2. This is nothing new. All of the fee structures described in the article have been around since the introduction of “alternative billing” in the 1990s.  My colleagues at Walker Clark, LLC, and I have been advising small and midsize firms on fee structures and pricing for years.  We have helped law firms work with each of the fee structures mentioned in the NLJ article, as well as some that it doesn’t include.  We have also helped them to use flexible fee structures as a component of their marketing strategies.

What NLJ describes is important, but it is not “out of the box.”

To learn more about Walker Clark’s fee structuring  services for small and midsize law firms, send me an e-mail.

Norman Clark

It is becoming increasingly apparent that the global economic decline is going to continue through 2009 and into 2010.  Nobel-prize laureate economist Paul Krugman, in a very thoughtful column in the New York Times on 15  February 2009, characterized the current crisis as a “debt trap.”  Until individual consumers and businesses can get out of now unpayable debt, there is only guarded hope for a sustained recovery. 

Krugman concludes:

If you want to see what it really takes to boot the economy out of a debt trap, look at the large public works program, otherwise known as World War II, that ended the Great Depression. The war didn’t just lead to full employment. It also led to rapidly rising incomes and substantial inflation, all with virtually no borrowing by the private sector. By 1945 the government’s debt had soared, but the ratio of private-sector debt to G.D.P. was only half what it had been in 1940. And this low level of private debt helped set the stage for the great postwar boom.

Since nothing like that is on the table, or seems likely to get on the table any time soon, it will take years for families and firms to work off the debt they ran up so blithely. The odds are that the legacy of our time of illusion — our decade at Bernie’s — will be a long, painful slump.

Today’s Washington Post, published an equally somber assessment by the U.S. Federal Reserve of the long-term prospects for the U.S. economy:  high unemployment and economic stagnation through 2011.  In the past week, we have seen similarly bleak forecasts from the United Kingdom and Western Europe.

We all can hope that Paul Krugman and the Federal Reserve are wrong; but denial and wishful thinking usually make things worse.

How should a law firm prepare for Dr. Krugman’s “long, painful slump?”  

There are some disturbing questions that law firms must ask now. For example:

• We have already had one (or two) rounds of layoffs?  Who is going to go in the next round?
• We need every cent of fee revenue; but what to we do about clients who are unprofitable for us, but still pay promptly?
• We have already cut our professional and support staffing deeply. How do we ensure top productivity and morale among those who are still here?
• How will we respond to increased client pressure to cut fees?
• When will we have to tell a client “no?”
• If we convert from the hourly rate to fixed fees, how will we ensure that we can protect at least a modest level of profitability?
• The market for legal talent will probably allow us to get away with salary freezes for associates; but what will happen if we are forced to cut salaries?
• What do we do about the partners who are not carrying their own financial weight? If we sack a partner, will we also lose clients that we need long-term?

For many firms, these issues have been little more than interesting topics for panel discussions at bar association meetings.They have now become immediately real for almost every law firm, regardless of practice specialty, size, or location.

Although law firms still must meet the monthly payroll and keep the electricity on, crisis–by-crisis improvisation will not be good enough. 

It is not to early to start working on your business plan for 2010…

…maybe even for 2011.

Norman Clark

One trend has already become clear: In-house counsel increasingly are asking law firms to convert to fixed fees or total fee caps for work that previously has been billed on an hourly rate. 

For example, The Lawyer reports today that Slaughter and May will now “embrace” fixed fees and discounts, although the firm has always offered some alternatives to the unlimited hourly rate.  Recently, the firm has been under considerable pressure from clients to shift from “value billing” to fixed fees.  

The discounting scheme will include feature such as a reduced rate for deals that are not completed.

The author of the piece in The Lawyer, Kit Chellel, quotes Slaughter and May executive partner Graham White: 

We’ve just responded to what clients have asked us for.  The model of many City firms was, for a long time, to agree fixed hourly rates. I think in-house counsel have realised over the last couple of years that it’s not necessarily the most efficient model.

The hourly rate is far from dead, but Slaughter and May’s shift in its fee structures is another sign that law firms must provide clients with greater predictability and manageability in legal costs.

The challenge will be to quote a fixed fee that is attractive and competitive, but also provides the law firm with a reasonable degree of confidence in its profitability. Many law firms are unable to do this. They either lack reliable data about operating costs and staffing requirements; or, if they have the data, they do not know how to extract it and use it.   Moreover, the current round of staffing cuts may have resulted in actually increasing the internal cost of producing some client services.  These issues should stimulate law firms firms to take a close, probing look at the productivity and cost effectiveness of their internal operations — something that many firms have never undertaken.

[Note: Walker Clark, LLC, offers a Core Business Skills Development Program in this area:  How to Design Profitable Proposals.]

Norman Clark