RULES of Law Firm Profitability, Part 1

Topics: Billing & Pricing, Business Development & Marketing Blog Posts, Law Firm Profitability, Law Firms

PMI

Law firms of all sizes are constantly trying to fine-tune the basic levers of profitability, which are commonly referred to as RULES:

  • Rates
  • Utilization (high productivity)
  • Leverage
  • Expenses
  • Speed (of billing and collection)

These levers are worth pursuing by any law firm, because improvement in any of these areas will enhance profitability. However, there is one aspect of a law firm’s practice which influences all of these levers in a significant way—the quality of the firm’s services. Improving the quality of a firm’s services will improve the chance to achieve good performance under each of the profitability levers.

Rates

In the decade prior to the economic downturn that began in 2008, large law firms increased billable rates an average of 7% a year, well in excess of the rate of inflation and, in hindsight, not at a sustainable rate. The principal reason why clients accepted these rate increases is that demand for legal services was outstripping supply during this period. However, law firms reacted to this imbalance (and the consequent favorable market for law firms) by adding capacity rapidly—too rapidly, as it turns out.

When business fortunes plummeted in 2008, demand for legal services dropped precipitously. The volume of complex business transactions, in particular, dropped suddenly; and many law firms were caught with overcapacity and, even worse, commitments to hire large future associate classes.

In a much more competitive market, clients soon were emboldened to drive hard bargains; and the balance of power shifted rapidly. Firms with an overabundance of lawyers offered big discounts in hope of winning work, even at much lower rates. Empowered clients also resisted having inexperienced associates working their cases, which only added to the overcapacity of many law firms, especially in their junior associate ranks.

In the years since 2009, demand has stabilized but not grown robustly. With the balance of power still tilting in favor of clients, firms have increased rates annually—though not at the percentages that once were possible. Not all of these rate increases stick, however, as clients with bargaining power simply don’t accept the increases or neutralize it with substantial discounts.

The firms with unique expertise and quality of service are better able to resist the competitive pressure on rates. However, when firms accept work that other firms are capable of doing more cheaply, clients will insist on lower rates or bigger discounts. This is basic economics, which can only be countered by a firm competing primarily in the market segments where it has discernibly better quality, and thus market power.

Utilization (High Productivity)

All the profit levers mentioned above are interrelated, and the tactics for addressing one will often help in pursuing others. If a firm accepts predominately assignments for which it has discernibly better expertise, for example, it can maintain rates against lower priced firms which cannot compete as to quality. In the same vein, control of headcount helps a firm maintain higher average hours worked per lawyer because there are fewer lawyers to keep busy. In this way, by focusing on the type of work pursued and the number of lawyers pursuing it, firms can maximize utilization.

Productivity is also enhanced by strong project management and by careful assignment of work. Strong practice management involves the planning of each project to utilize lawyers efficiently and deliver value to the client with each hour worked. On a large project, each lawyer, whether more or less experienced or skilled, is doing work which utilizes his level of experience, expertise and also stretches him to expand his skill. Adept project management requires partners who are well organized, and practice managers who are aware of the capability of lawyers at different levels of expertise.

A firm also must coordinate all the different matters competing for resources. From the firm’s standpoint, it’s important that every lawyer be occupied 100% of the time, for gaps between assignments represent lost opportunities which can never be recaptured. Skillful practice managers can minimize these dislocations and assure that every lawyer is occupied full time and is doing work that supports the highest possible billable rate while building expertise which will make the lawyer more valuable for future work.

In summary, headcount discipline, strong project management, and efficient work assignment are all prerequisites for high utilization. And this high utilization, when used by a firm that does most of its work where it has the market power to command the highest possible rates in a competitive market, will contribute to higher revenue. In other words, the quality of a firm’s work will affect its ability to maintain high productivity measured by hours per lawyer.

In my next blog on RULES, I will examine how Leverage, Expenses and Speed of billing and collection all can add to a law firm’s profitability.

(Part of 1 of 2)