RULES of Law Firm Profitability, Part 2

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

PMI

In my previous blog post, I discussed the basic levers of profitability, which are commonly referred to as RULES—Rates, Utilization, Leverage, Expenses and Speed.

I wrote about how Rates and Utilization can add to profitability; now, let’s look at how Leverage, Expenses and Speed of billing and collection can play a part.

Leverage

In the years since the economic downturn, continued slackening demand and consequent overcapacity by law firms have given the client the upper hand. This shift in the legal marketplace has resulted in pressure against increasing rates and resistance from clients in the use of young associates, leading to a reduction of leverage (the ratio of associates to partners) in most law firms.

A firm can still use leverage as a profit lever if it employs young lawyers properly to add value which will be recognized by the client. The reason why a client puts restrictions on the use of young associates is that the client doesn’t believe the associates are adding value. The client feels that the associate is inexperienced for the work assigned, and the client doesn’t want be billed for what he often views as “training”. If the law firm assigns associates only to perform assignments for which they truly add value equivalent to their hourly rates, however, then the client will more readily understand that the client is receiving a benefit from the associates working on the matter. Obviously, some practice areas support more leverage than others. A huge litigation matter with complicated legal issues and thousands of documents to review under a tight timetable requires a large team of lawyers, paralegals and contract attorneys or “discovery attorneys” working simultaneously on many aspects of the case. The law firm can supply talented personnel for many different tasks if it truly delivers value for each of these tasks and the client does not have a lower cost alternative.

Thus, delivering high quality services is the key to utilizing leverage effectively, but not every matter in every practice area has the same need for leverage. It’s important that each lawyer or paralegal be assigned to a task which could not be performed as effectively by a cheaper lawyer or paralegal at another firm or by in-house lawyers or paralegals employed by the client. In the end, it may make sense for a law firm to offer services across a relatively wide range of practice areas and locations, but only if the work is staffed so as to add value to the client by every lawyer or paralegal working on the matter.

Expenses

During the downturn, most client businesses took a tougher stance with law firms (evidenced by resistance to rate increases and by choosing alternatives to high-priced law firms for certain work) that was driven primarily by their own need to control expenses. Similarly, cutting expenses became the lever most law firms adopted most quickly and effectively to preserve profitability.

Once the downturn hit, most law firms acted quickly to limit headcount; most saw they needed less office space and support staff if they had fewer lawyers. A number of law firms also established service centers in less expensive parts of the country which achieved further expense savings without diminishing the quality of legal services. Part of the reason law firms moved so quickly to pare expenses was that law firm leaders were aware of the high expenses at their firms and had been already contemplating expense reductions.

Expenses which were essential for the quality of service provided by law firms could not be cut without affecting the excellence of that service. Therefore, most firms’ priorities for cutting expenses were driven by their need to maintain quality of service delivery, ability to compete on price, and desirable levels of productivity. The fact that law firms were willing to cut expenses and operate a little more efficiently also resonated well with clients who were facing similar circumstances.

Speed (of Billing & Collection)

Nothing illustrates my thesis that a law firm’s quality of service helps it to use the basic profitability levers more effectively than the lever of speed of billing and collection. The more a law firm provides fungible services that other firms could do as well or which might be done in-house, the more the law firm is likely to be treated as a “vendor” subject to procurement rules rather than an indispensable partner in providing crucial expertise. If, on the other hand, a law firm provides critical services of a quality that the client cannot obtain anywhere else, its bills will be paid more quickly and questioned less often.

A law firm shows respect for the client by paying close attention to the reasonableness of expenses passed on to the client, and reviewing hours billed to the client to verify that they are accurate and necessary. Through active practice management, a firm can assure that every person on a case team is deployed efficiently as to hours worked. Hours that must be written off before being billed affect a firm’s profitability. Bills that must be reduced for inaccuracy or inefficiency discovered by the client not only impair firm profitability but shake the client’s confidence in the firm’s care and judgment. Payment is also delayed by questions about bills, and clients are more likely to audit bills if the firm has been sloppy in its billing practices.

Conversely, if a law firm delivers high quality legal service in an area of expertise and can efficiently deliver that service, it will have the market power to collect its bills promptly and without hassle.

(Part of 2 of 2)