Increasing law firm profitability – what’s working and what’s not?

Cameron's Profits for Partners Blog

Originally published in Canadian Lawyer

Leverage

One of the fastest and easiest ways to increase profitability is to increase leverage by moving work down to the most efficient staffing level.  I’ve noticed some firms are adding non-equity partners to increase leverage and profitability, and this is a trend that continues to build. Clients are pushing hard on rates and don’t want to pay to train associates.  Non-equity partners, by contrast, hit the ground running and don’t incur training and supervision costs. Firms don’t break even on associates until three to five years of call on average, while non-equity partners are profitable right away.

Other ways to use leverage:

– Large national firms are pushing out underperforming partners with practices that don’t meet their minimum size standards, as they continue to lever themselves for maximum profitability.

– Personal-injury firms are outsourcing legal work to India to reduce costs.  This is quite…

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Increasing law firm profitability – what’s working and what’s not?

Originally published in Canadian Lawyer

Leverage

One of the fastest and easiest ways to increase profitability is to increase leverage by moving work down to the most efficient staffing level.  I’ve noticed some firms are adding non-equity partners to increase leverage and profitability, and this is a trend that continues to build. Clients are pushing hard on rates and don’t want to pay to train associates.  Non-equity partners, by contrast, hit the ground running and don’t incur training and supervision costs. Firms don’t break even on associates until three to five years of call on average, while non-equity partners are profitable right away.

Other ways to use leverage:

– Large national firms are pushing out underperforming partners with practices that don’t meet their minimum size standards, as they continue to lever themselves for maximum profitability.

– Personal-injury firms are outsourcing legal work to India to reduce costs.  This is quite a step forward in Canada, where until recently our privacy laws have made law firms hesitate to make this move.  If the outsourcing company’s servers are based in Canada and the work is being checked by Canadian lawyers, then this option can work well.

– Large national firms have outsourced administrative tasks such as word processing and billing to reduce costs.  Many firms are also outsourcing entire facilities-management, technology and marketing departments to local outside vendors such as Ricoh and Pitney Bowes Inc.

Cost Containment

“New business-model firms” such as Delegatus services juridiques inc. in Montreal and Cognition in Toronto are effectively acting as outsourced general counsel for large clients.  They operate on a virtual basis to contain premises costs and have also stripped down the management infrastructure required to run their operations. Their lawyers spend most of their time at clients’ offices, using clients’ support staff on files, which helps keep overhead costs down to as much as 50 percent of the average large firm.

Some firms are getting into project management in a big way, and find that clients are very happy to work with them to reduce their overall legal costs by getting more effective and efficient in how their legal matters are handled. This is a significant trend, and one that some law firms are using as a warm-up to alternative billing.

Centralized Management

Firms of all sizes are centralizing their governance systems to increase their efficiency and profitability. By giving managing partners the power to affect partner compensation, these firms allow the managing partners to motivate partners to do non-billable tasks that help to achieve strategic objectives.

Setting up file-approval systems under the control of a managing partner can lead to significant gains in profitability. In my experience, top-down, centralized management is the most efficient and effective way to manage.

Selecting the right clients is also crucial to becoming more profitable. Successful firms evaluate clients for their profitability, their ability to pay, and their fit with the firm’s strategic goals.

Utilization

Some firms are using “full-day” time accounting where lawyers track all non-billable time in addition to billable time. The idea is to get lawyers to account for all of their available time at the office, e.g. eight or 10 hours a day.  By having lawyers and staff account for all of their time, firms are capturing 10 to 20 percent more billable time and adding significantly to profitability as a result.

Firms should also attend to this non-billable information to ensure that their lawyers are not just focusing on the short term and their own billable hours. As management guru David Maister would say, how you spend your non-billable time is where your real profit is in the long term—for instance, your business-development efforts.  Tracking lawyers’ non-billable time can also reveal whether project-management techniques are working effectively and efficiently.

Another recent innovation is smartphone time-capture technology that allows lawyers to log their time while they work it, rather than afterwards, when their memory is hazy. This is the key to maximizing time-capture percentage.

Strategic Planning

Firms that proactively carry out strategic planning are more profitable than firms that don’t. Today’s highly competitive legal market demands that firms maintain a continuous planning mindset if they want to succeed. In the successful firm, the managing partner takes charge of executing the strategic plan and focuses on getting partners to follow through on their assigned tasks in order to achieve the goals of that plan.  The most profitable firms reward partners who complete non-billable tasks and penalize those who don’t.

The firms that do the best in today’s market are the ones with a tight vision.  They keep their team closely focused on the firm’s strategic goals, as opposed to taking a silo approach in which everyone operates independently. The days are past when a law firm could make easy money while letting every partner do whatever he or she wanted.

Partner Compensation

Your firm will make better profits if it rewards partners for the value they provide to clients rather than if it rewards them only for hours billed. Partners also need to be rewarded for profitable practices, in addition to sheer volume of billings. Those who expend extra effort in the firm’s best interests should be rewarded the most, and those who lever work down to others and unselfishly lead their practice groups should get special rewards.

Generally speaking, firms with subjective compensation systems are more profitable than formula-based firms. This is because the formulas usually drive partners to focus on personal production, instead of helping grow the whole firm.  An “eat what you kill” approach can stunt the growth and profitability of a firm.

People

Firms with strongly defined core values for their people do better than firms without them. In order to succeed, a firm needs a strong culture, where everyone buys in. This helps it achieve its goals faster, and makes its staff work harder and feel more fulfilled.

As the push to acquire the best talent continues, small firms are capitalizing on opportunities to hire senior partners who are close to retirement and are being pushed out of large firms.  Some are leaving early, taking their clients with them, to join small firms and enjoy better work-life balance. This can be a great win-win for both the senior partner and the small firm, as these partners can bring big-firm institutional clients that are coveted by small firms and can significantly increase their profitability.

The Link Between Knowledge Management and Profitability

Did you know there is a direct link between Knowledge Management (KM) and Profitability for law firms?  In addition, did you know that this link exists right at the top of the profit pyramid, where the impact on profitability is the greatest?  I’ve heard this link mentioned before, but haven’t heard the reasoning behind it.  Here are my thoughts on this very important concept.

So, what is behind the link between Knowledge Management and Profitability?

First, it’s generally recognized that increasing Rates can have the biggest impact on profitability.  As David Maister states in his book “Managing the Professional Service Firm“, you can increase rates through specialization, innovation and adding value. The use of properly developed KM systems can significantly increase rates in all three of these areas.

KM systems organize the information that lawyers need to develop and maintain their specialty practice areas.   KM systems also allow lawyers to innovate the way they  provide legal services to clients. Finally, KM systems add value to legal services delivered to clients.    See here for further information from KM experts such as Ann Bjork of Virtual Intelligence VQ in an article from KIM Legal magazine.

I’ve always believed that the use of KM systems has the potential to make law firms extremely profitable.  For example, the reuse of past legal work product can dramatically cut the cost of legal services and allow law firms to recover the true value of the legal knowledge they are imparting to clients.  This is done by value billing without regard to the number of hours being spent on the legal task at the time.   It’s not unethical to value bill for KM if you let the client know what you’re doing up front and give them the chance to “buy in” to a new way to dramatically reduce their overall legal spend.  At the same time, this allows law firms to expand their own profit margins by increasing effective rates dramatically.  It truly is a win-win situation for the law firm and the clients who embrace this way of doing things.

KM provides clients with exactly what they want – lower overall legal costs – while allowing law firms to increase effective rates on the legal products and services they are providing to clients.  KM allows law firms to turn legal knowledge databases into products that can reused over and over.  This allows law firms to invest for the future like other businesses, and not just build fiefdoms of partners who are only in the enterprise for their own gain.   This is where most KM initiatives usually fail, as many partners can’t get past the short-term impact to their numbers by compensation systems which are driven by short-term results at many law firms.  It takes some work to convince partners that the KM initiative will truly benefit them in the long run.  Forward-thinking Managing Partners and Compensation Committees will take into account these long-term investments of legal knowledge by rewarding partners who contribute to the development of great KM systems.  Firms can start small and simply bonus partners who provide significant contributions to the KM initiative.  See the article from KIM Legal article magazine noted above for further ideas on how to approach the KM contribution/compensation issue.

KM contributes significantly to greatly increased profitability in law firms by driving and supporting higher Rates, which is the factor that has the biggest impact on law firm profits.  I believe that once law firms truly understand this, you’ll see many law firms revisiting the KM concept.  In combination with the drive for alternative billing models which clients are clamoring for today, law firms should be able to utilize KM to help clients reduce their overall legal costs while driving their own profits higher.  In this way KM truly can be “the missing link” you’ve been searching for to dramatically increase law firm profits.