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INCREASING PROFITS

The 5 disasters that run law firms into the ground

Can your firm profit in the current economy? Or more worrisome: can it survive?

The answer depends on how the firm is managed, advises one expert. And to a great extent it’s the intangible elements of management that tell the tale.

Law firms are living in a new world, says William F. Brennan, CPA, CMA, a principal with the legal management consulting firm Altman Weil in Newtown Square, PA. Brennan is also a former law firm CFO.

Supply is up, demand is down, and clients are scrutinizing their legal expenses and firm choices. Unless a firm manages itself with appreciation for that environment, survival is questionable.

Disaster #1: pusillanimous partners

The biggest door closer is nothing more than the partners’ failure to take action, Brennan says. In fact, in 25 years of legal office consulting, that is the most common death warrant he has encountered.

Sometimes the inaction is more aggravating than disastrous. The firm is expanding into a new practice area and needs to bring in an attorney to run it but can’t decide between Expert Attorney A and Expert Attorney B “so it doesn’t make any decision at all.”

But other times it’s fatal, and that most often happens when the unaddressed issue is a declining profitability, or too many people, too little work, and too much space.

He cites one large client firm that had lost several attorneys and was carrying 25 support staff it didn’t need. The partners were afraid of the PR ramifications of a layoff, so they let it ride and kept paying the unnecessary staff. “And that firm doesn’t exist today because of it.”

While it’s painful to make cuts, delay sends any firm “into a death spiral,” he says.

“Everybody is watching what’s happening.” The top producers see idle attorneys or idle staff, they know the picture is bleak, they watch the senior partners do nothing, they get anxious, and they leave.

And for lack of action, the firm has lost its rainmakers.

The spiral continues on, because with its ranks decimated, the firm is now staring at empty space. “People hate to see waste,” and to the remaining partners, the unnecessary rent “is like a tax. It keeps them from being profitable.” They too look at leaving.

Along with that, unused space creates an uncomfortable environment for employees and clients. As proof, he points to the fact that event planners schedule activities in areas sized for the crowd. If there are 20 people, they hold it in a small and often intimate setting, not in a hall.

If there’s too much space, “get out of it.” There’s no reason to keep paying for it. There’s enough commercial office space available to last for the next several years. Landlords are afraid of losing tenants, so even a newly signed lease is a negotiable item.

Disaster #2: skewed statistics

Bad business information can be disastrous as well, Brennan says. Many a firm measures performance against statistics that aren’t relevant to its particular circumstances, and the partners end up living with “erroneous comfort or anxiety,” one or the other.

In one firm, he says, the partners relied on associate salary statistics that covered a comparable market but only included salaries for first-year associates. They were content that they were paying above scale, but the associates weren’t so content. They were more experienced and more qualified than those represented in the numbers, and they were leaving for other firms that were offering them more.

Generic national averages are especially dangerous. He gives the example of $160,000 being the average overhead for an attorney. The number is indeed valid for an average firm, “but the problem is that there is no average law firm.”

Neither can numbers be applied the same way to all firms.

Suppose statistics show that the average partner profit is 50% of revenues. That’s not something to take to the bank.

Brennan gives the example of two firms, one with two partners and the other with eight, where all the partners make $200,000 a year. If the smaller brings in $4 million, the partners’ $400,000 comes to 10% of revenues. But the larger might have revenues of only $3.2 million, making the partners’ $1.6 million account for 50% of revenues. The first firm is by far the more profitable, yet it misses the benchmark entirely.

Also, he says, averages don’t take into consideration firm structure. What one firm calls a partner another might call a senior counsel.

Disaster #3: old fashioned fees

Survival further depends on alternative fee structures.

Clients demand flexibility, some because they are no longer able and others because they are no longer willing to pay hourly rates. They want to know up front how much their legal services are going to cost.

The fees have to meet the clients’ individual needs, he says, and they can and should vary. There’s no rule that a lawyer has to bill every client the same way.

Fee structure can be anything the firm and client agree on. But to be successful, the firm has to get proficient at analyzing the real cost of each matter, because any predetermined price shifts the risk to the firm.

Brennan points out that one type of fee that’s becoming both popular and profitable is the success fee, which is a sort of bonus for achieving some specific result.

“The success fee makes a tremendous amount of sense, because the attorney is truly partnering with the client.” Instead of getting paid only for the hours worked, the firm is rewarded for achieving some set outcome such as reducing the litigation or getting the client out of a tight situation.

With that and other types of alternative fees, a firm can see “a lot more profit for its volume of business” than hourly fees can produce.

Disaster #4: reckless rate hikes

Will the firm lose its clients if it raises the rates?

A lot of firms have that fear, Brennan says. And to a great extent it’s well founded, because clients keep a hawk’s eye on their legal expenses. On the other hand, if a firm doesn’t keep its rates on an upward climb, it’s going to see a continuous loss of money.

The key to successful rate hikes is prudence. Inch into them. Add small amounts every year instead of imposing a noticeable hike every several years. Clients will accept the smaller increases, but a single huge jump will meet with strong resistance.

More advice: Never assume rate increases can be passed on to clients across the board. There can and should be many, many rates for clients and even many rates per attorney.

Still more advice: There’s no need to lose a client because of a rate hike. If a good client balks at the increase, offer a discount or make an exception and continue on with the current rates.

And even more: It’s more appealing to start with a higher price and come down than simply to quote a lower fee. The attorney quotes $500, the client says it’s too high, the attorney comes back with $350, and the client has scored a win. Far from moving on, that client will stay because it has a sense of having negotiated a good deal.

By contrast, quoting the $350 up front doesn’t give the client anything but a bill. There’s no sense of getting something extra.

As to how much to raise fees, Brennan emphasizes that the decision has to be made with a learned eye, not with a knee-jerk response of “let’s raise the rates 10%.”

Rates have to fall in line with what the direct competition is charging.

A firm that offers specific expertise not found elsewhere should never hold back on increases. Neither should a firm with a reputation of success unmatched by the competition.

In addition, increases have to mirror the market.  A litigation specialist for aircraft collisions can scarcely base rates on what the firm next door is charging. By contrast, a domestic relations attorney has a wider market to consider.

But an overall caution to be aware of is that in the last two or three years, there has been a drop in demand for legal services. Along with that has come price resistance. “Clients don’t want to pay more for a lawyer than they have to.”

Disaster #5: Neglecting the rainmakers

Finally, be aware that survival rests to a great extent on rewarding rainmaking.

“The pendulum has been swinging toward origination,” Brennan says. Bringing in new business is what keeps a firm alive, so the compensation formula has to be set so as to pay extra for business origination.

Partner pay needs to be “very merit based.” The best rainmakers know they are in demand and will leave if they aren’t paid for what they bring in.

The same for the big producers. They know other firms want their business.


Related reading:

Some not-so-difficult ways to increase revenue


Keep profits on track with this quick 5-point spring financial checkup

To see better profits, look harder at where money starts and ends


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