Binge and Purge Cost Management

The recession brought about some rapid changes for law firms, most of which involved temporary cost cutting.  Then, almost as if the cost cutting exercise was designed to simply demonstrate what was possible, firms began returning to their free spending ways.  It makes one wonder how much could be added to partner earnings if law firms ever got serious about redesigning the expense side of their business model.

A classic MBA question is whether a company’s business model should be designed around its existing customers or whether the company should select a business model and then seek to attract customers to fit that model.  For many business law firms, their current business model was actually created for the 1980’s and may not come close to reflecting their existing practice and client base.  We particularly see this with firms that were the “go to” lawyers for major corporate clients located in their city.  Over time, these large local clients were acquired by larger companies located elsewhere.  In the process, the sophisticated legal work traditionally performed by local firms was directed by the new parent corporations to major markets like New York, Chicago, Los Angles and, increasingly, London.

Firms have pursued a variety of strategies in response to their shifting client base, but for most the strategy has been to continue with the status quo for all aspects of their firms’ operations.  Frequently this has been the result of an inability to gain consensus among the partners on any viable option.  The result, however, has been the continuation of business models that drive cost structures which cut into margins and make it harder to sustain partner earnings.  So when there are periodic recessionary cycles or the firm encounters some vicissitude with its practice or clients, the reaction is to slash and burn the expense structure.  Of course, when circumstances improve, firms return to their free spending ways like a bulimic eater – classic binge and purge.

The recession appears a long way from being over but the dust has settled on the initial rounds of cost cutting.  This might be a good time for law firms to look at the operating cost side of their basic business model and consider structural changes as alternatives to the next round of bingeing.  Here are some tactical changes to law firm business models that could contribute to higher profitability:

1.  Decrease capacity.  Law firms operate with a fear of possibly accepting a new engagement and not having the lawyers to perform the work.  This means that firms typically have a capacity that vastly exceeds the level of available work.   The result is that associates learn to practice in ways that maximize their recorded hours rather than efficiently serving clients.  At the same time, firms find themselves accepting work that compromises rate structures in order to fill the plates of lawyers.

In reality, it is rare that a large engagement walks in the door requiring immediately available staffing.  Instead, when “slammed” with work, a firm needs two things: a permanent lawyer cadre that has the levels of expertise that can not be acquired on an as needed basis, and established systems necessary to rapidly acquire the staffing necessary for the large project on an as needed basis.  This opens options for contract lawyers, outsourcing, and a stay-at-home workforce that is only paid when there is billable work for them to perform, thereby reducing overhead and making direct cost calculations more accurate.

2.  Specialize Staffing.  At least 70 percent of the legal work most law firms do is some level of commodity work.  This means that huge portions of firms’ practices are routine to the extent that there is little difference among engagements.  Traditionally, law firms have hired and trained associates with the expectation that they will advance to be able to perform the most sophisticated work the firm is called upon to do.  The result is that commoditized work is staffed by a revolving door of associates moving through to other work just as they reach their most productive levels.

If law firms, instead, recruited, hired and trained lawyers for specific areas of practice and specific types of work, they could:

• become more productive and efficient,

• be paid salaries appropriate to the work performed,

• participate in training that would provide an immediate payback in efficiency, and

• Advancement would be to supervisory levels within the practice rather than a move to other practices or partnership.

3.  Fewer Non-Fee Earners.  Traditionally, law firms had roughly one non-fee earner (staff members who don’t charge time) per lawyer.  This dates to the time when lawyers had single assignment secretaries.  Advancements in technology allowed secretaries to serve several lawyers but the addition of IT staff to support the technology kept the ratio at one to one.  Unfortunately, even though the number of personnel remained constant, costs increased because these technology support positions commanded higher salaries than the positions they replaced.  The title “secretary” has changed to “assistant” to reflect a world where all but the youngest lawyers do their own typing and a decreasing number of documents ever reach hard copy.

As law firms begin reconstructing their business models, staffing levels are more realistically approaching one non-fee earner per ten lawyers with many of the non-fee earner positions being outsourced or working from a home office. This is a politically difficult change because it affects lawyers’ work styles, but the savings potential is staggering.

4.  Less Space.  After personnel, occupancy expense represents law firms’ largest cost.  With historic support staffing levels, law firms have planned on an average of roughly 700 square feet per lawyer.  However, much of this space is in the core of the building.  Law firm office design is “window intensive” due to the number of private lawyer offices required.  Therefore, law firms’ are typically looking for ways to functionally use the non-window core space.  However, as firms have smaller libraries, need less space for centralized computer systems, and become less paper intensive (so there is less demand for filing space, mail rooms and reproduction centers), finding uses for core space becomes an even greater problem.

As the business model changes with the use of contract employers, outsourcing and decentralized workers, the required space for a law office decreases.  At the same time, as businesses move to suburban locations, law firms can enjoy the opportunity to house themselves in less expensive locations.  And, the desire to become more “green” supports more open floor plans that provide the more effective use of space.  The end result could easily be space usage of 300 square feet per lawyer in less expensive locations.

5.  Lower Cost Technology.  Law firms have long become accustomed to growing technology budgets with little potential for a direct revenue return on investment.  In large measure these investments have been in response to the demands of vocal tech savvy partners and associates and the desire to create a competitive advantage based on technological capability. The good news is that several factors have come into play to reduce technology costs.  First, lawyers and staff members have become more sophisticated in their user knowledge of software.  It helps that, until Microsoft Office 2007, there have not been any real huge changes that require user retraining and the programs have become more stable. The result is lower training budgets and fewer help desk calls.  Second, the availability of qualified IT staff at the fairly rudimentary levels that law firms use has increased which, together with the recession, has stabilized, if not lowered, salaries.  Plus, firms need fewer IT staff members – in 2000 the law firm average was in the vicinity of 25 users per IT staff member; today the ratio is 50 to one.  Finally, the cost of hardware continues to drop through the floor.

To take advantage of these savings, however, law firm technology has to be approached from the perspective of “what is the minimum cost of providing only the technology that the practice of law requires?”

The Bottom Line

For businesses that enjoy 35 to 40 percent operating margins, one might argue that management is strictly a revenue producing game – bring enough cash through the door and some of it is going to drop through to profits.  But, while something more than a third of new revenues fall to profits, every penny of expense savings becomes distributable income to partners.

The purging of expenses is a reasonable response to economic adversity.  But the real expenditure win for law firms is recognizing the impact of permanent changes in the marketplace and adjusting their business model to take advantage of them.