Practice Management

Law Firm Partners Link Profitability to Rate Increases/ Cost Cutting

By Brian J. Ritchey

One of the interesting questions posed in the Remsen Group Managing Partner Survey (part of the Juris 2007 Law Firm Economic Survey by LexisNexis (the Survey)) related to managing partners' strategic perceptions of profitability.  When asked "What strategy has your firm found to be most effective in its efforts to achieve higher profitability?", 26% of the managing partners responded that increasing fees was their firm's most effective strategy.  Coming in second was marketing and business development (25%), then cost cutting/ expense reduction ( 18%), improved efficiency (14%), higher billable hour requirements and divesting of low profit work (both under 10%). 

Though it isn't surprising that firms list rate as the top strategy to achieve higher profitability, most firms only increase rates at or just above the pace of inflation.  According to the Survey, standard billing rates increased an average of 5% to 7% between 2005 and 2006.  Adjusted for inflation (currently around 3.5%) this increases rates by 1.5% to 3.5% before other costs of doing business are calculated into the rate (such as the continual decline in client willingness to pay for costs such as online research).  Increasing rates in such a way may achieve higher profitability but at 1.5%-3.5% is it the most effective strategy? 

What is more surprising and at odds with other Survey findings are the respondents that claimed that cost cutting/ expense reduction was their most effective strategy to achieve higher profitability.  Survey numbers do not show any correlation to increased partner income and low expenses.  In fact, according to the Survey, the firms with the highest per-partner draws spent the most - but also had the highest margins.

Most Survey respondents gave low priority to improved efficiency, divesting of low profit work and (surprisingly) increasing billable hour requirements.  Yet survey numbers from both 2005 and 2006 consistently show that those firms who had the highest partner income performed well across all five of the key performance metrics (rate, utilization, realization, operating margin and leverage).

The New York Lawyer posted on December 4th that some firms have been cutting staff in a bid to lower operating costs.  Said Southern California legal recruiter Larry Watanabe, "They want to retain rainmakers, and to do that, you have to maintain a meaningful level of profitability."  So they must.  However, again, based on this year's Survey, the firms in the 1st Quartile (representing the highest per partner income) also had the highest operating expenses.  If you are cutting costs to maintain profitability, then the firm isn't growing and this is no achievement.   This may indicate that for those 18% of firms who used cost cutting as a strategy to increase profits, times aren't so good.

What factors are more likely to achieve higher profitability?

? Better efficiency in workflow ? lower the days to bill and days to collect fees;
? Discontinue ?lock-step? compensation increases to the extent your firm uses this to compete;
? Adopt and adhere to a written, achievable strategic plan;
? Measure your key performance metrics:
  o Effective rate upon collection of fees;
  o Realization both at billing and collection;
  o Productivity (billable hours or equivalent);
  o Operating Margin;
  o Leverage ? either by headcount or billable hours;
? Market to your strengths ? don?t be afraid to ask for business.

What strategy has your firm found to be most effective in its efforts to achieve higher profitability?

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Full post as published by More Partner Income on December 05, 2007 (boomark / email).