Powering Your Way Out of the Recession

All law firms have a primary financial concern as they come out of the last two years of economic change, including shrinking margins and the return
on the time invested in providing services. The vision of this article is to provide a model that may be used in discussing how a firm can power into the next few years. This article uses a watershed analogy to demonstrate drivers for higher margins and the skills required to maximize each stream of effort running toward the earnings “lake.” The implications are: 1) the need for credibility in leadership; and 2) an understanding of where to invest the resources of the firm to provide the highest impact on margins (and therefore earnings) to keep services at the highest possible level. The urgency is that the competition is seeking to bust out of this environment, and the role of the firm is to bust out first and gain a competitive advantage.

Introduction

An era is ending. That era is exemplified by the old law firm business model of leverage to increase the revenues over expenses through hours multiplied by rate. The old model created an overcapacity as demand slowed and as client dissatisfaction grew with the inefficiencies of the model. As law firms begin to adjust their strategies to come out of a very tough few years of trying to manage costs and reduce the burden of overhead, some key signs and trends become apparent, giving clues as to how to power out of this environment with higher margins.

The New Versus the Old Environment

There are four indicators that your current situation is inhibiting your firm from recognizing and acting upon the opportunities to increase margins. First, you find yourself having to explain the value your legal services are adding to the client. Second, you look to the same processes for serving clients, while other firms are offering new ways to provide legal and quasi-legal services. Third, you believe that your clients still value the way in which you provide services. Fourth, value for your clients is being created by other players in the legal services market.

An example will help here. As clients become more powerful and are demanding value-added services, they are looking for law firms to move away from the old business model of “hours-times-rate equals value.” At the same time, law firms are experimenting with alternative fee arrangements but are so risk-adverse that they tend to look at the same processes for delegating and supervising the work while other firms are coming up with new ways to provide services through more sophisticated intake, more sophisticated project management, contract lawyers, expert systems, and mined information on past matters through debriefings.

A new approach is becoming a necessity. What would be the ideal role for your firm to take in providing value-added services? How would you approach an understanding of the client's true needs that would create opportunities for you? What portion of your market for legal services do you control that would enable you to improve your position in the market? From where is the competition in your market coming, where you can offer a desirable alternative to your clients and to your market? What relationships can you build to ensure your new position? Are there outsourcing options or the uses of resources in the firm of which you have not taken advantage for the future?

The Required Building Blocks For Margin Improvement

Let's start with the building blocks necessary to answer the questions above. Is the firm collegial or is it collaborative? I use collaborative here to mean a group of professionals who operate under a common vision and are accountable to one another for the accomplishment of that vision. A collegial firm, on the other hand, is a group of people bound by a common profession, but independent of one another in their approach and actions. If the firm is collaborative, there is trust in making changes and the ability to build a learning organization. Efficiencies are then created that encourage people to realize that hours are not the only thing that creates margins

With those building blocks, professionals feel a sense of accomplishment and trust and perform more effectively and efficiently. The clients see the result and become more loyal to the firm, which in turn builds a trust relationship that increases margins. For example, that relationship in many firms has removed the requirement for discounts on billing rates (which is a key factor in lower realization and lower margins).

The Watershed Model for Margin Improvement

The analysis of a watershed model illustrates how to increase margins. Think of a watershed flowing to an earnings “lake.” The purest flow through the watershed will get the maximum margin and earnings. Every time something upstream pollutes the river, realization on rates and margins go down.

At the south end of the flow into the lake, nearest the shore, there are visible but low-impact improvements. As we move north toward the headwaters, the implications are less visible, but provide a higher impact on margins. The watershed analysis allows a firm to select the right programs for change through the use of two questions to a practice group, a client group, or a client:

What revisions to specific items up in the watershed will provide the highest return on the investment of time? Which polluter, if cleaned up, will increase realization on rates and margins the most?

What efforts have the highest probabilities of succeeding? Does the firm have the culture, talent, resources, leadership credibility, and other factors to make the program succeed?

A quick way to make choices is by using a scale of 1 to 10 on a graph where the Y axis represents the probability of success if the change is made and the X axis represents the impact of a change on the margins. Give the two scores to the following watershed streams and then multiply them together to see where they would fit in Figure 1 (below). Only if the impact score times the probability score multiplies out to 64 or above, do we address the scope of a program and select a course of action.

As stated earlier the program may be associated with a firm, a practice group, a client group, or a client. Make a choice so that a course of action can be followed that produces results. For example, start with a baseline of return on standard rates so that progress may be shown in the process used to fix the area of the watershed. This will establish a model for others to follow as a precedent. In other words, leadership and management may ask a practice group (or section) to score each of the following areas in the improvement of realization and margins. Is staffing, project management, client mix, or something else the major problem? If so, ask for an action plan to fix the problem.

As a reminder, look back at the second paragraph in this section for the difference between “Visible and Low Impact” versus “Invisible and High Impact.” Where there are current articles and publications discussing certain “tributaries,” they are listed. Where there is a new issue or point to be made, the point will be expanded. The list below begins with the most visible, short-term, and low impact areas where the river dumps into the earnings “lake” and moves to the high impact, long-term, and least visible areas near the headwaters.

WIP and A/R Management

Financial planning, management, and reporting. Management of the intake process. The intake of a client or matter must be considered a venture capital investment by the firm with an expected return on the investment. That means there must be a relationship of trust between the law firm and the client or potential client.

Management of the services and work performed. This is project management which assumes that individual matters are planned, organized, staffed, directed, and controlled to the highest level effectively and efficiently. This ensures that the highest potential realization on rates is accomplished with few discounts, write-downs, and write-offs.

The mix of lawyers and other professional staff in the firm. This takes into consideration the training and assimilation to ensure the recruitment and retention of the best team.

The structure for the delivery of services. The firm and groups work as a collaborative team meeting client needs as opposed to a collegial group with individual clients and individual practices operating under a name to share expenses. The various specializations do not operate in a silo, but provide services to clients through a multi-disciplinary, collabotative team.

Partner accountability. Partners must be accountable to the culture, core values, vision, mission, strategy of the firm, and to each other. Partners (and others) who refuse to be part of the above are either “lone-rangers” or put the firm in a position of having to waste leadership time and other resources in dealing with the problems created by these individuals.

The bundle of services offered by the firm. The “Service Investment Model” has been discussed in previous articles and may be found at the author's Web site, www.cobb-consulting.com. This statement assumes the firm identifies the core services and services that require investment to create a core competency. The statement also assumes the firm is dealing with services that are dying and/or need to be abandoned.

The client mix of the firm. The “Client Investment Model” has been discussed in previous articles and may be found at this author's Web site. The client mix assumes the firm has identified the core clients of the firm that need constant attention and the clients that are not yet loyal to the firm, but could become core clients in the future. This also assumes the firm is dealing effectively with clients who may fall into the high loyalty and low profitability category or are question marks coming through the intake process.

Vision, mission, and strategies. These are well communicated and understood by everyone in the firm. There is a constant learning process going on within the firm as to how the competitive world is causing the firm to adapt and adjust its mission, strategies, and programs.

The core values and culture of the firm. The most outstanding and profitable firms have kept and enforced their culture and core values throughout the last two years and will come out very strong. There has been some downsizing in the competition because they have based their future on the old business model and/or they have lost their way in the core values that made them successful in the past.

The watershed analogy and list above should give a firm (regardless of size), practice group, practice area, or client team a list of issues to attack in improving margins as we come out of this period of economic change.

Action Plan and Questions

First, determine how you are going to approach this watershed. If you have a firm of around 25 lawyers or less, you may want to approach this action plan from a firm perspective. If your primary economic drivers come from client teams, go at it from a client perspective. If your profitability is primarily driven by sections, practice areas, or practice groups, use one of those as your analysis unit.

Depending upon your analysis unit, list each tributary in the watershed and discuss the specifics that pollute that tributary and affect the realization on rates and margins. For example a litigation section may find that they are having to give too many discounts on standard rates given the mix of services they offer. A corporate group may find that the clients in their mix are forcing fixed fees on transactions. The corporate group has no process for dealing with fixed fees and is losing margin on each transaction.

What is specifically polluting a flow into the river? Is it a process or a lack of an efficient and effective way of culling out incoming work that will not provide a return on the firm's investment? Is it a particular lawyer who has very high turnover in associates and staff? The fact that the lawyer may provide a large book of business may be inconsequential relative to the impact on the firm's overhead with attorney and staff replacement costs.

Is it a lawyer or group of lawyers that are so out of step with the core values of the firm as to cause emotional cost of leadership in dealing with the problems they are creating by not acting like partners but like adversaries or selfish employees? There are firms that have told such partners that they have not behaved like partners for years and should leave and take their clients with them. As a result earnings went up because leadership and the rest of the partners could now put their energies toward clients and service instead of dealing with internal competition and whining.

Summary

The higher up in the watershed one goes in looking for pollutants and cleaning them up, the higher the credibility of leadership must be to make something good happen. If there is some doubt as to the credibility of leadership, the firm or the analysis unit should start at the lower end toward the lake and show some accomplishments in cleaning up the watersheds there before moving up river. Credibility and collaboration in leading the efforts above is critical success in cleaning up the lake and increasing margins.

[IMGCAP(1)]

William C. Cobb, a member of this newsletter's Board of Editors, is the managing partner of Cobb Consulting (WCCI, Inc.) based in Houston. E-mail: [email protected]. Web site: http://www.cobb-consulting.com/.

All law firms have a primary financial concern as they come out of the last two years of economic change, including shrinking margins and the return
on the time invested in providing services. The vision of this article is to provide a model that may be used in discussing how a firm can power into the next few years. This article uses a watershed analogy to demonstrate drivers for higher margins and the skills required to maximize each stream of effort running toward the earnings “lake.” The implications are: 1) the need for credibility in leadership; and 2) an understanding of where to invest the resources of the firm to provide the highest impact on margins (and therefore earnings) to keep services at the highest possible level. The urgency is that the competition is seeking to bust out of this environment, and the role of the firm is to bust out first and gain a competitive advantage.

Introduction

An era is ending. That era is exemplified by the old law firm business model of leverage to increase the revenues over expenses through hours multiplied by rate. The old model created an overcapacity as demand slowed and as client dissatisfaction grew with the inefficiencies of the model. As law firms begin to adjust their strategies to come out of a very tough few years of trying to manage costs and reduce the burden of overhead, some key signs and trends become apparent, giving clues as to how to power out of this environment with higher margins.

The New Versus the Old Environment

There are four indicators that your current situation is inhibiting your firm from recognizing and acting upon the opportunities to increase margins. First, you find yourself having to explain the value your legal services are adding to the client. Second, you look to the same processes for serving clients, while other firms are offering new ways to provide legal and quasi-legal services. Third, you believe that your clients still value the way in which you provide services. Fourth, value for your clients is being created by other players in the legal services market.

An example will help here. As clients become more powerful and are demanding value-added services, they are looking for law firms to move away from the old business model of “hours-times-rate equals value.” At the same time, law firms are experimenting with alternative fee arrangements but are so risk-adverse that they tend to look at the same processes for delegating and supervising the work while other firms are coming up with new ways to provide services through more sophisticated intake, more sophisticated project management, contract lawyers, expert systems, and mined information on past matters through debriefings.

A new approach is becoming a necessity. What would be the ideal role for your firm to take in providing value-added services? How would you approach an understanding of the client's true needs that would create opportunities for you? What portion of your market for legal services do you control that would enable you to improve your position in the market? From where is the competition in your market coming, where you can offer a desirable alternative to your clients and to your market? What relationships can you build to ensure your new position? Are there outsourcing options or the uses of resources in the firm of which you have not taken advantage for the future?

The Required Building Blocks For Margin Improvement

Let's start with the building blocks necessary to answer the questions above. Is the firm collegial or is it collaborative? I use collaborative here to mean a group of professionals who operate under a common vision and are accountable to one another for the accomplishment of that vision. A collegial firm, on the other hand, is a group of people bound by a common profession, but independent of one another in their approach and actions. If the firm is collaborative, there is trust in making changes and the ability to build a learning organization. Efficiencies are then created that encourage people to realize that hours are not the only thing that creates margins

With those building blocks, professionals feel a sense of accomplishment and trust and perform more effectively and efficiently. The clients see the result and become more loyal to the firm, which in turn builds a trust relationship that increases margins. For example, that relationship in many firms has removed the requirement for discounts on billing rates (which is a key factor in lower realization and lower margins).

The Watershed Model for Margin Improvement

The analysis of a watershed model illustrates how to increase margins. Think of a watershed flowing to an earnings “lake.” The purest flow through the watershed will get the maximum margin and earnings. Every time something upstream pollutes the river, realization on rates and margins go down.

At the south end of the flow into the lake, nearest the shore, there are visible but low-impact improvements. As we move north toward the headwaters, the implications are less visible, but provide a higher impact on margins. The watershed analysis allows a firm to select the right programs for change through the use of two questions to a practice group, a client group, or a client:

What revisions to specific items up in the watershed will provide the highest return on the investment of time? Which polluter, if cleaned up, will increase realization on rates and margins the most?

What efforts have the highest probabilities of succeeding? Does the firm have the culture, talent, resources, leadership credibility, and other factors to make the program succeed?

A quick way to make choices is by using a scale of 1 to 10 on a graph where the Y axis represents the probability of success if the change is made and the X axis represents the impact of a change on the margins. Give the two scores to the following watershed streams and then multiply them together to see where they would fit in Figure 1 (below). Only if the impact score times the probability score multiplies out to 64 or above, do we address the scope of a program and select a course of action.

As stated earlier the program may be associated with a firm, a practice group, a client group, or a client. Make a choice so that a course of action can be followed that produces results. For example, start with a baseline of return on standard rates so that progress may be shown in the process used to fix the area of the watershed. This will establish a model for others to follow as a precedent. In other words, leadership and management may ask a practice group (or section) to score each of the following areas in the improvement of realization and margins. Is staffing, project management, client mix, or something else the major problem? If so, ask for an action plan to fix the problem.

As a reminder, look back at the second paragraph in this section for the difference between “Visible and Low Impact” versus “Invisible and High Impact.” Where there are current articles and publications discussing certain “tributaries,” they are listed. Where there is a new issue or point to be made, the point will be expanded. The list below begins with the most visible, short-term, and low impact areas where the river dumps into the earnings “lake” and moves to the high impact, long-term, and least visible areas near the headwaters.

WIP and A/R Management

Financial planning, management, and reporting. Management of the intake process. The intake of a client or matter must be considered a venture capital investment by the firm with an expected return on the investment. That means there must be a relationship of trust between the law firm and the client or potential client.

Management of the services and work performed. This is project management which assumes that individual matters are planned, organized, staffed, directed, and controlled to the highest level effectively and efficiently. This ensures that the highest potential realization on rates is accomplished with few discounts, write-downs, and write-offs.

The mix of lawyers and other professional staff in the firm. This takes into consideration the training and assimilation to ensure the recruitment and retention of the best team.

The structure for the delivery of services. The firm and groups work as a collaborative team meeting client needs as opposed to a collegial group with individual clients and individual practices operating under a name to share expenses. The various specializations do not operate in a silo, but provide services to clients through a multi-disciplinary, collabotative team.

Partner accountability. Partners must be accountable to the culture, core values, vision, mission, strategy of the firm, and to each other. Partners (and others) who refuse to be part of the above are either “lone-rangers” or put the firm in a position of having to waste leadership time and other resources in dealing with the problems created by these individuals.

The bundle of services offered by the firm. The “Service Investment Model” has been discussed in previous articles and may be found at the author's Web site, www.cobb-consulting.com. This statement assumes the firm identifies the core services and services that require investment to create a core competency. The statement also assumes the firm is dealing with services that are dying and/or need to be abandoned.

The client mix of the firm. The “Client Investment Model” has been discussed in previous articles and may be found at this author's Web site. The client mix assumes the firm has identified the core clients of the firm that need constant attention and the clients that are not yet loyal to the firm, but could become core clients in the future. This also assumes the firm is dealing effectively with clients who may fall into the high loyalty and low profitability category or are question marks coming through the intake process.

Vision, mission, and strategies. These are well communicated and understood by everyone in the firm. There is a constant learning process going on within the firm as to how the competitive world is causing the firm to adapt and adjust its mission, strategies, and programs.

The core values and culture of the firm. The most outstanding and profitable firms have kept and enforced their culture and core values throughout the last two years and will come out very strong. There has been some downsizing in the competition because they have based their future on the old business model and/or they have lost their way in the core values that made them successful in the past.

The watershed analogy and list above should give a firm (regardless of size), practice group, practice area, or client team a list of issues to attack in improving margins as we come out of this period of economic change.

Action Plan and Questions

First, determine how you are going to approach this watershed. If you have a firm of around 25 lawyers or less, you may want to approach this action plan from a firm perspective. If your primary economic drivers come from client teams, go at it from a client perspective. If your profitability is primarily driven by sections, practice areas, or practice groups, use one of those as your analysis unit.

Depending upon your analysis unit, list each tributary in the watershed and discuss the specifics that pollute that tributary and affect the realization on rates and margins. For example a litigation section may find that they are having to give too many discounts on standard rates given the mix of services they offer. A corporate group may find that the clients in their mix are forcing fixed fees on transactions. The corporate group has no process for dealing with fixed fees and is losing margin on each transaction.

What is specifically polluting a flow into the river? Is it a process or a lack of an efficient and effective way of culling out incoming work that will not provide a return on the firm's investment? Is it a particular lawyer who has very high turnover in associates and staff? The fact that the lawyer may provide a large book of business may be inconsequential relative to the impact on the firm's overhead with attorney and staff replacement costs.

Is it a lawyer or group of lawyers that are so out of step with the core values of the firm as to cause emotional cost of leadership in dealing with the problems they are creating by not acting like partners but like adversaries or selfish employees? There are firms that have told such partners that they have not behaved like partners for years and should leave and take their clients with them. As a result earnings went up because leadership and the rest of the partners could now put their energies toward clients and service instead of dealing with internal competition and whining.

Summary

The higher up in the watershed one goes in looking for pollutants and cleaning them up, the higher the credibility of leadership must be to make something good happen. If there is some doubt as to the credibility of leadership, the firm or the analysis unit should start at the lower end toward the lake and show some accomplishments in cleaning up the watersheds there before moving up river. Credibility and collaboration in leading the efforts above is critical success in cleaning up the lake and increasing margins.

[IMGCAP(1)]

William C. Cobb, a member of this newsletter's Board of Editors, is the managing partner of Cobb Consulting (WCCI, Inc.) based in Houston. E-mail: [email protected]. Web site: http://www.cobb-consulting.com/.