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.