How Not to Get What You Have Always Gotten

“If you do what you have always done, you'll get what you've always gotten!”

That very famous quote from author and motivational speaker Anthony Robbins describes in a sentence the results of the 2011 Am Law 100 and 200 reports, with respect to profitability, that were released this summer.

For the first time in three years the reports showed positive results. Overall, revenue rose by 3.5% and profit per equity partner (“PEP”) increased by more than 8%. Revenue per lawyer (“RPL”) rose by 4.4%, accompanied by a decline in the overall number of attorneys employed in the Am Law 200 firms. The number of equity partners declined by 0.9%, while non-equity partners' ranks declined by almost double that amount (1.7%). Associates were the hardest hit as their numbers declined by 2.7% in 2010. These declines followed similar reductions in each staff category in the 2009 calendar year.

I believe these encouraging results are hiding a far gloomier picture of what happened in the top 200 American law firms and that before we pop those champagne bottles we should look into the results a little more closely.

The revenue figures reported for the Am Law firms are total revenue received and are not adjusted for any bill rate increases. I have recalculated and adjusted the 2010 revenue results for the Am Law 200 firms by applying a modest bill rate increase. The increase was based upon the results of several widely circulated surveys, including the Altman Weil, CitiBank and Wells Fargo studies.

The factors I chose were 4% for the top quartile in the Am Law 100 list. I then reduced the anticipated revenue increase by 0.5% for every subsequent quartile so that the last quartile in the Am Law 200 anticipated revenue increase was a very modest 0.5%.

Overall, the results show a 0.4% revenue increase for the Am Law 200 firms, and when one excludes outliers DLA Piper and Hogan Lovells from the calculation, the overall revenue for the Am Law 200 declined by 1.7% in 2010.

The increases in RPL and PEP that were achieved in 2010 were the result of old fashioned belt tightening on the expense side and the downsizing of the number of attorneys and administrative support staff within each firm.

My analysis shows that with the exception of the Am Law 100 first quartile and the Am Law 200 second quartile (on an adjusted basis) the remaining six quartiles of the Am Law 200 all experienced revenue declines.

By quartile, the reported and adjusted revenue for 2010 is illustrated in Table 1, below.

[IMGCAP(1)]

The Am Law 100 first quartile firms are (of course) the largest and most successful firms in the United States. The fact that they could implement and collect bill rate increases is not surprising. The results in the Am Law 200 second quartile firms are a little less obvious. I will leave that analysis for another discussion.

The results for the remaining six quartiles point to 2010 as the third year in a row during which revenue in the Am Law firms declined.

I also analyzed the results by geographic region and found similar declines in revenue as Table 2, below, illustrates.

[IMGCAP(2)]

Once again, the results, when adjusted for bill rates, show a flat to down year in all geographic areas except the Northwest. Washington, DC (when DLA Piper and Hogan Lovells are excluded) also shows a decline instead of the unadjusted significant improvement.

What the leadership of most Am Law firms did to weather the storm of the past three years was to slash expenses and cut staff. Considering the size of the storm overall, law firm leadership did a commendable job. Earnings in most firms may be flat, but the firms are still standing.

But what will happen if/when the economy dips again? The anemic growth of the U.S. economy in the first nine months of 2011 and the far from robust projections for 2012 mean that the economic troubles are far from over.

Increasingly, client demands for alternative fee structures, their refusal to accept first- and second-year associates on matters, the rise of virtual law firms and the off-shoring of some types of routine legal work will all contribute to a further squeeze on law firm profits.

The cuts of the past several years have captured most of the “low hanging fruit” that might have once existed in Am Law firms. While further expense reductions are possible, their identification and capture will be more difficult, time consuming, and will require more fundamental changes in the way that law firms manage and provide administrative support for themselves.

How Not to Get What You Have Always Gotten

The second-largest expense item for Am Law firms is administrative salaries and benefits, and in most firms the third is their occupancy costs. Indeed, occupancy expense is a function of the number of employees a law firm has.

The cost of Am Law firm administrative support is largely determined by geography, whereas the cost of a firm's attorneys is related to how many steps from the “going rate” the firm has decided to compensate its legal staff.

Determining attorney compensation and bonuses is a matter of strategy. Determining how to provide administrative support services is a matter of “best and highest.” The question law firms should be asking is, “How can I provide the firm's clients and attorneys with the highest levels of administrative support services at the best cost to the firm?”

Increasingly, law firms are determining that many of the administrative support services that they currently provide can be performed better and cheaper by third party vendors.

There are few administrative support services that cannot be outsourced at lower cost while achieving better levels of service. There are many reasons for this, but the most frequently identified is time and focus.

Law firm management (the managing partner and committee plus the administrative leadership) have more than enough work to fill their 10- to 12-hour working days. As a result, many old policies, procedures and technologies remain in place long after their useful life.

In a recent client engagement we discovered that the law firm's file room reflected its old corporate past and not its current focus on litigation. As a result, we eliminated a 12,000 square-foot file room staffed by eight clerks and a supervisor and replace it with a 200 square-foot space staffed by two clerks and a supervisor. The remaining space was returned to the building (saving the firm more than $600,000 a year in rent) and the files and clerical staff were transferred to an outsourcing vendor at a savings of an additional $300,000.

Service dramatically improved not only in the delivery and retention of files but also in the mail, messenger and copier functions for which the new vendor also assumed
responsibility at a savings of an additional $200,000. The vendor also introduced newer copiers, standardized uniforms and a messenger training program, all of which improved the firm's level of service and attorney satisfaction with the administrative support services.

In another recent diagnostic that we performed (for a large Northeastern law firm) we analyzed all of the firm's administrative support services. We found that the firm had secretarial support ratios reminiscent of the 1950s (1.5 attorneys to one secretary) and was not reflective of the current generation of attorneys who prepare most of their own documents. By increasing the support ratios to a more modern 4-to-1 and outsourcing the firm's word processing to a 24/7 provider in the United States, the law firm realized multiple millions of dollars in savings as well as improved service levels.

But perhaps the greatest potential for savings lies in the trend to outsource the High Value Add (“HVA”) administrative support services of Accounting/Finance, IT and HR/Personnel Records and Payroll.

The outsourcing of HVA functions was pioneered in the early years of this decade when I consulted with Akin Gump Straus Hauer & Feld and Orrick Herrington & Sutcliffe. Akin Gump moved its HVA services to a third-party provider while Orrick built a captive center. Since that time Baker & McKenzie, White & Case and Wilmer Hale have all built captives. Recently, Pillsbury Winthrop announced that it would do the same and locate in Nashville, TN. Currently, a group of Am Law firms and a respected provider (with whom I am working) are conducting a proof of concept study for an independently owned center that will provide HVA services to multiple law firms.

Studies that I have conducted document that the total cost of an HVA administrative employee in an Am Law 100 firm is between $125,000 and $140,000. In the Am Law 200 firms those costs are somewhat less ($105,000 ' $125,000) reflecting lower salary and rental expenses. Outsources can provide these services for an average cost of $90,000 ' $100,000 per employee and still make a profit.

Most Am Law firms have their HVA functions centralized in the main office, in effect outsourced from all the attorneys located in the firms' other offices. The difference is that law firms have outsourced these functions to locations with high-labor, high-occupancy and high-support costs, rather than take advantage of the significant savings that can be achieved in less-populated locations in the United States.

The push for HVA function outsourcing has many benefits. In those firms that have adopted the model, significant cost savings and service level improvements have been achieved and cost reductions in the 20% to 25% range are common. When coupled with the dramatic improvement in and expansion of administrative support services, firms that have adopted the model boast that they would never go back.

Conclusion

It is clear the HVA outsourcing is the next big thing for law firms. It offers law firm management a path to better service at a reduced cost. As more firms adopt the HVA outsourcing model, the competitive advantage to do so will become more and more apparent. It will be clear that firms are not doing what has always been done and that they will not get what they have always gotten.

J. Mark Santiago is a founding partner of SB2 Consultants, which specializes in consulting to law and other professional service firms. He began his consulting career at Price Waterhouse and led the Deloitte & Touche law firm consulting practice for nine years. He has consulted on developing law firm strategy, partner compensation programs, financial performance improvement efforts, strategic cost reduction projects and led the Akin Gump and Orrick Herrington outsourcing engagements. Santiago was one of the three originators of the Legal Tech conference series. He may be reached at [email protected].

“If you do what you have always done, you'll get what you've always gotten!”

That very famous quote from author and motivational speaker Anthony Robbins describes in a sentence the results of the 2011 Am Law 100 and 200 reports, with respect to profitability, that were released this summer.

For the first time in three years the reports showed positive results. Overall, revenue rose by 3.5% and profit per equity partner (“PEP”) increased by more than 8%. Revenue per lawyer (“RPL”) rose by 4.4%, accompanied by a decline in the overall number of attorneys employed in the Am Law 200 firms. The number of equity partners declined by 0.9%, while non-equity partners' ranks declined by almost double that amount (1.7%). Associates were the hardest hit as their numbers declined by 2.7% in 2010. These declines followed similar reductions in each staff category in the 2009 calendar year.

I believe these encouraging results are hiding a far gloomier picture of what happened in the top 200 American law firms and that before we pop those champagne bottles we should look into the results a little more closely.

The revenue figures reported for the Am Law firms are total revenue received and are not adjusted for any bill rate increases. I have recalculated and adjusted the 2010 revenue results for the Am Law 200 firms by applying a modest bill rate increase. The increase was based upon the results of several widely circulated surveys, including the Altman Weil, CitiBank and Wells Fargo studies.

The factors I chose were 4% for the top quartile in the Am Law 100 list. I then reduced the anticipated revenue increase by 0.5% for every subsequent quartile so that the last quartile in the Am Law 200 anticipated revenue increase was a very modest 0.5%.

Overall, the results show a 0.4% revenue increase for the Am Law 200 firms, and when one excludes outliers DLA Piper and Hogan Lovells from the calculation, the overall revenue for the Am Law 200 declined by 1.7% in 2010.

The increases in RPL and PEP that were achieved in 2010 were the result of old fashioned belt tightening on the expense side and the downsizing of the number of attorneys and administrative support staff within each firm.

My analysis shows that with the exception of the Am Law 100 first quartile and the Am Law 200 second quartile (on an adjusted basis) the remaining six quartiles of the Am Law 200 all experienced revenue declines.

By quartile, the reported and adjusted revenue for 2010 is illustrated in Table 1, below.

[IMGCAP(1)]

The Am Law 100 first quartile firms are (of course) the largest and most successful firms in the United States. The fact that they could implement and collect bill rate increases is not surprising. The results in the Am Law 200 second quartile firms are a little less obvious. I will leave that analysis for another discussion.

The results for the remaining six quartiles point to 2010 as the third year in a row during which revenue in the Am Law firms declined.

I also analyzed the results by geographic region and found similar declines in revenue as Table 2, below, illustrates.

[IMGCAP(2)]

Once again, the results, when adjusted for bill rates, show a flat to down year in all geographic areas except the Northwest. Washington, DC (when DLA Piper and Hogan Lovells are excluded) also shows a decline instead of the unadjusted significant improvement.

What the leadership of most Am Law firms did to weather the storm of the past three years was to slash expenses and cut staff. Considering the size of the storm overall, law firm leadership did a commendable job. Earnings in most firms may be flat, but the firms are still standing.

But what will happen if/when the economy dips again? The anemic growth of the U.S. economy in the first nine months of 2011 and the far from robust projections for 2012 mean that the economic troubles are far from over.

Increasingly, client demands for alternative fee structures, their refusal to accept first- and second-year associates on matters, the rise of virtual law firms and the off-shoring of some types of routine legal work will all contribute to a further squeeze on law firm profits.

The cuts of the past several years have captured most of the “low hanging fruit” that might have once existed in Am Law firms. While further expense reductions are possible, their identification and capture will be more difficult, time consuming, and will require more fundamental changes in the way that law firms manage and provide administrative support for themselves.

How Not to Get What You Have Always Gotten

The second-largest expense item for Am Law firms is administrative salaries and benefits, and in most firms the third is their occupancy costs. Indeed, occupancy expense is a function of the number of employees a law firm has.

The cost of Am Law firm administrative support is largely determined by geography, whereas the cost of a firm's attorneys is related to how many steps from the “going rate” the firm has decided to compensate its legal staff.

Determining attorney compensation and bonuses is a matter of strategy. Determining how to provide administrative support services is a matter of “best and highest.” The question law firms should be asking is, “How can I provide the firm's clients and attorneys with the highest levels of administrative support services at the best cost to the firm?”

Increasingly, law firms are determining that many of the administrative support services that they currently provide can be performed better and cheaper by third party vendors.

There are few administrative support services that cannot be outsourced at lower cost while achieving better levels of service. There are many reasons for this, but the most frequently identified is time and focus.

Law firm management (the managing partner and committee plus the administrative leadership) have more than enough work to fill their 10- to 12-hour working days. As a result, many old policies, procedures and technologies remain in place long after their useful life.

In a recent client engagement we discovered that the law firm's file room reflected its old corporate past and not its current focus on litigation. As a result, we eliminated a 12,000 square-foot file room staffed by eight clerks and a supervisor and replace it with a 200 square-foot space staffed by two clerks and a supervisor. The remaining space was returned to the building (saving the firm more than $600,000 a year in rent) and the files and clerical staff were transferred to an outsourcing vendor at a savings of an additional $300,000.

Service dramatically improved not only in the delivery and retention of files but also in the mail, messenger and copier functions for which the new vendor also assumed
responsibility at a savings of an additional $200,000. The vendor also introduced newer copiers, standardized uniforms and a messenger training program, all of which improved the firm's level of service and attorney satisfaction with the administrative support services.

In another recent diagnostic that we performed (for a large Northeastern law firm) we analyzed all of the firm's administrative support services. We found that the firm had secretarial support ratios reminiscent of the 1950s (1.5 attorneys to one secretary) and was not reflective of the current generation of attorneys who prepare most of their own documents. By increasing the support ratios to a more modern 4-to-1 and outsourcing the firm's word processing to a 24/7 provider in the United States, the law firm realized multiple millions of dollars in savings as well as improved service levels.

But perhaps the greatest potential for savings lies in the trend to outsource the High Value Add (“HVA”) administrative support services of Accounting/Finance, IT and HR/Personnel Records and Payroll.

The outsourcing of HVA functions was pioneered in the early years of this decade when I consulted with Akin Gump Straus Hauer & Feld and Orrick Herrington & Sutcliffe. Akin Gump moved its HVA services to a third-party provider while Orrick built a captive center. Since that time Baker & McKenzie, White & Case and Wilmer Hale have all built captives. Recently, Pillsbury Winthrop announced that it would do the same and locate in Nashville, TN. Currently, a group of Am Law firms and a respected provider (with whom I am working) are conducting a proof of concept study for an independently owned center that will provide HVA services to multiple law firms.

Studies that I have conducted document that the total cost of an HVA administrative employee in an Am Law 100 firm is between $125,000 and $140,000. In the Am Law 200 firms those costs are somewhat less ($105,000 ' $125,000) reflecting lower salary and rental expenses. Outsources can provide these services for an average cost of $90,000 ' $100,000 per employee and still make a profit.

Most Am Law firms have their HVA functions centralized in the main office, in effect outsourced from all the attorneys located in the firms' other offices. The difference is that law firms have outsourced these functions to locations with high-labor, high-occupancy and high-support costs, rather than take advantage of the significant savings that can be achieved in less-populated locations in the United States.

The push for HVA function outsourcing has many benefits. In those firms that have adopted the model, significant cost savings and service level improvements have been achieved and cost reductions in the 20% to 25% range are common. When coupled with the dramatic improvement in and expansion of administrative support services, firms that have adopted the model boast that they would never go back.

Conclusion

It is clear the HVA outsourcing is the next big thing for law firms. It offers law firm management a path to better service at a reduced cost. As more firms adopt the HVA outsourcing model, the competitive advantage to do so will become more and more apparent. It will be clear that firms are not doing what has always been done and that they will not get what they have always gotten.

J. Mark Santiago is a founding partner of SB2 Consultants, which specializes in consulting to law and other professional service firms. He began his consulting career at Price Waterhouse and led the Deloitte & Touche law firm consulting practice for nine years. He has consulted on developing law firm strategy, partner compensation programs, financial performance improvement efforts, strategic cost reduction projects and led the Akin Gump and Orrick Herrington outsourcing engagements. Santiago was one of the three originators of the Legal Tech conference series. He may be reached at [email protected].