Leadership in the Law: Profiting from the Learning Curve

To be clear, it's not as if law firm partners have turned a deaf ear to client concerns. There have been many efforts to improve client service even as law firm profits have grown at extraordinary rates ' a result that has not escaped the attention of clients.

According to an analysis conducted by management consultant Patrick Fuller, AmLaw 200 law firm revenue has grown 78% from 2003-2012 while profits have grown 90% over the same period. Within the top 50 AmLaw law firms, revenue has grown even faster than in the lower 150, at a rate of 59% to 95%.

But here's the rub: Any conflict between client satisfaction and law firm financial performance is self-induced. There's no economic principle that requires clients to be distinctly unhappy when law firms are profitable. This is not a zero-sum game. The billable hour isn't necessarily the culprit, though its tendency toward misaligned incentives does muddy the waters. The reality is that clients in most industries don't worry too much about the mechanics of the invoice when the value received is clearly commensurate with the costs incurred. Perhaps what's been missing is a mutually-beneficial alternative.

While the recent increase in alternative fee arrangements (AFA) suggests that changes are afoot, the vast majority of law firms come reluctantly to the AFA dance because they fear a loss of profitability. Or worse, they often have no idea what impact to expect from AFAs. What's needed, then, is a roadmap explaining how client satisfaction and law firm profits can be inextricably linked.

Alternative Medicine

Amidst the clamor from corporate counsel maligning the billable hour, there is and always has been the voice of the law firm partner who is dissatisfied with a system in which the market value of his trusted counsel to a client who avoids $10 million in costly litigation could be deemed equivalent to another partner napping at his desk, so long as each takes the same amount of time to accomplish his task. There is also the practice group chair lamenting the inconsistent training delivered to young associates rotating through other practices and offices by colleagues who have different ideas about what constitutes a proper curriculum. And there is the law firm leader who continually invests in growth through lateral acquisition or merger but who fails to see profits rise even as firm headcount and revenues grow. These partners recognize the inherent inefficiencies in the current law firm model as easily as their clients, but for different reasons. Is there a grand unifying theory that might address the disparate points of dissatisfaction? Indeed there is. Welcome to the micro-economic principle of the learning curve. At its core, the learning curve is the process of gaining cost advantage through experience. Whether through repetition, technology enhancements, process improvements or the constant influx of lower-cost raw materials, there is a continuous effort to improve efficiency and lower the marginal costs of production. In such a system, those who have more experience tend to generate more profits, even when revenues are flat or declining.

When law firms place the learning curve as a central performance metric, client satisfaction increases. When client satisfaction increases, repeat engagements increase and the cost of new revenue acquisition declines, further enhancing profits. So how does a law firm embrace the learning curve? It's as simple, and as complex, as understanding the different elements that comprise the legal work product. When a partner can break down even the most complicated, thorny and unique engagement into its component tasks, all of which (or at least a substantial majority) have been tackled previously, and there is constant attention to re-using lessons learned, documents and processes from these prior engagements, then the cost of delivery goes down over time. When these savings are passed on to the buyer, whether through cost reductions, cost certainty (e.g., in the form of budgets which significantly reduce surprise) or reduced fee increases, there is greater synchronization between the value received by the buyer and the value of the services rendered.

For partners weaned on the concepts of driving revenues through billing hours, and driving profits through high utilization and realization, proper leverage and lowering overhead, these ideas fly in the face of all that they know. But the concept is familiar to all of us who purchase goods and services in our daily lives. We recognize that WalMart can offer low prices because it aggressively removes inefficiencies and carrying costs from its supply chain. We recognize that pharmaceutical companies can sell medication at a very small unit price, even though the cost to create the first pill may have required substantial investments. We recognize that the experienced contractor hired to remodel our kitchen will charge less and generate less waste than the first-time contractor who hopes the client will subsidize his on-the-job training.

Conclusion

This is just the tip of the iceberg for law firm leaders who must embrace new economic and financial concepts if they hope to thrive in this time of great change. On the surface, we may see a relatively modest obstacle blocking our path, but outside our vision is a much greater obstacle that we can't avoid. Clients simply do not accept that legal work is by definition non-repeatable and therefore models that reward inefficiency are mandatory. So we can either fight to sustain our current approach despite the fast-approaching object on the horizon. Or we can try a new approach. Businesses of every size and in every industry have long embraced the learning curve as a fundamental driver of profit and client satisfaction. It's time for law firms to join the voyage.

Timothy B. Corcoran, a member of this newsletter's Board of Editors, authors the Corcoran's Business of Law blog. He advises law firm leaders on matters of strategy, business process improvement, legal project management and business development. He may be reached at 609-577-2234 or via e-mail at [email protected].

A recent study published by Altman Weil listed the ways in which chief legal officers would like to see their outside counsel embrace service improvements and innovation. The top four responses were greater cost reduction, non-hourly pricing, more efficient project management and improved budget forecasting. To anyone paying even cursory attention to the legal marketplace in the last half decade, these should not come as a surprise. In fact, as the study goes on to report, a significantly higher number of law department budgets experienced reductions in 2012 than in the three years prior, so the pressure on outside counsel is likely to increase rather than abate. But are law firms listening? Several managing partners speaking on a panel at the recent College of Law Practice Management Futures conference reported that their greatest leadership concern is increasing revenue, and the leading tactic to accomplish this is attracting lateral partners with portable, healthy and profitable books of business. Of lesser importance, though certainly on the radar, is the desire to institutionalize clients so they are less likely to depart when partners go. It's unclear whether these leaders see the irony. What is clear is that many law firm leaders struggle with the apparently opposing goals of improving client service and improving law firm financial performance.

Nostalgia Isn't What It Used to Be

Many lawyers lament the bygone era when they performed interesting and quality legal work, clients were satisfied and hired them again and again, invoices were paid promptly and the billable hour was a perfectly satisfactory method for capturing the value of legal work product. Trouble is, as with most nostalgia, this was more fantasy than reality. In 2002, when the ABA issued its report encouraging the demise of the billable hour, it relied on research conducted in the 90s, which was based on decades of complaints and general unrest from both corporate counsel and private practice lawyers alike. In fact, the Association of Corporate Counsel (ne' American Corporate Counsel Association in 1982) was formed in part to give a stronger voice to client concerns, one of which was, and remains, the billable hour.

To be clear, it's not as if law firm partners have turned a deaf ear to client concerns. There have been many efforts to improve client service even as law firm profits have grown at extraordinary rates ' a result that has not escaped the attention of clients.

According to an analysis conducted by management consultant Patrick Fuller, AmLaw 200 law firm revenue has grown 78% from 2003-2012 while profits have grown 90% over the same period. Within the top 50 AmLaw law firms, revenue has grown even faster than in the lower 150, at a rate of 59% to 95%.

But here's the rub: Any conflict between client satisfaction and law firm financial performance is self-induced. There's no economic principle that requires clients to be distinctly unhappy when law firms are profitable. This is not a zero-sum game. The billable hour isn't necessarily the culprit, though its tendency toward misaligned incentives does muddy the waters. The reality is that clients in most industries don't worry too much about the mechanics of the invoice when the value received is clearly commensurate with the costs incurred. Perhaps what's been missing is a mutually-beneficial alternative.

While the recent increase in alternative fee arrangements (AFA) suggests that changes are afoot, the vast majority of law firms come reluctantly to the AFA dance because they fear a loss of profitability. Or worse, they often have no idea what impact to expect from AFAs. What's needed, then, is a roadmap explaining how client satisfaction and law firm profits can be inextricably linked.

Alternative Medicine

Amidst the clamor from corporate counsel maligning the billable hour, there is and always has been the voice of the law firm partner who is dissatisfied with a system in which the market value of his trusted counsel to a client who avoids $10 million in costly litigation could be deemed equivalent to another partner napping at his desk, so long as each takes the same amount of time to accomplish his task. There is also the practice group chair lamenting the inconsistent training delivered to young associates rotating through other practices and offices by colleagues who have different ideas about what constitutes a proper curriculum. And there is the law firm leader who continually invests in growth through lateral acquisition or merger but who fails to see profits rise even as firm headcount and revenues grow. These partners recognize the inherent inefficiencies in the current law firm model as easily as their clients, but for different reasons. Is there a grand unifying theory that might address the disparate points of dissatisfaction? Indeed there is. Welcome to the micro-economic principle of the learning curve. At its core, the learning curve is the process of gaining cost advantage through experience. Whether through repetition, technology enhancements, process improvements or the constant influx of lower-cost raw materials, there is a continuous effort to improve efficiency and lower the marginal costs of production. In such a system, those who have more experience tend to generate more profits, even when revenues are flat or declining.

When law firms place the learning curve as a central performance metric, client satisfaction increases. When client satisfaction increases, repeat engagements increase and the cost of new revenue acquisition declines, further enhancing profits. So how does a law firm embrace the learning curve? It's as simple, and as complex, as understanding the different elements that comprise the legal work product. When a partner can break down even the most complicated, thorny and unique engagement into its component tasks, all of which (or at least a substantial majority) have been tackled previously, and there is constant attention to re-using lessons learned, documents and processes from these prior engagements, then the cost of delivery goes down over time. When these savings are passed on to the buyer, whether through cost reductions, cost certainty (e.g., in the form of budgets which significantly reduce surprise) or reduced fee increases, there is greater synchronization between the value received by the buyer and the value of the services rendered.

For partners weaned on the concepts of driving revenues through billing hours, and driving profits through high utilization and realization, proper leverage and lowering overhead, these ideas fly in the face of all that they know. But the concept is familiar to all of us who purchase goods and services in our daily lives. We recognize that WalMart can offer low prices because it aggressively removes inefficiencies and carrying costs from its supply chain. We recognize that pharmaceutical companies can sell medication at a very small unit price, even though the cost to create the first pill may have required substantial investments. We recognize that the experienced contractor hired to remodel our kitchen will charge less and generate less waste than the first-time contractor who hopes the client will subsidize his on-the-job training.

Conclusion

This is just the tip of the iceberg for law firm leaders who must embrace new economic and financial concepts if they hope to thrive in this time of great change. On the surface, we may see a relatively modest obstacle blocking our path, but outside our vision is a much greater obstacle that we can't avoid. Clients simply do not accept that legal work is by definition non-repeatable and therefore models that reward inefficiency are mandatory. So we can either fight to sustain our current approach despite the fast-approaching object on the horizon. Or we can try a new approach. Businesses of every size and in every industry have long embraced the learning curve as a fundamental driver of profit and client satisfaction. It's time for law firms to join the voyage.

Timothy B. Corcoran, a member of this newsletter's Board of Editors, authors the Corcoran's Business of Law blog. He advises law firm leaders on matters of strategy, business process improvement, legal project management and business development. He may be reached at 609-577-2234 or via e-mail at [email protected].