Speaker's Corner: Law firms tinkering as business model under stress

Law firms continue to grapple with finding new ways to mesh their traditional, if rapidly outmoded, business model with client pressures to control fees.

Most recently, Fasken Martineau DuMoulin LLP came up with a service package for incubators and groups of angel investors. Its startup program gives entrepreneurs two hours of monthly meetings with lawyers to discuss basic business issues for about $2,000 a year. It gives Faskens an early lead on companies with good growth potential with possibly higher fees down the road.

Torys LLP has a different answer. It will use a new office opening later this year in Halifax as a low-cost haven to handle routine matters such as reviewing standard contracts, employment agreements, and meeting other basic legal needs for clients of the firm’s other locations.

But Torys’ and Faskens’ novel strategies sidestep an uncomfortable yet key issue confronting many firms of all sizes: How to maintain traditionally hefty margins while coming to grips with genuine client concerns about fees in an era where corporate costs are under constant pressure and businesses keep looking for ways to wring dollars out of the profit and loss statement.

It’s too early to know whether these experiments will succeed. Yet even as businesses are hungry for new pricing and value models, a former chair of a major Toronto firm said recently: “There’s a lot of tinkering around the edges but no one wants to face the real question of whether a client or partner is profitable.”

Tinkering around the edges includes reducing the size of summer student and articling classes and hiring back fewer new lawyers as associates. Some firms laid off associates and staff, bounced partners who were blatantly unproductive, and encouraged older lawyers to take early retirement.

Yet many firms seem reluctant to use one approach used by most other businesses, including professional service firms such as accountants: Examining the profitability of specific clients and practices. Not doing so can be fatal. Indeed, numerous arguments over the profitability of offices and practice groups played a role in Heenan Blaikie LLP’s downfall.

Yet finding a profitable sweet spot doesn’t have to be contentious.

There are a number of workable approaches. The first step in our proprietary model is to look at client billings over the previous three to five years to get a comprehensive picture and taking out swings caused by one-off retainers that cause a brief blip. Against annual billings, we look at actual time billed and collected by lawyer with numbers split by partners, associates, and clerks.

The model also pro-rates some fixed costs against each file, allowing a firm to put clients into one of four tiers:
•    Most valuable/high-profit clients.
•    High growth/greater profit potential.
•    Low growth/little profit growth potential.
•    No growth/no profit growth potential.

While each firm’s criteria will vary, the process provides a complete picture of which clients are profitable and worth developing and which are not. An example is illuminating.

A top-20 law firm was curious about the financial impact of its diverse client base and asked us to apply our model. The findings astounded the executive committee.

One practice group processed a lot of loan agreements that accounted for significant annual billings and cash flow. But the model revealed that when first- to fourth-year associates did the work, it was profitable. However, once senior lawyers touched the files, profitability plummeted. In effect, the more work partners did, the less money the firm made.

The firm took four steps:
1.    It enhanced a precedent system to have more work done by juniors, meaning fewer agreements were drafted from scratch and requiring less partner involvement on each file.
2.    It shifted some associates to more profitable practice areas and stopped recruiting laterals for the area.
3.    It slashed the group’s entertainment budget, figuring lavish spending to get additional low-margin work didn’t make sense.
4.    It stopped hunting for similar work from prospects.
Not surprisingly, there was grumbling from partners in the affected group, but their whining stopped when the changes added $230,000 to the firm’s profit that year. Fixes in other practice groups combined for another $100,000.

The process forces firms to re-examine which clients, practices, and lawyers are profitable and ways the organization can confront the issue.

Accounting firms went through a similar process 15 years ago, partly because of the Sarbanes-Oxley Act but also because clients balked at paying high fees for what they perceived of as low-value work such as audits and tax filings. Indeed, accountants found that clients who only bought tax or audit work weren’t as profitable as those who bought financial consulting and business advice. By firing clients in the bottom two tiers, their profitability soared.

Law firms with more than roughly a dozen lawyers must deal seriously with profitability issues manufacturers confronted in the 1980s, accountants faced in the 1990s, and other service businesses dealt with after 2008.

The question is: Will lawyers drive the change clients are demanding or keep tinkering around the edges until they get run over by it?

Jana Schilder and J.C. Bliwas have each worked at and with local, regional, and national law firms on profitability, marketing, business development, and change management issues for more than 20 years.

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