Are Law Firms Ready For Rate Deflation?
10:11 pm April 24, 2009 by Brian J. Ritchey
After hitting 5% in July of 2008, inflation has dropped rapidly and is now in negative territory (annualized) for the first time in 54 years. This creates tremendous spending opportunities but there are many risks. One of the risks to law firms is a deflating billable rate. With deflation hitting most aspects of the economy (food and energy being notable exceptions that at least in the latter case isn’t expected to deflate for a while and in fact may be the next credit “bubble” if, err, I mean when cap and trade is passed), it is only a matter of time when clients will either request more discounts or a reduced rate – and if clients don’t ask, other attorneys will offer lower rates to lure new clientele. Many businesses will be working from much tighter margins while the cost of doing business, including defending lawsuits, won’t lower with their margins. Something will have to give – either longer A/R outstanding or reduced rates.
It may not come. But there is reason to believe it will. Attorneys from large law firms who have been laid off are finding themselves entering the mid-firm market and some enterprising ones will start their own firms, determine a model that maximizes profit, and “Wal-Mart” some out of business while still raking in incredible profits. All it takes is better efficiency in serving clients (and, in my view, an unprofessional but very business-like approach to targeting and accepting clients). The relationship you have with your clients puts you at an advantage right now. However, in forecasting models you should prepare for a fight for your business based on rate.
If you are faced with reducing rates to keep clients, efficiency is key to making up the lost revenue. Don’t rely on volume alone as it can fool you into thinking you are in a better financial position than you are. You may end up hiring excessive numbers of attorneys, especially as the costs of attorneys goes down (another inevitability that is already happening – salary reduction for new associates). If you are still making minimal margins because you are too busy to implement efficient processes and you get undercut by someone willing to lower their rates, your firm will be in for a rather intense correction.
Even assuming rates don’t increase, there is a high probability that any planned rate increases will be difficult to implement. Firms have been contracting for several months and most have already cut costs as low as they can. A reduction in rate is an unplanned occurrence that can place even more pressure on firms to reduce costs.
From the firms I have consulted, most are still unwilling to invest in efficiency – rather, they are placing more emphasis on productivity and staff reductions. There are a few firms who are changing their model to streamline processes – those who invest in better procedures will not only be in a better position to absorb rate stagnation (or deflation) but will be in a better position to increase profitability later this year when the economic numbers start to improve. The test will be whether they retain earnings, a concept that is anathema to many firms.
Please note that due to the activism of the Federal Government to re-inflate the credit markets, there are arguably two possible results: massive inflation or another asset bubble (which will lead to a result similar to what we are experiencing now). Either way, the pattern of erratic markets is not likely to end anytime soon and with trillions being poured into the economy, money may get loose for a while – smart firms will invest in their firms (take advantage of the deflation) and set aside sufficient amounts to take short hits on revenue rather than make distributions (in case of a rapid spike in inflation or another asset bubble). We are in for a long period of uncertainty. Universal health care, carbon emission taxes, and of course the obvious tax increases to pay for the action taken already and to sustain the new entitlements.
Law firms will not be needed less (and in fact in some areas they will be needed more) but they are not immune to shifts to the economy. There will be areas of rate inflation but your firm may not be one of the beneficiaries. Some areas of law that have flourished for decades will suffer greatly and some boutique firms will cease to exist entirely.
Prepare for it. If your firm flourishes and all the doom and gloom above doesn’t come to fruition, great. Your bottom line thanks me for helping you have such a strong equitable position during your time of saving – go buy a new touch screen whiteboard or make a distribution so you can pay for all those projects at home. If the firm struggles, however, you may avoid having to make decisions that are not only uncomfortable but can lead to a fracturing of the firm.
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