Are Law Firms Ready For Rate Deflation?

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.

Process Modeling: Putting To Print Things That Work

For most firms, knowing what needs to be done to effectively manage a case is something learned through time and experience.  Unfortunately, this valuable information is rarely put to print for others to follow.  The result is constant “reinvention of the wheel”.  For associates, how well you can swim after being thrown in the shark-infested pool determines whether you become partner, career associate or looking for other work.

Likewise, if there is staff turnover, how quickly they are up to speed on your processes will determine how long it takes for productivity to reach or exceed pre-turnover levels.

Modeling your processes provide a concrete method for everyone in the firm to know not only what is expected, but why the expectation is in place and how to go about performing the task(s) in a manner approved by the firm.  This has several benefits, not the least of which is a reduction in the “change curve” time,  improved efficiency and the increased capacity to scale.

There is, of course, a process to building the process model.  The first step is to outline all of the processes in the firm.  This includes administrative processes, practice-related processes, client and matter-related processes, and any other process that pertains to firm business.

Once outlined, those who have the experience must brainstorm and put to print all the years of experience that has taught them to know on instinct what to do as the work-flow meanders from question to question.  Mapping this visually helps to find the gaps and gives you the opportunity to take out redundant tasks which may cause bottlenecks that reduce efficiency.

The example to the left is a mapping of a collections process (click on it to view in full screen).  It started with just picking a point in the process, going through the steps, then reading and re-reading to fill in the gaps and add in the details.

Once you have the process visually mapped, the next step is taking each step and reviewing why it is there.  The “why” helps to confirm that the step is necessary – if you can’t figure out why a step is needed, then it isn’t needed.  The “why” is also for new employees or others who may have to temporarily perform the task later.  One of the complaints I often hear from partners has to do with the lack of “ownership” some in their firm have towards files given to them.  In my opinion, a lack of understanding the entirety of the file is one reason an associate may do subpar work.  Thus, part of the process of taking a file from a partner should include a thorough reading of the file, paying particular note of certain things the partner always looks for to help understand the important issues in the file.  Although this is obvious to those with experience, it may not come as second nature to new associates or staff.  The “why” helps them see it from the partner’s perspective without forcing the partner to lose productive time in having to explain it.

This has more than one benefit.  Although highly unlikely (tic)¹, it may be that the partner’s time tested process may miss out on a detail or two that an enterprising associate or support staff discovers.  In cases such as this, having the “why” helps the associate or support staff understand the purpose and he/she then can propose process enhancement, furthering continuous process improvement².  (This can be encouraged through upward reviews).

After providing the “why”, the next part is the “how”.  Use a step-by-step approach so that others can follow the process in an easy-to-understand manner.  An example approach for a collections process would be:

1. Sort AR for collectible and non-collectible accounts;
2. Distribute to responsible attorneys to determine if any should be held from normal process;
3. Determine age of oldest unpaid  invoice;
4. If older than:
   1. 30 days – go here
   2. 45 days – go here
   3. 60 days – go here
   4. etc
5. etc

After completing this tedious but necessary list, model it visually through a tool like Microsoft’s Visio.  An example output for a part of the above process might look like this:

After review of the processes to ensure they are appropriate and are easy for others to understand, make it easily available for your staff to access.  In today’s connected world, this means access through a web browser.  Your site should be easy to access from within the network and should be easy to navigate.  An example site may look like the below (shown without theme – in practice it may mimic your external website’s design):

Besides the benefits discussed above for modeling your firm’s processes, there are quantifiable reasons as well that can lead directly to the firm’s bottom line.  For example, you can assign an amount of time it should take to perform a certain task.  Having this information available allows you to set baselines for performance reviews (efficiency of employee versus the firm efficiency standard).  It also gives the firm an opportunity to offer different billing options to clients; for example, if a client desires more cost certainty, the firm can offer a flat rate based on how long it takes to perform the tasks in a typical case, taking into consideration the facts and the potential to vary from the norm.  You can then add your margin to this number to provide a fee that is both acceptable to the client and ensures profitability for the firm.

As you can probably note from reading the above, modeling your processes is a tedious and time-consuming process in itself.  However, the benefits of taking the time to map, model and follow your processes shouldn’t be understated.  Not only will it improve the manner in which work is performed, but it can bring measurable benefits to your bottom line.

Of Counsel Consulting can help your firm map, model and price your processes so that you attain maximum benefit for taking the time to further the goal of continuous improvement.  Please feel free to call or email us for more information.

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¹ tongue in cheek – Go Back
² The idea of continuous process improvement isn’t new but is laid out nicely in a book written by Tom Pryor called Using Activity Based Management For Continuous Improvement that I recommend. – Go Back

Forecasting Attorney Revenue

Forecasting is important for law firms so that they are not found “accidentally” out of business.  There are tools available, perhaps within your own organization, that are more than capable of helping you forecast attorney revenue.  However, some tools are better than others at showing the results.

Below is a graphic showing attorney monthly productivity, any variance from the budget and the attorney contribution percentage.  Clicking on any of the attorney initals changes the data to show the chosen attorney’s productivity numbers.  (You must have the free Adobe Flash Player to view.  You may download it by clicking here).

Graphical dashboards such as the one below provides an easy way for managers to stay informed as to the critical performance drivers of the firm without having to pore over rows of data.  This, in turn, makes the information more actionable and thereby helps focus the firm on reaching its goals.

Feel free to click on any of the sample attorney initials below to see the data change.  If you would like more information on how you can have dashboards like the one below implemented in your firm, please feel free to email me or call 205.588.4OCC (4622).

All Bets Off – Massive Deflation And Fed Still Lowers Rates

All the ingredients are coming together for protracted, painful and seriously impaired economic conditions.  As stated in an earlier post,  a deflationary crash is characterized in part by a persistent, sustained, deep, general decline in people’s desire and ability to lend and borrow.   It appears we are in the midst of one.  Consumer prices, after a record decline in October, set another record in November, pushing inflation down to 1.07%.  After a year that saw inflation hitting almost 6% in July, this is a painful indicator of things to come.  In spite of OPEC’s threat to drastically cut production, oil prices are still relatively low.

Worse, the Federal Reserve appears to be acting counter-intuitively by lowering interest rates to “zero to .25%“, leading to speculation that once our economy does rebound, hyperinflation will be the next crisis.  It doesn’t help that our government continues to spend money it doesn’t have.

On top of all this, President-Elect Obama announced that his “stimulus plan” will be somewhere between $600 billion and $1 trillion.  The spending spree never ends.

The time to voluntarily liquidate assets has passed.  Foreclosures dipped in November, but few expect that trend to be anything but temporary in spite of Fanny Mae’s Christmas gift to renters of homes in foreclosure proceedings.  Best to hold on to assets and try to keep as much cash on hand as possible.

We can hope that the aggressive moves by the Federal Government will prevent another depression, but it sure seems like we are about to embark on the same policies of the Roosevelt administration that arguably kept the country in a depression for an entire decade.  One of the proponents of further governmental intervention is oddly a scholar of the Great Depression.  Fed Chairman Ben Bernanke believes that the cause of the Great Depression was the lack of action by the Hoover administration to stop banks from failing and by keeping interest rates too high.  In Bernanke’s mind, it was Hoover’s inaction that caused the depression, not Roosevelt’s activism.

There are (at least)  two arguments as to what caused the Great Depression.  One argument postulated by Irving Fisher and furthered by Bernanke states that debt deflation caused the Great Depression and, in at least Bernanke’s case, government inaction during the 3 1/2 years between the stock market crash of 1929 and the swearing in of Franklin Roosevelt caused productivity to become depressed and unable to recover in spite of FDR’s programs for an entire decade.

Fisher was not exactly on target with his arguments in his lifetime (from wikipedia):

The stock market crash of 1929 and the subsequent Great Depression cost Fisher much of his personal wealth and academic reputation. He famously predicted, a few days before the Stock Market Crash of 1929, “Stock prices have reached what looks like a permanently high plateau.” Irving Fisher stated on October 21st that the market was “only shaking out of the lunatic fringe” and went on to explain why he felt the prices still had not caught up with their real value and should go much higher. On Wednesday, October 23rd, he announced in a banker’s meeting “security values in most instances were not inflated.” For months after the Crash, he continued to assure investors that a recovery was just around the corner.

Once the Great Depression was unavoidable to notice, he theorized that debt deflation was a major cause – debt deflation that could have been avoided (according to some) had the Hoover administration taken more aggressive steps to intercede.

The other argument is that it wasn’t Hoover’s inaction that led to the Depression but the Smoot-Hawley Act of 1930, which raised tariffs on goods sold to trading partners and led reciprocal action, skyrocketing unemployment and global isolationism.   Those who would argue this would point that both low interest rates and ample liquidity were available in 1930, but that due to economic uncertainty, few wanted to borrow and take risks.  Further, FDR prevented the economy from pulling itself out of the depression by overly taxing the population (specifically the producers) and redistributing wealth using a “trickle-up” philosophy of using government to employ the people.  Even with FDR’s policies, unemployment was still over 19% in 1938.

You can argue both arguments are right and wrong.  It is plausible that at least having a Federal Reserve that would have released funds to troubled banks could have avoided the panic that led to over 9,000 banks failing in the 1930′s.  However, there is ample evidence that government intervention did more to exacerbate the Depression than remedy it.  The primary force that led us back to economic expansion was the Second World War.

Unfortunately for Bernanke, debt deflation is intensifying in spite of his actions to improve liquidity.  What may come from all these measures, however, could spur the same depressed conditions that he is trying so hard to avoid.  If liquidity does improve, even moderately, inflation will be a large concern.  The question will then be whether it would be better to allow inflation to run amok or to raise interest rates and threaten the improving economy.

One thing I feel relatively certain in predicting:  so long as the government intervenes in the economy, there will not be a lot of certainty in the markets, which will result in further volatility.  And, it doesn’t appear the government is planning on taking its hands out of the economy anytime soon.

False Sense Of Security Still Prevalent Among Law Firms

In spite of overwhelming evidence that the booming economy enjoyed practically uninterrupted for the past 20 years has ended, at least for the near term, many law firms are still optimistic of their 2009 prospects.  I beg to differ.  I believe 2009 will start a strong shift in the make-up of many law firms due to the lack of any planning for the economic conditions.

Who can blame attorneys for being optimistic?  Regardless of the economy since at least the early 1980′s, lawyers have enjoyed consistently increased business and profits.  This has led to a complacency and a denial of the economic conditions that are facing the country.

Law firms aren’t alone.  In fact, the “big three” auto makers (Ford perhaps excepted) are acting out of a similar denial as they attempt to scare Congress and the President into paying for their internal problems.  Who didn’t see the failure of GM coming?  Was no one noticing the extravagant pensions being offered to the employees?  Did anyone who dared notice believe the ever slimming margins would cover the ever growing benefits?   Not likely.  As the Legislative and Executive branches delve deeper into the phantom pockets of our tax base, a  nice summary of the fallacy of “avoiding acting like Herbert Hoover” has been inked in an opinion piece by Todd J. Zywicki in the Wall Street Journal.

Law firms, though not nearly in the long-term slide as the domestic auto industry, is more sensitive to this economic downturn than many attorneys would like to admit.  Many firms have been spoiled by margins that exceed 50% without spending more than a passing glance at the indicators that led them to such bounty.  The issue isn’t so much a drop-off in business, though some firms who specialize in areas that are in the midst of collapse will certainly feel the pain.  Rather, the issue is how firms will retain good talent, retain their expected incomes and avoid layoffs of associates.

These are regular issues for most industries but are foreign to the mid-size law firm.  Many firms pride themselves in their “family” atmosphere, which includes the bratty sibling rivalries that are tolerated when times are good.  Salary incongruousness may seem a bothersome itch when profits are high, but once the deadwood becomes heavy the scratching becomes intolerable.  Some may panic to find their balance sheet showing a loss without ever seeing it coming.  Drastic change is put into place – at a time no worse to prepare.  No more is it wise to visit a market when hungry than to suggest change while in the midst of a spiral.

Yet our economy has afforded all of us time to prepare.  It was suggested by many (myself included as far back as March) that our economy was in for some hard times.  Firms with the foresight and gumption to plan and hold timekeepers accountable for providing not only quality service to their clients but ensuring prompt billing and payment for the betterment of the long term financial health of the firm are in a position now to profit over the firms who were complacent.

It’s not too late, however.  Many firms are just now seeing the first bumps in the road.  It is my opinion that the economic downturn is just now really beginning to hit middle America.  The massive layoffs (over 533,000 in November) are an indicator that the many months of body blows caused by the collapse of the credit and housing markets (not so unlike what happened in the late 1920′s, speaking of Herbert Hoover) are finally taking its toll.  The question now is, where is the bottom?

No one knows.  That is a troubling concern that should make you want to hug every dollar your firm receives and not let go of it.  In times such as these, power goes to those who hold cash.  This may change if our government attempts to over-spend its way out of our economic downturn (thereby devaluing the dollar, leading possibly to hyperinflation combined with stagnant productivity – a prescription for the “d” word), but as of right now, many believe that the economy should rebound sometime in 2010.

In my opinion, firms need to pay more attention to the profitability of each fee earner and place more emphasis on marketing activities and their key profit drivers.  Please feel free to email me (by clicking here) if you would like some ideas on how to not only retain your current income, but increase profits during an economic downturn.

Simplifying the Law Firm Business Model

The law firm business model, as defined by David Maister, is made up of the following equation:

1. Leverage
2. Rate
3. Productivity (Utilization)
4. Realization
5. Margin

If you are not tracking these profit drivers, it doesn’t matter how many reports you are thumbing through – they won’t measure the keys to per-partner profits and are thus, as far as profitability is concerned, irrelevant. The good news is that it doesn’t take much to track these drivers.  You can derive a simplified financial statement by just plugging in your numbers.  The below graph shows how tracking these key indicators can help you see exactly what drives your firm’s profits.  To download and plug in your own numbers, click on the graph.

 

I will be going over each of the drivers in more detail over the next several weeks.

Does Your Law Firm Have a “Level 5″ Leader?

In a recent entry posted to the Harvard Business Review’s Editor’s Blog, Diane Coutu wrote of a deceased Columbia University professor who she describes as a “Level 5 leader”:

“that rare person who can successfully combine drive, intelligence and humility to attract followers and to encourage them to perform to do the best of their abilities.”

Why is such a combination so rare?  From the standpoint of any practicing attorney, humility isn’t common.  Yet in the context of a leader, humility isn’t so much in how you practice but in how introspective you are.  Those who spend time congratulating themselves for their achievements are not preparing themselves for future success.  With this in mind, how can managing attorneys become level 5 leaders?

At first glance, most successful partners have two of the three characteristics off the bat.  Drive and intelligence are hallmarks of any successful lawyer.  Where the disconnect occurs is how they apply their drive and intellect.  Good lawyers use these qualities to represent their clients.  Good managers use these qualities to “attract followers and to encourage them to perform to do the best of their abilities”. 

To be an effective leader should require total dedication.  Yet for many firms, the managing attorney is also a leader in productivity.  I have talked to many managing attorneys who are also one of the highest producers in their firms.  To expect them to succeed both as managers and practicing law is not a recipe for success for at least one of their responsibilities.

For firms who can’t afford to have a partner dispense with their billable productivity while managing the firm, consider among other things the following ways to encourage positive results from your managing partner:

• Choose a managing partner who can develop consensus.  Many managing attorneys state that they spend as much time building consensus as they do all the other responsibilities of managing the firm combined.
• Choose a managing partner who has a vision of where they want the firm to go.  Managing partners must not only drive the vision, they must also develop and nurture it.
• If possible, don’t choose a managing partner from your top producers.  To be effective, the managing attorney will have to reduce their workload.  Taking a high producing attorney away from the field will have an immediate negative impact on the firm.  Attorneys aren’t the most patient of people and seeing a reduction in productivity isn’t the best way to support a new managing attorney.
• Encourage “upward reviews“.  Getting the best from others may hinge on keeping an open ear to their needs and concerns.  If there are grumbling associates that are either afraid or disinterested in sharing their concerns, they can be like a cancer that becomes hard to eradicate.
• Measure performance.  The way to judge how well a managing attorney is focusing their drive and intelligence to encourage those to perform to the best of their abilities is by setting standards and holding everyone, including the managing attorney, accountable for their results.

As noted in the first comment of the blog entry, “such leaders {don’t} focus on {themselves} too much, but on defining a vision, articulating it, and then actualizing it.”  I believe that these qualities aren’t as rare as Ms. Coutu suggests.  On the contrary, I believe most firms have people in their own firm who, with the right support and responsibilities, can develop into such a leader and can provide a great service to the firm.

The devil is in finding them.