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.

Measuring Missed Time

According to a 2007 study by Ipsos Reid, people gain on average one hour of productive time per day by having a Blackberry.  That is an average of 250 hours per year!  Regardless of whether an attorney has a Blackberry or not, it isn’t a stretch to say that attorneys miss at least one hour of billable time per day.  At an average rate of $200 per hour, this can result in lost value of up to $50,000 per year per timekeeper!  Recovering “lost” time can help increase profitability as well as provide leverage opportunities.

The problem is establishing the habit of timekeepers entering time regularly.  As in every other area of law firm management, measurement improves performance.  Using a Missing Time Report, such as the one shown below (click to enlarge), can help timekeepers get into the habit of paying attention to their time spent serving their clients and making sure they are recording the time spent on such activities.

In this report, the timekeeper can see the days they missed during a range of days – whether it be a month or week or whatever the time range entered.  A gauge is a good graphical method of tracking time entered for the range – in the case of the report to the left, it is looking at a month’s range.  The minimum hours is set to 167, or just over 8 hours per day.   Any day that the timekeeper does not enter 8 hours is shown, as well as the average rate on the day the time target was missed.  This will be used at the end of the report to determine value of the time missed.

The report also shows, per timekeeper, the total number of days where the time target was missed and the total hours entered for the range of dates.  The report should be flexible, however.  As much as we would like attorneys to enter time daily, some are stuck in the habit of recreating time at the end of the month and, if they are equity partners, they can minimize the value of this report by explaining that it doesn’t take into effect their total hours at the end of the month.  Therefore, the report should first filter out any timekeeper that, over the entire range of dates, records the minimum time expectation regardless of whether it was put in daily or all in one day.  If the firm decides that it wants to enforce daily time entry, that is fine.  The report just needs to be flexible in the event that the firm can’t enforce such a measure.

Finally, the report summary should show what timekeepers are accounting for the lost time, as a percentage.

This way you know who may need additional mentoring (or needling) in developing good time recording habits.  To emphasize the importance of recording your time, add  in the report summary  the total days where the target wasn’t missed, the total time missed, the average rate of all timekeeper time lost and the value of the time lost (the total hours missed multipled by the average rate).

Click on the graph to the left to see it in action.  If you are interested in using reports like the one described in this post, please feel free to email me or call (205) 588-4622.

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.

______________________________________
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

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.

Bankruptcy “Hot and Sexy”; Hildebrandt, CitiBank Scratching Heads

The ABA Journal posted an article describing bankruptcy as a “hot and sexy” field for Weil, Gotshal & Manges summer associates.  Imagine that:  bankruptcy a hot field during an economic downturn.  This wouldn’t be news to me except for the fact that Hildebrandt and Citibank advised in their 2008 Client Advisory that the “perfect storm” was hitting the US shores, “in which finance, transactional, and litigation work have all trended downward at the same time, with no offsetting surge in work related to the economic downturn itself.” (p 2)

Apparently the cart was ahead of the horse on this.  While bankruptcy filings may have not been hot in January, the prediction was pretty bold considering history and logic.  Yet they had their reasons (spelled out in a More Partner Income post in January).  This isn’t the first post to find holes in the Advisory’s predictions.  I wrote in March regarding the market indicators showing great opportunities in bankruptcy and related litigation and in April regarding record foreclosure filings in Florida.

In Hildebrandt and Citibank’s defense it isn’t easy to predict the future (note to Global Warming Climate Change enthusiasts), but the tone of the Advisory appears almost hopeful.  After all, they “ha[d] for some time been predicting that the legal market was perhaps overdue for a ‘correction’ and that the era of easy or widespread double digit annual growth in profitability could well be coming to an end.”

Perhaps the era of double digit annual growth is in suspension, but the “perfect storm” just didn’t pan out.

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.