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.

The Case Against Universal Healthcare

A major part of the Democrat platform is the advancement of universal health care.  And who would blame them?  The health care system is ridiculous.  It is as far away from market-based as it has ever been in this country.  But is the solution to have it centrally managed by the federal government?  Or to return it to it’s market-based roots?

In my opinion, health care costs were bad in 1992, but since then have spiraled out of control.  I believe some measure of blame can be made on the universal coverage push made by then First Lady Hillary Clinton.  Though the objectives were noble, it mandated employers cover employees via heavily regulated HMOs.  HMOs had been around since the early part of the 20th century, but it wasn’t until the 1980′s in response to threatened socialization of medicine that they became popular.   The commercialization of HMOs came to a head in 1992, when for-profit HMOs were more numerous than non-profit HMOs.

There is little question that the 1993 health care plan exacerbated HMO growth and insurance carriers have taken over health care decisions ever since.

So is the answer federally guaranteed health care?  I went to a specialist the other day (referred by my primary care physician who seems more a referral stepping stone than a physician) who was refreshingly frank as to why doctors wouldn’t perform a certain procedure that used to be routine – lack of repayment by insurance carriers.  Insurers are controlling doctor decisions.  Even when doctors will perform procedures, they have to go through hoops to ensure payment even if they are certain the procedure must be done.  This causes needless delay and makes health care more expensive.

If I were a conspiracy theorist I could easily blame this on those seeking to instill universal healthcare on us – make the system so unworkable that people just want something different – change.

I prefer to think it is the meddling of health care by politicians with good intentions but with poor business sense.  If I were to go to 10 attorneys, I would get 10 variances in quality representation.  Based on the results, demeanor and cost I could determine who was the best and go to that attorney.  If I were to go to 10 doctors, I can only choose based on results and demeanor.  Cost is completely out of the picture.  This takes a market force and throws it in the trash – and is wrong.

Our country has safety nets for indigents that are subsidized by taxpayers – Medicare, Medicaid, and the Emergency Medical Treatment and Active Labor Act, which requires ambulance and hospital access to anyone regardless of citizenship status, legal status or ability to pay.

However, there is a problem with insurance coverage and preventative care.  Solving it, in my opinion, requires giving consumers the freedom to choose their care based on their pocketbook – not the pocketbook of an insurance carrier.  If individuals were able to choose care and insurers were only able to insure against catastrophic care (something, like any other supplemental insurance, can be done relatively inexpensively) the cost of care would reduce.

How?

How does the market work in every other arena?  Competition. Competition fosters efficiency and innovation and that leads to lower costs.

The alternative is universal care, or socialized medicine.  The argument for socialized medicine always starts with “every other industrialized nation has it”.   The Cato Institute has an article from 1996 that addresses European socialized medicine.  A highlight:

The Europeans have run into a very simple economic rule. If something is perceived as free, people will consume more of it than they would if they had to pay for it. Think of it this way: if food were free, would you eat hamburger or steak? At the same time, health care is a finite good. There are only so many doctors, so many hospital beds and so much technology. If people overconsume those resources, it drives up the cost of health care.

I maintain that we have been operating under a semi-socialized system for several decades.  Even if you consider the cost of health care in your paycheck, if you have met your deductible or have unused purchased health care, you are apt to use it more often, regardless of need.

I also believe that if the federal government were to control health care (and the cost of health care) it would damage the system tremendously.  Why?  Because lower cost reduces the incentive for quality doctors.  The best doctors would be in highest demand and those who don’t want to sit on a waiting list would pay a premium.  In other words, the only people would would benefit from universal care would be the rich, those who could afford paying extra.

Don’t fall for the rhetoric:  universal health care is a bad idea.  Our health care system needs to be fixed, but instead of socializing the system, we should look to lessening the presence of insurance companies in health care decisions.  In my view, putting the cost decision in the hands of consumers is a good step.

A federal tax incentive for saving for health care would encourage saving for your needs.  Rather than forcing you and your employer to set aside over a thousand dollars per month for a family of 4 that is paid to an insurance carrier, how about saving it in a money market account?  Then if you don’t use it, it accumulates and if you live long and healthy, you have saved up a nice retirement supplemental fund.

Catastrophic care needs insurance.  However, the risk associated with this for those who are healthy are low, meaning low premiums.  For those with chronic ailments, I believe the taxpayers are willing to help expand the safety net for those who need it.  It will still cost less than covering everyone.

What do you think?  Do you think universal coverage is a good idea?  Please let me know why.  If not, please give me your opinions on an alternative to what I propose above.