With an uncertain economic climate, law firms need to ensure that they take all necessary steps to maintain their profitability. Roger Zair and Peter Gamson look at what can be done




It is the middle of the hurricane season, summer holidays are a distant memory and we are in the middle of a credit squeeze – the fall-out from which is proving to be spectacular for those involved in the financial services industry.



In the last year alone, according to reports, the UK’s largest 100 law firms collected £12 billion in fees, and the first six months of 2007 exceeded the total figure for mergers and acquisitions activity in 2006. Yet for law firms which have generated significant fees from the halcyon days of corporate activity, and also for those firms which face the housing market, the party is now quietening down. Instead they will be battening down the hatches and focusing on how they can ride out what has become an unpredictable market, which could easily lead to a downturn in firms’ profitability.

In this article we explore what will be going on in the boardrooms of successful law firms, and what measures finance directors will be taking to maximise profit levels over the coming 12 months.



What is it all about?

So why is profit so important? The obvious answer is that profit sustains a business. Unless a law firm is profitable, it will not attract the people it needs and therefore will not survive. At a conceptual level, profit highlights how well a business is doing its job and, ultimately, it is the best measure (to date) of a business’s success that anyone has come up with. In the end, a successful law firm requires its clients to be satisfied.



Broadly speaking, actions for profitability improvement (and therefore client satisfaction) can be broken down into two categories – those that focus on the people management side of the business and those that focus on the financial side. Each is equally important to the profit equation, but contribute in different ways. Get both right and you are on to a winner – get them both wrong, and your business is likely to feature in the history books, but for all the wrong reasons.



So if profitability is a consequence of happy clients and happy people, what can be done to ensure that both are in fact happy?



People management

If you ask any business what gives them a competitive advantage over key contenders in the industry, the majority will say it is their people. Yet this is the very issue that keeps practice heads awake at night, worrying about how they can retain the employees they have, and how to attract the best people in the future.



Given that people are a firm’s largest expense, it is essential that issues related to recruitment and retention are resolved, because if your biggest asset walks out the door tomorrow, then as a business, you are faced with a big problem. So where do you start?



By stepping back and taking a ‘helicopter view’ of your business, it allows you to assess where you want the business to be in the future and the most efficient and effective way to get there. Often it helps to involve someone from outside the businesses because they can be far more objective in helping you look at the key strengths and weaknesses of the business.



Some key questions that should be considered include: Is your staff turnover unusually high? Are your staff stressed beyond the ‘norm’ for the legal industry? Are your reward strategies closely aligned with your business objectives? Lastly, consider solving the million-dollar question: what it is that clients want and how can employees help achieve this?



Recruitment and retention

It is worth benchmarking how your business compares with your competitors and with the legal industry as a whole – this will give you a feel for where you stand. If turnover is particularly high, then it is likely that this highlights a number of issues, with the most obvious being unhappy staff.



In addition, it is likely that you will be paying recruitment agencies (and head hunters) significant figures to help you recruit replacement staff. Reducing ‘churn’ within the business is an excellent way to instantly save your firm significant sums.



Working closely with HR to conduct exit interviews may be one way to find out why staff are unhappy, why they are leaving and what could be done to improve working conditions. In addition, many firms offer a recruitment bounty to staff if they recruit a new employee who stays for a certain period of time. This can help to increase loyalty, improve motivation and over time turn the firm into a great place to work.



Closely linked to turnover may be stress. While stress and the legal industry are age-old companions, the best firms will be doing their utmost to ensure staff stress levels are not unacceptably high. Offering solutions such as flexi-time, the purchase of additional holiday entitlement or even on-site stress reduction massages all go some way to addressing this.



It is also important to ensure workloads are managed effectively and that a culture is created which allows people to express how they are coping – or not. Staff who have lower stress levels are more productive and are less likely to leave a firm because they are unhappy.



Reward strategies

When it comes to performance indicators, it is important to avoid the mistake of applying a ‘one size fits all’ approach that gets very little response from employees. Identifying the objectives for each employee group, and their current responsibilities and reward structures, and then working to align their reward structure with the business’s strategic objectives usually elicits the best response from employees.



To do this you need to clarify what your business objectives are and then the best reward structure to help achieve them. It is worth considering what your competitors offer, to assist you in making an informed choice.



When it comes to making changes to reward strategies, the most successful firms believe that communication is key – from finding out what employees value in terms of reward options to implementing a new structure and getting employee buy-in.



Any new scheme should aim to appropriately incentivise staff to succeed and it should match the direction in which you wish to take the business – that is, increased long-term growth.



Once finely tuned, a specialised reward package for staff, based on their role, performance indicators, individual objectives and the business’s goals will be more effective in reducing turnover than a general pay increase or extra fringe benefits, which may not carry any weight with employees.



To achieve this, it is essential that senior HR staff are involved in top-level management discussions from the outset, because they can be invaluable when it comes to knowing what staff want.



What do clients want?

The most successful firms continually seek client feedback to understand what their clients want. There are significant changes occurring in the legal world, and client needs are evolving at an equal pace.



Developing a strong commercial culture is something that clients are now demanding. Just being a good lawyer is no longer enough – clients want a law firm that can demonstrate the ability to understand the strategic objectives of their business and lawyers who can act in a commercially sensitive manner. Acting in this manner demonstrates an understanding of the clients’ business and in effect demonstrates that law firms are willing to get close to their clients, and, in turn, allowing clients to get closer to their lawyers.



It is also essential that costs are managed. While cost is an issue that constantly arises when it comes to client relationship handling, clients do not like surprises when it comes to paying the bill. Effective communication between the client service team and the client can address this issue.



Financial management

As competition within the legal industry continues to be intense, successful financial management is an essential tool when it comes to profit levels. Finance directors will be looking closely at issues surrounding profitability analysis, working capital improvements, cost reduction, and providing a wider range of services and fees.



Profitability analysis

Successful financial management can help identify which practice areas or service lines within the firm are the most profitable and where resources should (or should not) be allocated. For many firms the most obviously successful areas will fall into corporate and commercial.



However, the key issue is not just determining which are the most ‘successful’ areas, but distinguishing between billing and profitability. It is often assumed that a large fee is a profitable fee, but this may not be the case. Furthermore, many firms have not identified what areas of their practice are insufficiently profitable to sustain the business. Undertaking such an exercise will allow firms to ascertain what practice areas are driving the business forward, where investment should be made and where it may be time to exit some sectors.



Working capital improvements

The accounting standard UITF 40 provides an excellent rationale for timely billing. This encourages business-like attitudes in staff, therefore helping to develop a strong commercial culture. Timely billing should improve cash flow and reduce borrowing levels, but perhaps most of all, it encourages good communication between a firm and its client, enabling service delivery issues to be identified quickly.



Cost reduction

To sustain profit levels, it is essential to review the expenditure budgets and undertake a cost-review benchmarking programme. This can involve reducing costs through carefully reviewing all areas and may result in alternative suppliers or better allocation of resources across the firm.



Firms have become much more sensitive to market conditions and staff cutbacks are often made quickly if the future is looking uncertain. Cutting staff numbers and reducing overheads is a strategy which requires careful consideration – when the future begins to look more positive, the expensive process of rehiring begins again. This process is neither efficient nor improves profitability in the long run. It indicates that a business is addressing the short term, rather than focusing on longer-term goals and what it takes to be successful in the market.



Wide range of services

All law firms believe they can do more for their clients than they currently accomplish. If you can interest a client in buying further services from you, this is a good means of maximising profits.



In theory this is an easy concept, but in reality it is much more difficult. Why? Because client/adviser relationships are built on trust, a level of trust which has been built up over time through demonstration of knowledge levels. When talking to clients about areas which are outside your immediate knowledge, this will be demonstrated through your body language and vocabulary.



Therefore, when trying to offer clients a wider range of services than you currently provide, the first step is to know what your client wants and the second is to either build up your own knowledge levels or broaden the delivery team to ensure you can demonstrate such knowledge.



The best fee is a fair fee

While billing optimisation is one way of driving profits, clients have a sense of what a fair fee looks like and what the ‘market rate’ is considered to be. Clients also have a view of when their law firm has done a good (or bad) job for them and hence all of these factors need to be considered before a fee is rendered.



When assessing billing levels, any approach needs to take into account ‘what good looks like’. If the firm has performed some excellent work, then ask the client to recognise that by accepting a higher fee. However, if the firm has performed poorly, then expect a challenge.



Finally, the key is timely communication – all fee-earners must communicate effectively to ensure that there are no surprises when it comes to presenting the client with their bill.



Conclusion

Profitability is the output of a flourishing firm. It is the product of successful inputs – good people management, great client service, and focused financial control. Addressing the issues that underpin these inputs will lead to a greater probability of sustained profitability.



Roger Zair is head of Grant Thornton’s professional practices group and Peter Gamson is head of its London professional practices group