It is easy to make money in the good times, but a new report emphasises that in worsening economic conditions law firms need to be as commercially efficient as possible, says Philip Hoult

One of the lessons of the recession of the early 1990s was that many firms failed to take action early enough to adapt to the worsening economic conditions.

So, was this message taken to heart by the latest generation of management? Judging by the findings of PricewaterhouseCoopers' (PwC) annual survey, 'Financial Management in Law Firms 2003', it would seem the answer is 'no' (see [2003] Gazette, 12 February, 3).

Reviewing the finances of 17 out of the top 25 firms and 47 of the top 100 for the 2002/2003 financial year, the report revealed a difficult trading environment.

Fees and partner earnings were 'under considerable pressure', it said, while profit margins were also 'much reduced, principally as a consequence of escalating staff costs and reduced recovery rates'.

The top 25 firms were particularly hard hit, with almost half reporting decreases in profits per partner.

Only 59% of the top 25 achieved increases in fees per partner, compared with 68% of the top 50 and 70% of the top 100.

Market conditions, and in particular depressed levels of transactional activity, created much of these pressures.

But the survey also suggests that firms were guilty of not doing all they could to meet this new challenge.

Of course, a sense of perspective is in order - the economic slowdown in 2002/2003 was nowhere near as sharp as the last recession and, looking objectively, firms continued to make sums undreamed of ten years ago.

Nevertheless, there is still the key issue of how well a firm is doing against its peers - if it loses ground to the firms against which it benchmarks itself, it could become increasingly vulnerable.

According to PwC partner Peter Buckle, professional firms need to manage their businesses more commercially.

'It is easy to make money in the good times,' he says.

'But when the bad times come along, how well placed are they culturally as well as organisationally?'

Despite the pressure on their margins and sharply rising professional indemnity insurance for most of the large practices, many firms chose to increase the size of their equity partnership in 2002/2003.

What is more, many anticipate a further enlargement this year, which suggests that internal pressures remain strong.

The PwC report also indicates that firms are failing to tackle staff costs generally.

Although many projected a reduction in their overall headcount in 2003/2004, significantly this was not true of the number of partners.

Another area where PwC argues firms could significantly improve their performance is in working capital management.

The report gives credit to firms for improving the timeliness of billing and taking steps to reduce the 'year-end billing bulge', but is critical of the length of time it takes them to get paid.

It took the top firms an average of 76 days to collect fees owed to them in 2003, while 84% of the top 100 took more than 60 days.

Firms may be trying to get tough, of course, but could be facing strong resistance from clients under their own financial pressures.

According to Mr Buckle, there are a number of steps firms can take as part of a more commercial approach.

These include taking the initiative about calling clients about payment and making an assessment of potential clients as to whether they are likely to be prompt payers.

'It is not something that comes easily to lawyers, but you need to put yourself on people's priority list for payment,' he says.

One firm that did take action in 2002/2003 was Addleshaw Booth & Co (as was), which asked 11 partners to leave - almost 10% of the partnership.

Although the move earned headlines such as 'The Addleshaw axe massacre', managing partner Mark Jones is convinced it was right and paved the way for the merger with City firm Theodore Goddard in May last year.

'We are now far more disciplined about issues such as partner promotions and budgetary disciplines,' he says.

The PwC report is not all bad news, however.

One bright spot is that the years of investment in overseas networks appear to be paying off.

In the previous year's survey, nearly two-thirds of the top 100 firms reported a decline in profitability in their overseas operations.

This year, the position is much improved, with 54% and 75% of firms claiming increases in profitability in western and eastern Europe respectively, although conditions remain tough in Asia and the US.

Management consultant David Temporal says that one of the challenges for firms has been to build up their overseas offices to the critical mass necessary to attract the right quality of high-end work in sufficient volume.

Firms have also been spending a significant amount of management time trying to ensure their networks work effectively together.

'The worst thing you can have is just a collection of local practices,' he says.

When it comes to 2003/2004, most firms remain pretty bullish, with nearly two-thirds (63%) of the top 25 saying they expect to increase profits per partner.

It may well be that a continued economic upturn, greater investor confidence in stock markets and a boost to mergers and acquisitions activity will justify that optimism.

Should the recovery turn out to be a false dawn, however, or events take a significant turn for the worse, firms could yet regret their failure to take decisive action sooner.

Tony Williams, founder of legal management consultancy Jomati, says there is a clear concern from the PwC report - and one that has carried on into this year - that firms have been relatively slow to address their cost base and issues surrounding fees and payment of bills.

'It is still patchy,' he says.

'There is considerable suspicion that firms are doing too little, too late.'