Law Firms Must Focus on Profits, Not Revenues

Law Firms Must Focus on Profits, Not Revenues

By Keith Lipman, President of Prosperoware

The recent Buying Legal Council’s Managing (Supplier) Relationships Conference in New York brought together legal procurement and operations professionals, in-house counsel, private practice lawyers, technologists, consultants and law firm executives to discuss one thing:  how to best manage legal spend. There were many compelling arguments concerning the definition of the word ‘best,’ most of which danced around an equally slippery term, ‘value.’

There was, let’s say, a spectrum of opinions and a buffet of relationship metaphors in attempts to flesh out ‘value’, including a memorable comparison of the dating app, Tinder, to the sentiment felt by some law firms regarding the influx of procurement professionals in the sourcing process of legal services.

The reason for this is that problem of value is complex — and the subsequent changes which are now evolving and will continue to evolve in the law firm business model, uncomfortable.

This is all because clients have reduced their demand for legal services from law firms and are choosing to increase internal staff instead.  Over three years ago, now, pharmaceutical giant, GlaxoSmithKline, announced the results of their new approach to procuring outside legal counsel — replacing relationship-based selection and law firms’ traditional time-based billing with data-driven decision making and an online reverse auction led by procurement professionals — creating a trend and shocking the system.

All these changes in the legal industry have put law firm partners in an uncomfortable position. Traditionally, partners have had little need to focus on negotiating fees for their services, creating budgets, or making sure their team delivered services efficiently, nor were they concerned about drawing a profit on their work.  The end result, however, can be summarized thusly: value in service delivery is no longer contained within legal expertise — legal expertise is only a piece of it.

The slippery problem of value means, amongst many things, that firms will need to evolve their business model fundamentally away from the traditional, revenue culture to a profit culture; as well, staffing models will need to shift, placing law firm administrators in front-line negotiating positions with their business counterparts within the legal department.

In a revenue culture, any amount of revenue is considered good. In a profit culture, only matters that actually return a profit are considered acceptable. To achieve this, a firm must comprehensively understand its costs: resourcing, who is working, how much the firm is leveraged, what the margin is as well as, importantly, what bottom of the bill discounts are, or will be, applied.

Creating a profit culture is probably the most difficult part of the business model transition. The end goal of this transition is to have partner compensation driven by profit instead of revenue. The traditional partner compensation model is focused on revenue and realization, where realization has been the traditional measure of matter health. Realization is basically an inverse measure of discount: A 20 percent discount equals 80 percent realization. A matter with low realization and high leverage (ratio of partners to non-partners) is likely still profitable compared to matters with high realization and low leverage.

When building towards a profit culture, the firm needs to determine a model that will calculate a cost per hour. There are two elements for determining the direct cost of timekeepers/fee earners (salary plus benefits and taxes) as well as the distribution of the overhead to each timekeeper. Typically, overhead is divided across four dimensions: (1) firm level (such as IT and administration) (2) office level (rent) (3) department (assigned staffing) and (4) fee earners (miscellaneous charges).

Clearly, the problem of value also means firms will need to evolve their staffing model. As the business model evolves and procurement paves the path, the business people associated with the client want to speak with the speak business people associated with the law firms.

Lawyers need to be surrounded by a set of expert business people, including experts in pricing and scoping matters, experts in reducing the cost of the delivery of services, and those experts who can help the lawyers more effectively sell their services.   These new roles are given the titles of pricing, LPM, knowledge management, and business development. These experts enable lawyers to focus on delivering the right service for the right problem. Each of these experts, integrated into the staffing model, will be critical to help firms evolve their business model to a profit culture — and deliver on the other aspects of value outside of expertise.

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