Law Firm Lessons of the Great Recession
By Edward Poll, April 2010
Whatever else can be said about the Great Recession of the past two years, it is unquestioned that law firms, like every other sector of the economy, have learned (or, more likely, re-learned) they cannot ignore the fundamental rules of business.
These rules are nowhere stated in the statute books, but they are unquestionably part of a lawyer’s responsibility. Chapter II of the CBA’s Code of Professional Conduct has extensive commentary on the lawyer’s “duty to be competent,” which contains this observation: “Competence involves more than an understanding of legal principles; it involves an adequate knowledge of the practice and procedures by which those principles can be effectively applied.
To accomplish this, the lawyer should keep abreast of developments in all areas in which the lawyer practises.” A good case can be made that understanding the business of law is a necessary part of “the practice and procedures” by which lawyers offer their professional services.
Lessons from the “School of Hard Knocks”
Staffing: Firms will no longer indiscriminately add lawyers. Already firm hiring out of even the most prestigious law schools has reversed the incremental increases of the past. Likewise, today’s troubles are driving many young or newly unemployed lawyers to smaller firms or their own practices, where lawyers are added seldom if at all. It’s unlikely they will want to go back to big firm practice, and equally unlikely that firms will want them back. The hiring lockstep will likely be frozen for years to come.
Lawyers definitely need better business sense because they begin practice behind the curve compared to other service
providers. Most lawyers still enter law school with an undergraduate degree in the liberal arts. Law school curricula have little business focus and many professors view the law as a profession in which any business training is trade-oriented and therefore inappropriate for law schools. This problem at the very start of a career is too often perpetuated throughout a lawyer’s lifetime by a lack of professional training in management and client service issues. Lawyers learn lessons in these areas from the “School of Hard Knocks,” and the recession has provided the equivalent of a graduate school course. These are some of the lessons that firms likely will carry into the future.
Compensation: Firms will no longer pay compensation out of scale with what clients will accept. A number of firms have already cut starting associate pay in conjunction with associate participation in training or apprenticeship programs for their first year or two. Similarly, million dollar partner compensation and $1,000 per hour billing rates established a “choke point” for corporate clients that likely will not be breached in the near term.
Strategy: Firms will not indiscriminately pursue mergers with each other. Combining law firms to make them bigger only makes them better when the parties have thought through what they want to accomplish and what synergies exist between them, and the evidence is mounting that few merged firms have done so. Because size inevitably creates inefficiencies, and firms are slow to eliminate redundancies, smaller, more adaptable and flexible law firms will increasingly leave the big dinosaurs in an uncomfortable position.
Billing: Firms will not automatically raise rates. The billable hour may not be dead, but alternative billing is here to stay. There is nothing magical about hourly rate alternatives – they all seek to achieve the same thing. Rather than setting price by a standard unit or result, billing alternatives focus on actions taken to benefit the client. Choosing the right alternative has become a business matter for both the firm and the client. The casualty in the process is unilateral rate increases by the firm.
Marketing: Firms will no longer just take whatever clients are available because trying to grow without a clear strategy is a recipe for disaster. For too many lawyers the idea of marketing is daunting because there are so many potential clients, so little time to reach them and so many options for pursuing them. Marketing can only be approached practically with a narrow focus that creates a profile of ideal clients and develops a strategy for communicating about one’s services and capabilities for this target, not everyone. It requires defining the location, demographics, occupation, financials and other characteristics of clients who will provide the most profitable and professionally desirable work.
Finance: Firms will no longer dismiss the importance or even the practicality of preparing a budget for a matter. Lawyers have previously believed that providing their services depends on too many unanticipated variables. They also too often don't want their quality of services to be constrained by budget limitations, or think the client will use the budget to seek a discount. These are myths. Budgets define successful business planning and any business (whether it sells widgets or legal services) can and should operate according to a budget. Client involvement in the cost equation is here to stay, and smart firms will involve their clients in the budgeting process, get formal approval of the completed budget, and communicate constantly about how expenses are tracking.
Technology: Firms will no longer view the computer as a threat to fees. Admittedly, technology is putting downward pressure on both costs and fees, and has made information about the practice of law widely available on the Internet. Clients are thus becoming more sophisticated and demanding, and less accepting of lawyers who tell clients what they must do rather than consult with clients on what they want to do. Law firms realize they should partner with their clients and show them how they use technology to reduce their legal costs by reducing the amount of necessary labor – without needing to reduce the lawyers’ per unit fees, but reducing the total legal cost to the client.
Facilities: Firms will not put such a premium on appearances. Wood paneling and oriental rugs do not a law firm make. Firms reviewing office space needs increasingly consider what they can afford, which features are most critical to operations, and what clients expect. With the virtual practice of law a viable option, physical locations become less important. Offices should be spaces that lawyers, clients and prospects are comfortable with, but affordability as well as comfort has gained equal prominence in more firms’ thinking.
Collections: Firms will no longer be banks for their clients. In today’s economy, more than ever, law firms should not be banks that carry their client’s expenses. Firm after firm has had to deal with financial crisis even as literally millions of dollars in receivables sit on their books. Stipulating payment rates and terms in the engagement agreement and then enforcing them is the best way for firms to survive a recession, and to prosper in an expansion.
Law and Business Management
These lessons do not constitute an exhaustive list, but they do have a comprehensive message. Like every other profession and trade and business, the practice of law is a business. That means law firms are governed by the same formula that defines all business success: P = R - E. Profit (take home pay) equals revenue collected less expenses. If you make widgets, the question becomes, “Can I sell enough widgets to cover all my costs and have something left over?” Replace “widgets” with “hours,” and you have the issue that goes to the heart of lessons learned in the Great Recession.
Poor business management has killed many law firms, large and small. Managing the flow of money is the number one consideration for a firm’s survival, and the recession lessons discussed here all directly or indirectly impact that management. Most lawyers, and even many large law firms, have in the past realized that they are in trouble only after the money ceases to come in the door. However, cash flow cessation is usually the last symptom of a downward spiral that started long before, with inattention to business. Lawyers, as owners of their firms, realize more than ever that they have a responsibility and commitment to the success of the firm.
Many large and even mid-sized law firms went their own merry ways for years, happily assuming that high associate salaries and partner draws, rising rates and the occasional leveraged merger with another firm was a pattern that would continue indefinitely. Now, crisis has forced law firms to sit up and pay attention. There’s no time like the present to begin. With every crisis there comes opportunity, and firms that have learned the lessons of the Great Recession will find the most opportunities in the post-recession world.
Edward Poll (email@example.com) is a certified management consultant and coach in Los Angeles who coaches attorneys and law firms on how to deliver their services more profitably. He is the author of Attorney and Law Firm Guide to the Business of Law: Planning and Operating for Survival and Growth, 2nd ed. (ABA, 2002), Collecting Your Fee: Getting Paid from Intake to Invoice (ABA, 2003), Selling Your Law Practice: The Profitable Exit Strategy (LawBiz, 2005) and, most recently, Growing Your Law Practice in Tough Times (West Pub. 2010).