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The Fixed Costs Issue


As we have argued many times in the past, law firms are predominantly fixed cost operations – the consequence of which is that the break-even point for most firms is high, and in uncertain times this saddles the partners with a high level of risk. If revenues are not consistently high, the prospect of reduced drawings for the partners and even losses for the firm becomes very real. The watchword here is flexibility; if firms are to maintain healthy profits in unpredictable markets, fixed costs must be made variable wherever possible.

When we drill down a bit further into the detail, it is clear that a number of the major categories of costs that a law firm must bear – including premises, IT and insurance – are often fixed in the longer term. However, the ‘people’ side of the cost structure (including both fee earners and support staff) are short-medium term fixed costs. (There is flexibility in the shorter term with partners’ drawings, but that is not something most partners would want to reduce!). There is also generally very little scope for delaying outgoings.

Weighing the Options

Even in those firms where there is a genuine desire to get a handle on the costs issue and to introduce more flexibility to the cost structure, in the short term (say, 3 months) the options are very limited.

Over a slightly longer time frame (6 months), firms have more options available to them but these may in fact require a certain level of investment, such as in technology to improve processes and reduce reliance on the people/time factor. These options can include moving to cloud services as a substitute for hardware, and employing software as a service.

In the long-term (12-18 months and beyond), it is possible to implement transformation of the firm’s cost structure, to introduce a far higher level of variability. This is an issue to which we will return in future months, but the scope is there to achieve reductions in costs of 20% and more, where there is both the resolve and the know-how to go about such a cost-reduction programme.

Focus on the People

Options here include renegotiation of property leases to include break clauses, and even in some instances relocation of some or all of the business to lower-cost locations. However, the major part of any cost-reduction initiative must, unfortunately, focus on the major part of the firm’s cost structure – the people. Employment packages and remuneration can be structured so as to introduce flexibility, and staff can be cross-trained so that a reduced workload in one area does not necessarily leave people underemployed, but the biggest potential for transformation lies in outsourcing. Both legal process outsourcing and business process outsourcing are becoming more widespread, and this is an area in which firms could find themselves left behind very quickly if serious consideration is not given to the options.

The number of reports of firms encountering financial difficulty seem to be multiplying, but for those partners who take this issue seriously and are prepared to embark on a process of change, the opportunity to forge a leaner, more sustainable business should not be ignored. 

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