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Having last month reviewed our 2011 report Beyond ABS: The Future for Independent Law Firms, we now turn to a recent report by Alan Hodgart of Hodgart Associates, considering the Key Challenges Facing the UK Legal Market in the coming years. The analysis is, as ever, insightful and recognises a number of key trends that we have ourselves identified and considered to be pertinent to UK law firms for some time.

Market Segmentation

Four key market segments are identified, all of which are likely to be subject to pressures for change – albeit differing in scale and nature.

The Global Elite – the Magic Circle and a number of high-profile American firms.

Business Law firms – which are further segmented into International Business Law firms (operating globally and just below the elite level); London Business Law firms (with similar clients and work types to their international counterparts, but with a London focus); National Business Law firms (usually broad corporate/commercial firms headquartered outside London and with nationwide coverage); and Regional Business Law firms (competing as leaders within a specific region, often forced by market realities to adopt a focus on a particular type of work).

Retail Law firms – mainly focusing on private clients and small businesses, either on the High Street or in areas such as Personal Injury.

Specialist Focus Law firms – niche and boutique firms, specialising in a very narrow part of the market.

There is, of course, a further segment – the generalist or ‘full service’ firms that lack a focus on a particular section of the market. These are identified, however, as having an economic structure that makes them “too expensive to win lower value work, and they often lack the capability and reputation to win higher value work.”

Squeezed in the Middle

This description of the market mirrors our own analysis, that the forces shaping the profession would squeeze the general, mid-market firm both from above (the high-value business law firms) and from below (retail firms), forcing those firms trapped in the middle to follow one of two paths – increasing specialisation, or consolidation at regional or national level.

Hodgart indeed goes on to describe this trend, pointing out that “the number of practices with five partners or fewer fell by 2% in 2012, whereas there was a 5.3 per cent increase in the number of firms with five to ten partners, further increases in those with 11 to 80 partners and a 16 per cent increase in the number of firms with 81 or more partners.”

The data suggests that a significant number of smaller firms are disappearing, with their partners joining more specialist SME practices or larger regional/national rivals.

The conclusion to which we return is that increasing specialisation in the mid-market is likely to breed greater profitability, as firms jettison clients, partners and entire practices that are unprofitable and take up management time and resource. Achieving this will involve some very difficult decisions within the partnership, but could be essential for future success and longevity.

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. 

The legal sector was historically regarded as being low-risk and high-value, and was therefore an extremely attractive lending proposition for bankers. However, this has not been the case for five years now – and in a number of cases, firms have been slow to realise the implications.

As lending to law firms is no longer seen as low-risk and high-return, firms need to make sure that they have resources of their own and that they are no longer reliant on significant amounts of borrowed money relative to the firm’s equity.

This means both making sure that there is capital subscribed by the partners, and that the partnership has considered the possibility of external investment – even if the decision is ultimately not to change the ownership structure.

The long-term culture of profit extraction that still characterises the profession means many firms lack a buffer for a rainy day, but they also do not have the resources available to fund expansion. In an intensely competitive market, with new entrants and changing management and funding structures emerging, having those resources on hand for investments that will reduce costs and improve the client experience will be an important characteristic of the firms that will survive and maintain their independence (or attract investment).

Focus on Cash Flow

Firms must develop an absolutely relentless focus on cash flow and cash generation, to create sufficient balance sheet strength to fund growth. This is not a good time to be relying largely on debt to fund the future.

The first action should be to ensure that all partners are aware of the cash flow imperative, and to make sure that partner and fee earner standards include measures that will improve cash flow.

Those standards should not be limited to chargeable hours, but should also include aged WIP and debtors, and rewards should be linked to the level of lockup by fee-earner, department and, ultimately, across the firm.

Strengthening the Balance Sheet

Cash flow can be greatly improved in a short period of time through such a dedicated lockup reduction programme, and this will strengthen the balance sheet – an important factor in any potential investment decision.

It should also be recognised that different work types have different cash flow profiles – Personal Injury and Clinical Negligence will take much longer from instruction to cash than Conveyancing or Company Commercial work.

Billing processes and standards should reflect cash flow profiles, so that upfront billing and interim billing are used where appropriate, but ultimately the firm must be absolutely sure that it can fund its work, through a healthy mix of debt and equity. 

In our previous article, The Three Forces and Profitable Partnerships, we outlined the threats that confront law firm managers, and suggested that a new approach to client acquisition and retention is required.

However, this is not an easy shift to make – if it were, all law firms and lawyers would be taking this approach already. One of the key obstacles to success is that the value to the client often remains hidden, and therefore actually closing sales is extremely difficult. On the first day of the Profitable Partnerships Programme, we focus on uncovering and demonstrating value, and overcoming objections from potential clients.

Focus on Value

Many lawyers struggle when talking about value, as for them the value in a case lies in the technical interpretation of the law. However, this is a statement about content – and for most clients, the value lies in the context of the work. Rather than describing technical competency, which should be a necessary condition for hiring a solicitor, lawyers should focus on the tangible benefits they can bring, such as the extra cash winning a case may generate, or the peace of mind of a swift and amicable resolution.

The key thing is to understand what the client values, and to frame the conversation in terms of the specific value for that individual or company. When the client perceives that their needs are prioritised, they are much more likely to engage the services of a professional.

Value in a Niche

It is far simpler to demonstrate the value of your services to potential clients when you operate in a niche. Developing a reputation as a niche specialist reverses the normal selling process, and encourages clients to seek out the services of a specific individual or team – rather than the individual constantly searching for new sources of work. The client will already have some knowledge of the individual’s technical abilities, and the focus on the value to them will be all the more welcome.

Operating in a niche means that alliances can be developed, contact can be more easily and systematically maintained, and introductions and referrals can be cultivated. Right from the outset we deal with these very issues, looking at practical ways to carve out a reputation and develop a sustainable flow of new work, maintained in a systematic way.

To find out more about the Profitable Partnerships Programme, click here or email info@wilkinsonread.co.uk.

In an economy that promises to be ‘choppy’ for some time to come, and in a legal sector where ‘choppy’ would be an optimistic description of the outlook, managers could do worse than to focus on law firm profitability.

Strategy and Law Firm Profitability

It is true that a hallmark of the profession over the years has been the emphasis on profit per equity partner, almost to the exclusion of any other measure. League tables have driven this approach, and figures have often been ‘massaged’ in light of their powerful role as a marketing and recruitment tool. This has indeed diverted attention from measures that could be of greater use to management teams, such as the firm’s cash position.

However, profitability is still an extremely important measure for law firm managers, and when used in the right way should underpin the firm’s competitive strategy.

Law Economics versus Law Politics

In even the most successful partnerships, politics has traditionally been the determining factor in strategic decisions and their implementation. Firms can no longer afford to allow law politics to defeat law economics. To be successful, the partnership must be united and divisive figures should be dealt with. This may be the best opportunity the firm will get to restructure and create a harmonious partnership (if one did not exist in the first place…).

Legal Cost Structures

Achieving optimum law firm profitability requires optimal legal cost structures – and this is no simple matter. Law firms have always been described as ‘fixed cost operations’, and to an extent this limits the scope for change. However, certain costs can be made more variable, using arrangements such as part-time working, paralegals and contract solicitors, and outsourcing (IT is the prime example, but more and more services are becoming susceptible to outsourced delivery, and make or buy decisions are an important consideration for managers).

Ultimately, any law firm’s cost structure will be defined by its people, and therefore any major restructuring must focus on people. This may be painful, but it should also be fair – and fair does not mean equal. Some departments, teams or support functions may need to be cut back, whereas others may require investment. Focusing on profitability means identifying and realising potential, whether this requires investment, divestment or scaling back.

Successful Partnerships

Although managers and partners may feel that the worst is now over, the partnerships that will succeed in a challenging environment will be those with a relentless drive towards efficiency. Whatever the approach, law firm strategy should be driven by a clear focus on profitability.
 

We discussed this issue back in September and, looking at the discussion going on over on LinkedIn, it seems as though the debate isn’t going to abate.

The American author Ron Baker has written at least five books on the subject of pricing – although you don’t need to read every word of every book. He demonstrates that you can make real money out of fixed prices if you take the trouble to know the client, and to set up the pricing conversation properly. This is a question of demonstrating value to individual clients.

We personally know an accountant who runs a small (4 fee earner) firm doing largely one-off project work who claims that by using these pricing techniques he has earned over £1million in additional fees over the past 5 years – compared to his standard hourly charges. I have no reason to disbelieve him.

Can it be done in legal work? In many cases, the answer is yes. But it is not as simple as thinking up a number and sticking to it. And sadly, many lawyers (encouraged by their performance measurement systems) are unwilling to put in the upfront effort, either in learning the techniques or getting to know the clients.

In work where the price is externally determined, the focus has to be on identifying and improving cost of production. This will be the focus of an article we have appearing in the Gazette’s In Business section in the spring. Any thoughts would be much appreciated.

We have had quite a bit of demand recently for more information on our bespoke services. This post is a case study illustrating how we would tailor our consultancy services to our clients’ specific requirements. And how the “obvious” answer is not always the right answer!

The client is a high street firm, with the old three-legged stool mix of Conveyancing, Legal Aid and General Private Client work. We were asked to help following a difficult period of more than two years. One of the founders had retired and not been adequately replaced. The Legal Aid departments in particular, had become very busy but had not been managed.

Matter starts were plentiful – but not all matters were being progressed satisfactorily to completion – and the Legal Services Commission had inadvertently overpaid the firm and wanted its money back – which was not available.

At the time we became involved, the firm was not profitable, not generating cash, was losing good people and, in some areas, was losing its reputation.

We did our initial analysis, but in this case extended it and interviewed around far more people than usual – not just partners and fee earners. We had to find out WHY things were so awry. We identified over 50 action points, grouped under key headings, including:

Financial management
Management of the partnership
People issues
IT
Negotiations with creditors

Our ratio analysis showed that the most important underlying issue was people performance – too many people producing not enough output.

The obvious remedy was to cut back and institute immediate staff cost savings. However, we had identified that previous cutbacks had caused much of the problem. Low profitability had led to low salary reviews and non-replacement of good people who understandably left.

So we did the exact opposite of the obvious. We put in place a very, very focused programme of file completion, billing and collection. This not only generated the cash to satisfy the lenders but also meant that the remaining good staff could be paid more. Those staff not up to scratch were replaced with better, albeit in some cases more expensive, staff.

What we did was to turn a vicious cycle of decline into a virtuous cycle of recovery.

We persuaded the individual partners to take responsibility for specific aspects of the recovery programme. One of the partners, despite a lack of accountancy training, successfully took responsibility (with our help) for hands-on management of the finances.

Within a relatively short period of time, all the creditors had been paid in full and the firm’s overdraft is well within manageable levels. Its reputation has been recovered, and in some areas the firm is continuing to grow and take on significant new clients.

If you would like to see more case study examples, please click here.

How ambitious is your firm? Are you happy to perform in line with the benchmarks for your peers; are you aiming higher; or is money in fact not your primary purpose? If not, what motivates you?

An analogy may be instructive. In his book Winning, Clive Woodward explains that there are three “levels” in sport – Recreational, Competitive, and Elite. The same game and often the same innate ability, but very different outlooks, lead to very different results.

More than a Vocation?

I see an equivalent analogy for Law Firms. At one end we have the Vocational – lawyers who espouse a cause or look for intellectual satisfaction in their work. Much social law falls into this category. Success is not measured by money! At the other end of the spectrum is the purely commercial or even “Corporate” firm, for whom money is the only thing that matters. In between we have the traditional Professional, for whom the money matters but it is not the only or even the most important thing. Professional recognition, status in the community and long-standing client relationships may matter equally as much. We can add other categories to fill in the spectrum, such as “lifestyle”.

The crucial point is that the underlying purpose or ethos of each firm drives the decisions it takes – and in particular, how it treats people. This includes staff, clients and even partners. After the crash, rather than lose loyal staff, partners in many of the traditional Professional firms accepted lower profits. This could not happen in the “Corporate” firms. Many traditional professionals look askance at the “corporate” firms as being unpleasant and excessively pressurised. If you can earn five times the national average income (which is the benchmark for 5 to 10 partner firms), is the extra money worth the hassle?

The Advent of ABS

Unfortunately, the Legal Market has moved on. The advent of ABS and the entry of businesses whose sole purpose is to make money has tilted the balance. These firms have said, in effect, “if you can make that much without being money-oriented, just think how much you can make if you really focus on it – way Beyond Benchmarks!”

The competition is not just for clients. It is even more intense for staff, and particularly young qualified solicitors who are so scarce because of the hiatus in recruitment and training following the crash. The highly profitable commercially funded new entrants are using their financial clout to drive up salaries and attract the best staff from traditional firms. They don’t offer partnership, but many Generation X and Y lawyers are not attracted to partnership in any case; they are quite happy with a better salary and growth prospects.

How can you respond and compete? You to have to go beyond the current benchmarks so that you can offer a package of prospects and salary that appeal to the younger solicitors. This means looking closely at the competition, seeing what they do well, and adapting it to your environment and ethos. You certainly do not have to adopt the more unpleasant attitudes, which may produce results in the short term but are not always sustainable.

Key Differentiators

We have had the pleasure (?) of seeing several of the newcomers at close quarters over the past year and seeing how they achieve their results. We have drawn two main conclusions. Firstly, as David Maister said in Strategy and the Fat Smoker, everybody knows what to do (i.e. chargeable hours, billing and lock-up), but we don’t all do it. The newcomers DO it, their focus is relentless. Secondly, they use a variety of financial management techniques that have been around (and I have been using) for over 20 years, but have not taken root in the legal sector.

The big lesson is that getting results well Beyond Benchmarks does not require brute force or unpleasantness. It does, however, require skill, habit, self-discipline and a mindset that recognises that commercial performance is part of being a professional (the opposite being amateur?). Furthermore, it does mean challenging the way we have always done things. But there are plenty of opportunities! In a recent Beyond Benchmarking Workshop for Managing Partners and Finance Directors we generated over 150 performance improvement ideas in a matter of minutes. Some were implemented the very next day!

One of the impacts of opening up markets is to increase the level of competition – and the only way that markets know how to define success is in monetary terms. As a result, there will be a widening gap between winners and losers (it is already happening). Benchmark performance may mean being left behind. Don’t allow this to happen, aim higher, Beyond Benchmarks!

As we have argued in this article, the market segmentation described by Alan Hodgart is likely to lead many mid-market firms to follow one of two routes – growth via merger/acquisition, or increased specialisation and the divestment of services that do not align with the firm’s core expertise. One consequence of this – and this is something we have advocated for some time – is the need to be more strategic in the selection of clients with whom the firm chooses to do business. Know your ‘ideal client’ and focus on serving their needs.

The evidence presented by Hodgart suggests that “the more sophisticated clients increasingly see many firms as having real strength only in a few areas and not across a wide range of practices.” The result of this is that firms have practices and clients that underperform financially, and indeed at times we have seen examples of practices being cross-subsidised by more profitable areas of the firm.

Client Selection and the Bottom Line

This demonstrates that client selection is more than a matter of strategy and business development – it is a key determinant of profitability and overall financial performance. Many firms, especially those in the mid-tier, maintain relationships with clients who are neither profitable nor a strategic ‘fit’ for the firm’s core business, because they fear that if they cannot offer services across the board then this will lose them business (and therefore money).

In fact, the opposite is often true. Clients very often buy only in those areas in which they perceive the firm to be strong, and retaining underperforming practices can indeed dilute the firm’s brand. Moreover, time and resources are spent on non-core clients, consequently limiting partners’ opportunities to focus on their core clients and develop their practices.

Strategic Choices

We have written before about the value of categorising clients, and of effectively ending the relationship with those clients who are not profitable and can even be a drain on the firm’s resources. This is as much a matter of prudence as it is of strategy, but firms must increasingly be looking to be more strategic in the selection of clients – and this comes back to the services the firm offers and the practices it chooses to retain.

These are not easy choices, especially when divestment of practice areas inevitably means that some partners (and other fee earners) will have to leave the firm. However, in the medium-term the choice is likely to be one of growth or specialisation – and for those firms for whom growth is not a viable option, specialisation will inevitably mean losing non-core clients and, ultimately, losing non-core practices.

It will be better for firms to make the choices proactively rather than have the decision made for them by defecting clients and talent.

Our approach to sustainable business development has for several years encompassed a six-part strategy involving:

• Repeat business from existing clients;
• Referrals from existing clients to their contacts;
• Strategic alliances with other professionals in allied fields;
• Networking in the local professional community to find new potential allies and sources of introduction;
• Keep-in-touch programs to ensure all of the above remain aware of our presence; and
• Showcase – all the publicity materials, including website, seminars, articles, publications, etc. that bring you to the attention of the relevant market.

Repeat, Referral or Recommendation

At a recent law management section seminar I chaired at Chancery Lane, David Gilroy of Conscious Solutions delivered a very interesting speech on this subject, in which he identified that amongst their client base (over 200 law firms) the overwhelming majority of incoming work came, in essence, from three sources. He said that 92% of incoming work came from Repeat, Referral or Recommendation.

This fits very closely with our view that the first three sources in the list above produce the major part of the new work (terms of both quantity and quality) coming into practices – and that “your next piece of work is likely to come from someone who knows you, or someone who knows someone who knows you”.

So, in a recent speech to a group of specialist niche practitioners, I focused more closely on the top three issues – repeat work, referrals and strategic alliances – but christened them “the 3R’s of Legal Business Development” – i.e. Repeat, Referral and Recommendation. In the follow up questions this simple piece of phraseology seemed to have caught the mind of the audience more than any other single aspect.

Asking the Question

We often find in interviewing clients they say that the best work comes by the recommendation route – either from satisfied clients, or from other professionals. However, when we ask the supplementary question “how often do you ask your clients for a referral?” the answer is usually “very rarely”. Even when we ask “how often do you ask other professionals to recommend you?” the answer is “rarely more often”.

As the Americans would say, “every time you don’t ask, you don’t get” – so learning to ask constructively for more work from existing clients or close contacts is one of the most important skills for any lawyer. After all, as 92% of your work is likely to come from these sources, learning to do this simple thing well will put you ahead of your competitors.