Five Components Hampering Law Firms’ Profitability

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In today’s increasingly competitive market for legal services, most people would surely agree that profitability can no longer be taken for granted in any law firm. In addition, profitability ratios now vary more than ever as different firms adjust at different speeds to the new realities of the marketplace. What may have been tried and trusted processes in times past might just be the very same processes that are hindering profitability right now. Whilst most law firm partners and managers will be aware of the following issues, it never ceases to surprise me how few firms have the necessary management systems in place to effect real improvements in their bottom line.

1. Inefficient Process

Outdated working practices and inadequate IT systems can be a severe burden on the productivity of a law firm; a lack of delegation, process and, where appropriate automation, severely affects the gearing of the business, with highly qualified lawyers potentially wasting their time on repetitive tasks that require little legal skills.

Profit per partner can be directly reduced by the inability to leverage client relationships and legal skills to the full. Whilst not all legal work can be de-skilled, unbundled or process-driven, good process design and appropriate technology can provide financial benefits to all areas of law.

2. Lockup and Shortage of Working Capital

Whilst not necessarily affecting profitability per se (although a series of future interest rate rises may change that), a lack of working capital is often the reason given for lack of investment in improving the above shortcomings in the process.

For many law firms, huge amounts of working capital is locked up in WIP, unbilled disbursements and debtors. This represents a constant drain on the funding of day-to-day operations as well as reducing the capital available for investment. Firms which efficiently and effectively manage this locked up capital are able to reduce their overdraft and/or invest in improved process.

3. Fee Earner Utilisation 

The NatWest 2013 Financial Benchmarking Report revealed a 20% difference between the chargeable hours recorded by fee earners of the upper quartile law firms and the lower quartile. The average utilisation (chargeable hours as a proportion of working hours) across all firms was just 60%.

However, an increase of just one extra billed hour per week by 40 fee earners over 45 weeks could produce an increase in revenue of £255,000 per annum with zero additional cost. This is an area where any improvement goes directly to the firm’s bottom line.

4. Operating Costs

Reducing operating costs is an obvious route to improving profitability. However, managing the operating costs of a law firm (or any business) is not a one-off exercise; it is a process based on a continuous cycle of improvement. All costs should be constantly monitored and any potential changes should be made as soon as possible.

The results of those changes should be assessed, both in terms of financial impact and operational impact and then further adjustments considered. A continuous cycle of monitoring, amending and measuring is necessary to keep expenditure in an organisation firmly under control.

5. Poor Quality Management Information  

Each of the previous four issues that hamper a law firm’s profitability can be directly addressed in different ways, but in each case, the necessary change requires two basic management processes:

  1. the setting of targets for improvement; and
  2. monitoring progress towards those targets

Unfortunately, in my experience, the management information systems used by the majority of law firms are simply not up to this task. Often information required by decision-makers is delivered too slowly, or it is poorly presented and not easily understood. Very often these systems are little more than a set of Excel spreadsheets produced at significant expense on a once per month basis. This is surely not the optimal way to manage a modern law firm?

Law firms need a management system that provides timely information that is clearly presented and available at the click of a mouse. The Exen SmartEye management information system is specifically designed to not only assist firms in setting their targets and implementing the necessary changes, but also in measuring the immediate and long-term effectiveness of their implementation.

This blog post was written by Graham Moore, Managing Director of Exen.

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