PROFIT FOCUS
by Neil Oakes, FMRC Legal

Neil Oakes takes a snapshot of the 2007 legal profession from the findings of the 2007 Law Firm Performance Benchmarks.

He also promotes the 7 opportunities for lawyers to enhance their performance.

Profitability

Country practices tend to be efficient and profitable with the exception of South Australia where suburban practices are the most profitable.

Practices with 4 to 9 principals struggle to keep a high net profit and the biggest challenge facing small firms is improving their productivity.

Practices with more than 20 principals have the highest net profit at 34.21%. Generally the largest practices are most profitable because on average they record more hours, charge more per hour, realise more and are more effective at lock-up management.

There are five basic drivers of profitability, which we examine:
1. Leverage
2. Blended rate
3. Effective chargeable hours
4. Realisation
5. Total overheads

Leverage

In the simplest analysis, legal firms sell time. Staff leverage, which is the number of employed fee earners per equity principal, is critical to law firm profitability. These are the findings:
• Leverage in high profit firms tends to be at more than 4 employed fee earners per equity principal.
• 35% of firms have a leverage higher than 5.
• CBD practices tend to dominate in leverage regardless of State.
• Country and suburban practices struggle to secure strong leverage except in South Australia where country practices enjoy the best leverage.
• The best leverage numbers are found in single principal practices and in 10 - 20 principal practices.

Blended rate

Blended rate is price setting to ensure that you fully recover your cost of production. Proper pricing strategies will provide an environment where your practice will be fully and properly rewarded for work done by all fee earners.

The cost of production within your practice should underpin the price of your legal services. Therefore you should determine the cost of production by author type and add sufficient profit margin to this cost of production in order to generate the income your owners require. The findings show:
• CBD practices enjoy the highest blended rate in most States with the exception of South Australia where suburban practices have the highest rate.
• All firms with a blended rate of more than $350 per hour have a profit greater than 33%.
• As the number of principals in a practice increases, so does the charge out rate. Practices with more than 20 principals charge approximately $100 per hour more than any other range.

Effective chargeable hours

Your objective is to ensure that all fee earners are appropriately productive. As a general rule, the most profitable firms aim at a minimum of 1000 billable hours per fee earner per year.

It is critical that all authors receive an indication of what you consider to be acceptable performance. ‘Performance’ will involve both subjective and objective factors and would include measures such as chargeable hours, file throughput as well as quality issues. The findings show:
• Practices with fewer than 7 partners struggle to generate 1000 effective chargeable hours per principal. The largest practices generate over 1100 hours.
• CBD practices tend to dominate in leverage in all States except Tasmania where major regional practices are best.
• There is a positive correlation between effective chargeable hours and net profit – the more effective a firm is in billing chargeable hours, the more profitable it will be.
• 74% of equity partners record less than 1200 effective chargeable hours, 12% record more than 1440 effective chargeable hours.

Realisation

The primary production objective is to ensure that work done is recorded, billed and collected. The findings show:
• Country practices tend to dominate in realisation in NSW, Vic and QLD.
• Country practices in SA and NZ have the worst realisation results.
• The “2 to 3 principal practices” have the worst realisation rate and the largest practices have the best realisation.

Total overheads

Your objective is to ensure that practice costs yield an appropriate return on your investment. Country practices tend to dominate in expense management in NSW, Vic, QLD and NZ. SA practices are carrying high expense overheads.

Comparison between CBD, suburban and regional high profit firms in ‘07.

FMRC Legal ‘Law Firm Performance Benchmarks – 2007’. It is important to note that these are averages from the participating firms and not averages of the profession as a whole.

Comparison between work types of high profit firms in ‘07.

Opportunities for law firms

1. Life balance versus performance ethic

Motivating young lawyers to perform at best practice levels is a function of engagement. Modern employees will only work well if they want too. They need to be engaged by the matters that they are working on and the talent that they are working with, all the while maintaining a healthy work life balance. In short, get ready to pay more for less!

2. Generational skill sets

The management and motivation of talent will become a significant differentiator. Good firms will always earn solid profits beyond partner salaries through staff leverage. Attracting talent, retaining and compensating them won’t get easier.
Partners wishing to maintain success need to learn and practise new leadership skills, not the ones that they learned by being mistreated themselves. The old “it was good enough for us, it will do for them” approach won’t work with talented employees.

3. The boutique emerges as the norm

Clients want specialists, even in commodity areas. Having made a decision not to be a large, general service firm the question begs, “What do you want to be?”
I think that we will see a growing number of top profit firms being quite boutique. Within five years boutique providers will, most likely, make up the entire top quartile of the high-profit sample population in all FMRC Legal performance surveys. These firms will out-perform the generalists in many areas, most critically in client quality and talent attraction.

4. Good firms combat commoditisation with client intimacy

As clients become more sophisticated, perceived value is becoming more important than brand. Know and like your clients, become an expert in your client’s industry, their staff, suppliers and customers. Visit clients regularly and develop a keen awareness of the needs and wants of all critical individuals. It really isn’t that hard. It is currently a differentiator but will emerge as the norm.
The mid-tier firms of the Australian profession have experienced excitingly rapid growth in total fees billed and profit in the last two years. Much of this growth has come at the expense of the top tier firms. Another symptom is price fatigue. As a result we have seen the growth of in-sourcing of legal work by significant corporate clients. It is only a matter of time until smaller corporate firms and small to medium-sized enterprises catch the bug.

5. New ownership and wealth building opportunities

There are many reasons why modern firms should explore incorporation. By 2010 many successful legal firms will have diverse ownership. The value placed on these firms will be a function of profitability, systems and management quality, and to an extent client quality.

6. Knowledge management a major differentiator

Maintaining a high performance culture, quality and steep learning curves is all about the effective management of knowledge. Smaller and mid-sized legal firms are starting to manage this better.
Good knowledge management is much more than a technology challenge. To work well it must be cultural. Partners and senior lawyers must embrace knowledge-sharing and owners must be prepared to see learning and lawyer skill building as an opportunity not an expense.

7. Flexible working arrangements retain talented individuals

Our analysis of the composition of solicitors in NSW confirms an increase in the number of women in the profession:  The necessity to introduce more flexible working arrangements to retain talented individuals is likely to see the trend toward women dominating the profession gain momentum.

By 2010, firm size (lawyer numbers and gross fees billed) will be less important to the maintenance of profitability than flexibility, quality, leadership and client intimacy. Good firms should ready themselves now.