“If you focus on delivering good services at reasonable prices, people will still come. Of course, with a recession, you might see a downtick in revenue, but it doesn’t necessarily mean that it has to be the end of your law firm. Ultimately, if you’re passionate about what you do and you offer good products or services, I don’t think a recession is anything to be too worried about.”
Regardless of the area of practice, all law firms tend to have one thing in common: they wish to be profitable! And the path to firm profitability has traditionally been by way of taking on as many clients as possible and, when necessary, raising hourly rates.
But what happens when the client roster is full, business is booming, and rates have increased, yet, profitability is suffering? It is under those circumstances that it becomes time to examine the other side of the profit equation: the expense side. Especially now, during times of inflation, law firms must put in place mechanisms to reduce overhead without adversely impacting the provision of professional-level legal services.
Defining Firm Overhead
A quick survey of law firm overhead expenses basically reveals that the term is a very broad one that encompasses such necessary operations items as rent, technology, utilities, furniture, equipment, supplies, and an array of non-lawyer salaries such as those of secretaries, paralegals, and other support staff. Lawyers’ salaries themselves are, naturally, excluded from the overhead accounting. Yet, all of these expenses can and do affect firm profitability and, subsequently, lawyer take-home salary, with most estimates calculating overhead expenses at between 45% to 50% of a firm’s gross revenues.
A look at how overhead is spread among the various operating expenses can be a first step to reining in those expenses. For example, the cost of upfront tech equipment, software, and installation can typically eat up 4% of overhead; however, the silver lining is that tech outlay has a relatively long shelf life, especially when compared to the extent to which it significantly improves productivity. Rent can take up 9% to 12% of overhead—depending upon region and prestige of location—and although high-end spaces are often times believed to add to a firm’s profile image and therefore ‘billing rights’, in fact, there are firms that achieve top billing based on professional reputation alone—even from modest loft-type spaces.
One of the Big Bites of Overhead
Significantly, it is the cost of bringing on new talent, training them, and building a practice group that relies on such talent—only to have the lawyer leave the firm not long afterward—that takes up a disproportionate percentage of overhead costs. In fact, it is employee turnover that accounts for, on average, 30% to 50% of mid-level employee salary expense, while turnover of high-level employees can end up costing 150% of what was budgeted to bring on such high-priced talent. It is, therefore, prudent to examine how this particular budget line item can be improved.
Although it may, at first glance, seem counter-intuitive, experts have found that by increasing starting pay, onboarded lawyers have a tendency to stay onboard longer. Another factor that is increasingly employed to reduce turnover is the offering of greater flex-time options, which a whopping 69% of employees now rank as ‘the most important factor.’
Lawyer Leveraging
In their COVID-19 pandemic analysis of law firm successes and struggles, the Thomson Reuters Institute issued a report titled 2021 Pandemic Performers in which they examined how different firms achieved substantially different Revenue Per Lawyer (RPL) returns based on ‘Lawyer Leveraging’. That metric was defined as the ratio of the number of full-time lawyers (full-time equivalents or FTEs) who were not equity partners divided by the number of equity partners. The best performers had a much higher leverage in that ratio despite the fact that their growth was actually slower-paced. However, the FTE metric was then weighed against another metric, the ‘Demand Leverage’, which looked at the number of hours worked by each classification. Non-partners and associates were found to typically work more hours in order to facilitate their rise to partner or at least advance through the ranks.
Seasonal Hiring Impact
The report further examined when successful law firms did their hiring, with top firms hiring new lawyers in Q2 as opposed to Q4. The latter quarter is typically the busiest, and business-savvy firms, therefore, did their hiring in Q2 in order to bring their new hires up to speed in time for the seasonal rush six months later. The new lawyers were then better positioned to provide added value to the firm, increasing demand leverage relative to FTE leverage and, consequently, improving profit margins.
And Leave the Billing to…Them
One overhead area that seriously drains law firm efficiency is the tasking of lawyers with billing their own clients, this being true, especially among smaller firms. One survey of 300 solo practitioners and small firms revealed that lawyers in those settings were spending up to 40% of their time on administrative-type tasks such as billing clients, as well as DIY research. By outsourcing those processes to specialized service providers or by bringing in part-time or as-needed staff, lawyer efficiency, and correspondingly profitability actually increased. If such outsource hiring is not practical for a firm, then the lawyers should consider investing in time-tracking, invoicing, and billing software products that can greatly streamline all of those tasks, thereby cutting down overhead.
When it comes to achieving strategic growth through expense management, the bottom line, of course, is to increase ‘the bottom line.’
Executive Summary
The Issue
How to best achieve growth during times of inflationary pressures?
The Gravamen
If the revenue side is not the problem, then close attention must be paid to the expense side of the profit equation.
The Path Forward
Reducing overhead is key to achieving strategic growth during times of challenging business development, and high on the list of efficiency tweaks is the proper hiring and retention of legal staff.
Action Items
Line-Item Budget Analysis:
As a first step to addressing inflationary pressures, your firm should analyze what your various overhead expenses consist of.
Your Firm’s FTE and Demand Ratios:
A formal study of law firm profitability during the pandemic revealed that a firm’s FTE and Demand ratios were significant indicators of success versus struggle during difficult economic times.
Lowering Turnover:
Because legal team turnover can end up adversely impacting your firm’s overall overhead expenses, consider expanding flex-time options that have been proven to up employee loyalty and retention.
Turn to Tech:
Many other excessive overhead expenses can be resolved by employing technology over employees, and this can be particularly applicable to time-tracking and billing.
Further Readings
- https://www.askcody.com/blog/law-firm-overhead
- https://realeconomy.rsmus.com/law-firms-are-feeling-pressure-despite-steady-growth-in-demand-and-rates/
- https://www.law.com/dailybusinessreview/2022/04/26/how-law-firms-can-stay-competitive-in-an-inflationary-economy/
- https://www.cibc.com/en/business/advice-centre/articles/preparing-your-firm-for-recession.html
- https://www.law.com/americanlawyer/2022/08/22/firms-likely-to-make-course-corrections-as-inflation-challenges-billing/?slreturn=20230122044504
