Managing leverage the key to law firm profits

Carefully structuring the balance of paralegals and senior lawyers to deliver the best value is essential for any law firm seeking to enhance efficiency and profitability, writes Neil Oakes.

Most law firms are well aware of the economic benefits of leverage; many, though, are not optimising performance. If you are the owner of a law firm, you are in the business of selling your knowledge capital. You only have so much to sell. If demand exists, it makes sense to acquire additional knowledge capital and sell it at rates greater than cost; in a pure economic model, the more the better.

The right model
When we relax the assumptions inherent in a pure economic model, some challenges emerge. The success of a well-leveraged law firm will depend on the nature of the work it undertakes and the experience mix of the cadre of employed fee earners. Closely related to these challenges is the impact of price. Considering work type on a scale of complexity, ranging from process work at one end of the scale to complex, unique ‘rocket science’ work at the other, leverage potential will range inversely, from high to low. Experience required will range from low to high.

Firms that manage their leverage effectively are able to match task complexity with experience level and, therefore, the cost of production. Others have mid-career lawyers working along the entire complexity scale, becoming more expensive (to the firm) every year as their experience grows, regardless of task complexity and the value of the work they undertake. The implications for profit margin are obvious. Some will claim that they become more efficient as the years pass, but this is not evident in any FMRC data beyond year-four experience, with the notable exception of lawyers practising at the complex end of the work-complexity scale. If you have relatively senior lawyers who are paid market salaries and doing process work, you may not break even. An appropriate employed lawyer mix will correct this if work is delegated to the correct level.

Wise investment
In my travels around Australasia I regularly encounter small law firms (say, one to 10 partners) that are constantly searching for a commercial lawyer with five years’ experience and a bit of a following. These people seem to be impossible to find, and expensive if you do. In our benchmarking data, small firms often experience decreasing returns relative to career seniority. Dollar returns per salary dollar invested usually decline with experience. It is often the case that paralegal staff return more than $3 for every salary dollar invested, as do graduates and those with up to five years’ experience, with some returning as much as $4.50 per salary dollar invested (typically in their third year of practice). Beyond five years things often change. It is common for more senior lawyers to return $2 to $2.40 per salary dollar invested.

I am not suggesting that law firms should only employ paralegals and junior lawyers, but I would suggest that career progression beyond year five should be accompanied by a capacity to attract more complex and, therefore, more valuable work. Subjective contributions such as practice development, culture contribution and partnership potential must also be considered. I am also questioning the perpetual search for the lawyer with five years’ experience. Perhaps a talented graduate or a lawyer with a couple of years’ experience – who is well supervised, trained and coached and with access to quality precedents – could be a better choice.

War of attrition
All firms have agonised over attrition, seeking to retain all staff for as long as possible. I suggest defining your attrition goals. If you are interested in maximising business performance, the critical people to retain are generally paralegals, graduates and early-career lawyers. Bending over backwards to accommodate the aspirations of mediocre mid- and senior-career lawyers appears to make little economic sense. Sure, we would welcome their continued involvement, but it is by no means the end of the world if they wish to move on. Of course, anything you can do to retain the star performers at any level is a good thing.

How you staff your firm will ultimately depend on your view of the legal market. If you take the view that there is an abundance of demand for legal services and that your firm is well placed to attract this demand, then productive solicitor attrition, at any level, will more than likely reduce firm profit. If, on the other hand, you take a realist view (that in the Australian legal market the amount of work done over the past few years, ignoring fee increases, has not increased and that any given region will probably have a given and relatively fixed legal market) then every individual practice or bundle of fees has an opportunity cost attached to it. If the firm loses a senior solicitor, retains the practice and employs a capable junior solicitor, attrition can increase profit.

Price point
Now to the perennial issue of price. If the nature of your work lends itself to fixed fees, or the amount you can recover has an accepted market maximum, the challenges outlined above compound. Managing for success in a fixed-price market requires close scrutiny of cost of production. Subject to the maintenance of quality and client satisfaction, the more junior the fee earner, the better. Putting a positive spin on things, charging one price for a certain service may enable you to enjoy significantly greater returns from your investment in knowledge capital. If a 20-year-old estate agent turns up to sell your property, you do not get a discount (although you may get a shock). The value is in the service, not the relative age of the provider. Why should you be any different?

If you are confident in the quality of the service, it should be priced at market value, regardless of the fee-earner’s seniority, whether priced on time, fixed fees or otherwise. Of course, this would be reflected in your fee agreement and fee estimates. I would encourage you to examine your leverage structure, relative cost of production, delegation strategy, retention goals and career progression guidelines to enable you to get the most out of your investment.

Neil Oakes is the director of FMRC, which has provided research, training and management advice to law firms throughout Australasia for the past 30 years.
www.fmrc.com.au