Five Gears of Law Firm Profitability

How To Get Moving In The Right Direction

Law firm stakeholders affect their firm’s profitability every day, with every move they make. And probably more importantly, they affect it with every move they don’t make; which is actually much better news than they may realize.

Once they understand that they affect their firm’s financial picture even by doing nothing, it becomes easier to take positive action instead of sitting back and hoping good things happen.

The five “gears” of law firm profitability, and their movements, are all firmly in their hands. It’s merely a matter of fine tuning each one, one at a time, to get them all working smoothly together.

Why gears?

Think about the movement of gears in a well-oiled machine. While they’re all working together toward a common purpose – driving the machine forward or backward – adjacent gears are actually moving in opposite directions.

The same goes with the five primary gears driving law firm profitability. Instead of the individual gears moving independently, they’re all interdependent with each other. They can’t move one gear without affecting the others, sometimes in the most unintended ways.

So it stands to reason that getting every gear moving perfectly in sync with every other is a process of constant adjusting, then analyzing the numbers after each adjustment to understand where to make the next tweak.

Attorneys can’t move one gear without affecting the others, sometimes in the most unintended ways.

Before we get ahead of ourselves, though, let’s start at the beginning:  defining the five gears.

The Five Gears Driving Law Firm Profitability

We’re no more interested in turning them into an accountant than you are in being an attorney, so let’s keep this simple:

  • Production Value – the amount of fees timekeepers are expected to bill
  • Utilization – the actual amount of billable time a timekeeper logs
  • Realization – how much money the firm is paid vs. how much they bill
  • Leverage – matching the right resource to the task
  • Margin – the difference between the money their firm brings in and the amount they spend

Getting back to the interdependent movements of the five gears, let’s look at how a singular focus on cost-cutting to improve margins can affect their total profitability picture with possible unintended consequences.

There are a couple of obvious targets for extreme cost-cutting, either or both of which can easily set into motion the law of unintended consequences:

  1. Employee layoffs
  2. Technology cutbacks

Employee Layoffs

With a grim economic outlook in the Great Recession years after 2008, many firms worked fiercely to increase their profit margins by cutting costs. That meant layoffs for thousands of lawyers and cuts to benefit programs. As a result, short-term margins improved.

But extreme cost-cutting is a temporary Band-Aid®, one that eventually has to be ripped off. And when it is, it generally reveals more painful challenges for the future.

With a singular focus on cost cutting, both leverage and margins end up taking a hit:

  1. The combination of layoffs and employees leaving the firm due to cutbacks leaves fewer employees for partners to leverage work from, so less work gets done, decreasing revenue and growth opportunities.
  2. Lower-level tasks have to be performed by higher-level employees at a higher cost, eventually eating into the profit margin cost-cutting was supposed to increase.

That’s a painful result however you look at it. And unfortunately, the effect can be even worse when firms slash costs by delaying technology investments.

Technology Cutbacks

In an ideal world, firms looking to increase profitability in the face of layoffs would balance out the productivity loss by making smarter investments in technology, allowing the remaining employees to get more done in less time.

But in their zeal to cut costs, some firms also brought technology spending to a grinding halt. The result—a one-two productivity hit that made it near-impossible for firms to recover momentum even when the economy started to improve.

Cutting technology budgets only delays expenditures; by no means does it eliminate them. And because of the nature of technology, those delays often result in higher costs in the long term.

The moral of the story: Profit margin is important, but it’s just one of five gears. If you’re betting your firm’s profitability entirely on extreme cost cutting, you’ll bring other profitability gears to a grinding halt.

To make sure the Gears of Profitability stay turning in the right direction at your firm, get the complete how-to guide free from LexisNexis.

Author:Dave Honaker

About Law Technology Today

Law Technology Today
Law Technology Today is the official legal technology blog from the ABA Legal Technology Resource Center (LTRC). Law Technology Today provides lawyers and other legal professionals with current, practical and innovative content developed by some of the leading voices on legal technology.

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