Published on 3/23/09
The recession is sending many law firms back to the basics, and nothing is more fundamental to "The Business of Law®" than the two basic models to make money. In model one, look at your revenue and figure out what your cost structure should be so you can turn a profit; in model two, look at your costs and determine how much revenue you need to cover them and make a profit. Either way, you must sell enough legal services to cover your costs for something to be left over.
Consider a law firm where the revenues from a given client are 10% less than the costs to service that client in lawyer and staff compensation. This should be an obvious warning sign to the firm, but it is one that is often missed because law firms generally do not understand their cost of operation. They set fees based on gut feel or wishful thinking, not on a cost benefit analysis of how operational and attorney costs affect the firm's billing structure and bottom line.
Firms faced with this conundrum typically take one of two approaches: assess whether fewer people can handle the same client workload (which may require taking some services now being performed out of the mix of what the client receives), or adjust staffing and leverage ratios. Staffing level is the critical cost analysis factor. Do you need two senior lawyers, each with high hourly rates and personal assistants, to handle the work? Can you involve an associate, or even a paralegal, and get by with one senior partner? Do you even need a senior lawyer involved -can two associates or a mix of associates and paralegals do most work with proper partner oversight?
As these questions indicate, and as many firms have found, it's not easy to adjust costs to revenue. That brings us to the second economic model: determining how much revenue is needed to cover costs. In a law firm, revenue is highly personalized because it is produced by individual effort. The measure of that effort is billing rates, so increasing revenue puts the focus on whether to raise rates - an issue off the table in today's economy. And because billing rates determine a partner's compensation, the greater revenue generated from billing rates is inseparable from how compensation is determined.
This is the best argument for linking individual compensation and the firm's overall revenue by servicing major clients with teams (not just a single rainmaker). The client receives "one-stop shopping" from a group of lawyers who address specific needs, by practice specialties as well as billing rates. The team approach allows for blended high and low rates on client work, which maximizes profitability and collections. This is the corporate model, in which compensation is paid based on what is generated for the organization - not for any one individual.
Teams represent a cooperative effort to increase revenue. Base compensation is tied to the effectiveness of involving other firm lawyers as part of the team delivering legal services to clients. Compensation is paid based on what is generated for the organization - not for any one individual - because the organization's revenue is maximized. So too are profits, the lifeblood of organizational survival.
