7/17/09

From Revenue to Profits – The Big Shift

Law firms, especially BigLaw, like to talk about leverage these days. We at 3 Geeks have previously posted on various aspects of this discussion, especially as it relates to alternative fee arrangements.
But what are we really talking about when we talk about leverage? I suggest we are actually talking about profit. But just like 'marketing' was a dirty word before firms embraced it: profit is a dirty word now. So instead we talk about "leverage" with some veiled, hoped-for result of sustaining or growing partner incomes. I suppose we do talked about Profits Per Partner (PPP). But this discussion is a ruse since it doesn't really address the issue of profitable work for a firm, but instead is some odd reference to how much money - on average - a partner at a given firm is making. Leverage aside, we are now starting to see a shift in the dialogue actually to "profit." This shift is a good thing. What this shift means for law firms is very important. For all the talk about Alternative Fees - what clients really want is efficient law firms. They call it "value" but this effectively means that firms are doing more for less. Of all the discussions about how things are changing, this point may be the most critical. By shifting the dialogue, the metrics of a partnership will become more about profit and less about revenue. Revenue is what firms have focused on for years. Being able to continually increase billing rates which drove revenue faster than costs has meant firms have enjoyed growing partner incomes. But no longer. Rates are flat while costs are still increasing. So now we start to talk about profits. Initially firms have focused on cost reductions. This approach is a short-term tactic for driving overall profitability of a firm. The next layer of analysis becomes the profitability of types of work, matters, clients and even industries (a.k.a. markets). At this level, law firm profits become a value driver. If firms are measuring and reacting to profitability at the matter level, they shift their attention to being efficient. Now we have client and law firm interests aligned! A major reason law firms have avoided measuring profit at this level is its potential for divisiveness among partners. If you know your partner’s profitability and her compensation and the two don’t match then we have a problem. But I would argue that problem already exists. Firms have had the luxury of avoiding it - but no more. I predict the shift of focus away from Revenue and towards Profit will ultimately be a healthy thing; both for firms and clients. This shift will be a major factor in addressing the concerns clients are raising and will bring healthy business practices to law firms. However in the short run, change will come at a cost.

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2 comments:

Ron Baker said...

Toby,

Good post. Here's a pricing axiom: Innovate for growth, price for profit. Growth for the sake of growth is the ideology of the cancer cell, not a profitable, sustainable business.

But I have one major disagreement with your post. Clients don't want efficiency. They want effectiveness. There's a huge difference. The former is doing things right; the latter is doing the right thing. I want my heart surgeon to be effective; I don't give a damn about his efficiency. Was Einstein efficient? How would you know? Who cares?

This is a major shift in a knowledge firm, one we don't think many firm leaders understand. The talisman needs to be effectiveness (a judgment), not efficiency (always a measurement).

For more on this very issue, see this post:

http://www.verasage.com/index.php/community
/comments/was_drucker_wrong_about_
knowledge_workers_a_book_review/

A business isn't paid to be efficient. What if you're efficient at doing the wrong things, like the buggy whip manufacturers or dot matrix printer manufacturers? A business is paid to create wealth for its customers--and that's effectiveness, not efficiency.

Let me say it this way: lawyers are artists. If I have them paint-by-the-numbers I can increase their efficiency. But they will produce crappy art. If I tolerate some waste and inefficiency, they are far more likely to create a Rembrandt. I want an artist, not a factory worker.

Regards,
Ron Baker, Founder
VeraSage Institute
www.verasage.com
Twitter @ronaldbaker

Toby Brown said...

Ron,

Excellent addition to this post. I shall choose my words more carefully as I continue this exploration.

Thanks - as usual.

Toby

 

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