As part of a series on law firm profitability, I explored reducing the number of hours it takes to deliver a legal service. In Part 2 of this section, I explore the concept of reducing the cost of the time involved in delivering the same service. Per a prior post in the series, I suggest three different ways this might be accomplished, “a) paying people less, b) giving people less resources to do their jobs, or c) pushing work to lower cost labor sources (a.k.a. leverage).”
Part 2 – Paying Less Per Hour
Or … Paying People Less
The first option for this topic could also be called hiring people who cost less. This approach suggests a different staffing model; hiring lower paid lawyers, not necessarily on the partnership track. Call them staff lawyers, counsel or whatever makes sense; these lawyers will be technician, work-horses. They can have high expertise, but no expectation to bill 2000 hours a year or bring in work. Another option is out-sourced lawyers, either local contract types or even off-shore lawyers. The overall concept is having a broader range of lawyers, with an equally broad range of hourly costs to meet various needs.
Next up – theoretically, law firms could pay associates less, or at least wait until they demonstrate value before over-paying them. As noted on a prior post, 1 and 2 year associates are not generally profitable, since their cost is greater than the revenue they generate. An overall problem with associates and other non-partner lawyers is that their billing rates tend to be more a function of their comp and not their value. In any event, in the short to mid-term, it appears highly unlikely firms will change their approach for compensating associates.
Give People Less Resources to Do Their Jobs
Over the last two years, too many firms have taken this approach too far. People without the right and best tools take longer to get their jobs done. So even though this idea may sound appealing to law firm partners, the results are counter-productive.
Push Work to Lower Cost Sources (a.k.a. leverage)
This concept has the most potential for lowering the cost per hour of legal work, since it can utilize existing resources and have an immediate, measurable impact on the cost. The big problem is that this behavior runs counter to what compensation systems reward. Current compensation systems reward the hoarding of hours, such that work tends to be pushed to its highest cost source, which means paralegals are typically the first ones to know when the workload has gone down at a firm. This may have been profitable behavior in a cost-plus world, however, in a margin world it … lowers the margin.
Putting a finer point to this point, below is an analysis of hourly costs at various levels of leverage. I am using a leverage of ‘2 to 1’ as a basis, since that is a relatively typical matter leverage. ‘2 to 1’ leverage is defined as 2 non-partner hours to every 1 partner hour worked on a matter. I’m also using $100 as the baseline cost per hour to simplify the math. These metrics are taken from industry standards. Of course the numbers will vary with different firms and practices. This is just intended to give an average example of the impact of leverage.
This graph is a nice demonstration of the power of leverage on profitability. By moving just 8% of the work from partners to non-partners (going from ‘2 to 1’ to ‘3 to 1’), partner income will rise 8% ($14 on the graph). If you make a bigger shift of 24% (going from ‘2 to 1’ to ‘10 to 1’), profits go up 26% ($43). These profit margins were calculated using a rule of three approach.
Being able to increase profits by 8% with virtually no investment is unheard of in most business environments. This makes a strong case for law firms to improve their leverage on all types of matters.
On one level this might appear to be turning back the clock to the days of the “pyramid of leverage.” However, that is not what I am suggesting. The pyramid was an unsustainable scheme meant to drive up partner incomes by continually adding to the base of the pyramid. Instead, this approach is about having workers do the work and getting partners to act like owners. I’m guessing that the partners at Big Four Accounting firms don’t actually do audit work. Whereas senior partners at BigLaw still conduct run-of-the-mill depositions. This behavior needs to change.
Better leverage, non-partner track attorneys, LPM, process improvement: there are a number of well-defined paths firms can take for reducing the cost of delivering legal services in order to remain price competitive and maintain profit margins. Some of them are very cheap, if not free. The big hurdle is getting firms to make these investments of time and money. In a industry based on precedence thinking, embracing this change is no small challenge.
My 2 cents: Any firm that wants to head down this path should shift its internal economic dialogue away from billable hours to profitability. That one thing will initiate the conversations about reducing the cost of services, embracing process innovation, and ultimately, improving the value of client services.