Having been both a managing partner of a regional firm and later the founder of a successful boutique firm, law firm profitability has been the focus of my adult life (and we have previously written about why the traditional law firm business model is dyingHERE). While the work we as lawyers do is complicated and important, the business models we employ are not. Over the couple of decades I have been in this business, I have identified 6 proven ways to improve your law firm’s profitability.
1. Look for a Business Model that Moves Away from the Billable Hour
Renting your time and charging by the 1/10 of an hour will make you a good living, but it’s unlikely to make you wealthy. The billable hour as the dominant model for the business of law dates back only 75 years (for an interesting history of the billable hour click HERE), but legal markets are evolving. At the time it was adopted, the billable hour was the best proxy for measuring value. But that was a different world – one in which the output of labor was traditionally measured by time (think the output of a factory worker).
However, we live in a much different world today, a world of leverage (and I don’t mean financial leverage). Today’s world of leverage is made available because of technology, broad markets, and specialization. Each of these forces allows forward thinking lawyers to look to alternative pricing models to improve their law firm’s profits.
For litigators, the answer has long been to measure value on a contingency basis. But for a growing number of other practice areas, it’s becoming possible for lawyers to leverage their intellectual capital to improve the bottom line. Real estate lawyers are turning to flat fees to capitalize on their cutting edge from banks, transactional lawyers are increasingly using hybrid success fees, and corporate lawyers are incorporating subscription models. The common thread among these models is the ability to measure value to the client in a way that isn’t based upon time. And while there is no one size fits all model for your practice and your firm, find a way to avoid measuring your output as a timekeeper. Instead, find or create a business model that leverages your individual knowledge and work product in a way that compensates you for the value you drive to your clients not the hours you work.
2. Sub-Specialization Is a Way to Increase Your Rates
New lawyers putting up a shingle to be a general practitioner has been over for decades. Of course there are still successful general practitioners, but they are the exception that proves the rule. We live in a world not of specialization, but of sub-specialization. For example, I am a bankruptcy lawyer, but I am primarily a Chapter 11 lawyer who represents large corporate debtors. With few exceptions, I refer out creditor work and my business model is one where I never represent banks. This type of sub-specialization has two benefits. Not only does it allow me to charge a premium, it allows me to refer creditor work to others who specialize in that type of work, who in turn refer me back to debtor work. The result of this type of specialization is that 90% of my client base are referrals from other lawyers.
Perhaps it’s unfair, but we live in a world in which generalists (regardless of profession) rarely make as much money as specialists. For that reason, the hourly rates of non-specialists, particularly in legal services, have a ceiling. It’s a simple economic reality that clients perceive generalists to be providing a commodity that can be replaced by another generalist, and as such, there is greater price sensitivity. The sub-specialist, however, can charge a premium as they are perceived as having a unique, valuable, and harder to replace skillset.
3. Find the Right Metrics – You Can’t Manage What You Can’t Measure
From Money Ball to the internet connected sprinkler clock that waters my yard, we live in a world of data. And just likeevery otherindustry, business intelligence and data analysis need to be applied to your law office. KPIs (Key Performance Indicators) are all the rage in the legal industry, and you could spend hours a month (or probably hours a day) measuring the unique visitors and conversion rates of just your website, but there are a few obvious examples of KPIs you simply can’t ignore. For most of us, our businesses can be measured in an easy and straight forward formula:
Partner Net Income= You (plus any leverage (i.e. associates/paralegals)) x Billing Rate x Utilization x Realization x Margin
Billing Rates– We covered above how diversifying away from the billable hour is among the most important ways to increase profitability, but for the overwhelming majority of lawyers it remains the basis on which they measure revenue. If you have a legal practice that bases revenue on an alternative model, substitute your gross revenue for Billing Rates and Utilization in the formula above.
Utilization– Utilization is not the number of hours you work, it’s the number of billable hours you work. When I was the managing partner of a regional firm, I can’t tell you how many associates and partners alike tried to convince me the “intangible value” of their non-billable hours. And of course marketing, strategic planning, and mentoring are valuable, but they don’t keep the lights on and they don’t contribute to net-income. And the simple reality is most lawyers spend too much time on non-billable work. Most of this work (excluding marketing) is probably not the highest and best use of your time (which we will talk about below). Keeping your costs under control but your personal utilization high is the single hardest thing about running a small firm, but it’s also the easiest way to increase your bottom line.
Realization– I have never once looked back and regretted turning down a client. But I sure have looked back and regretted taking a client that my instinct told me would be a slow (or nonexistent) pay. Early in my career, I actually convinced myself it was better to take on non-paying cases because the “exposure would be great marketing”. I am sure that scenario worked out to someone’s benefit, but certainly not mine. For the purposes of measuring net-income, there is no difference between burning the midnight oil at my desk for an hour of work I will never collect and sitting on the beach with my kids. Your job as a business owner is to maximize your realization rate with ruthless enforcement.
Margin– Margin is your net-income divided by your fees collected. And this is where the wheels of the business have fallen off for many a weary lawyer. Not all law practices are created equal. Different practice areas have different billing structures (revenue) and vastly different cost structures. And too many lawyers measure success without looking at the cost of services sold.
The easiest way to stay on top of your KPIs is to employ cloud based, off-the-shelf, legal technology. Most practice managementsoftware (including the industry leader Clio provide powerful reporting tools for managing your business. In my experience, the KPIs you focus on will shift over time as you build processes and your firm evolves. But you can’t measure profitability until you are able to measure productivity and performance.
Some of the best lawyers I know (from a technical perspective), can’t grow their firms because they can’t get out of their own way. “The client expects me to draft this pleading.” “This work is too complicated to delegate.” “It would take me longer to explain it than to just do it myself.” Sound familiar? Stop lying to yourself. 99% of the time, the client doesn’t care who drafts the pleading. They are paying you to be their quarterback, not the scrivener. In order to boost profitability, lawyers have to find ways to only do the work that is the highest and best use of their time, and then figure out how to delegate the rest. This is the single most important piece of advice that I received and has allowed me to increase my income by 10x. And its the primary reason I co-founded LAWCLERK. The ability to stick to the few (very few) things I do best and delegate the rest is disproportionately the basis of my success as a lawyer.
This is a game changer in terms of small law firm profitability, and here are some examples to demonstrate just how valuable it can be in boosting profitability. Let’s say you hire a virtual associate or freelance lawyer (it won’t surprise you that I think LAWCLERK is the best place to find top talent) to draft a summary judgment motion. Over the years, I have lost many of the research skills I had when I graduated law school. For the purpose of this example, assume I pay the freelance lawyer $1,000 for the summary judgment motion. When my virtual associate (a freelance lawyer I work with on a regular basis) completes the project, I receive a timecard (automatically through our platform). Let’s assume the virtual associate reports they worked 8.5 hours. In my practice, I regularly change my virtual associates out at $265 per hour. This means I bill the virtual associate’s time to my client for over $2,250 (a profit of over $1,250). And the best part is its win-win. It would have cost the client more for me to do the work myself at my billing rate, but it also allows me to stick to my highest and best use, which might be working on other paying work (at my higher billing rate) or might be client development. Regardless, it frees me to work on other things while also driving revenue to my practice. I would strongly recommend you check out our Ultimate Guide to Legal Outsourcing.
Now, imagine what happens over the course of a year when you replicate this process — your profitability will skyrocket. Plus, it’s going to free up your time to do the things that are better uses of your talents, like attending court, meeting with new clients, and so on.
5. Manage Your A/R and WIP
Billable hours are great, but they don’t pay the bills; only collections do. Recent data suggests that up to 20% of billed time never gets paid. And that’s not hours worked, that’s receivable hours actually included on an invoice transmitted to a client. If your bills don’t get paid, you are never going to be profitable.
At some firms, A/R and WIPexceed6 months and sometimes a full year of productive time. That’s insane! And the number one contributor to this problem is sloppy billing habits. Some of the smartest lawyers I know possess some of the worst billing habits. But discipline in these three areas will get your bills paid faster, and more often, which is profit directly to the bottom line.
- Contemporaneous Time Keeping– This one seems so obvious, but remains the number one problem among lawyers I know. Recreating your time at the end of the week or even the end of the month guarantees you lose money. Without exception, lawyers who attempt to recreate their time after the fact lose time, not only in failing to account for hours worked, but also in the wasted hours spent recreating their time. Failure to keep contemporaneous time records is the easiest way to undermine your utilization ratio.
- Transmit Your Bills By the 5th of the Month– Clients have short term memories. If your billings aren’t important enough to get out by the 5th of the month, why are they important enough for your clients to pay timely? I have learned this truth – there is no better way to ensure that a client calls to “negotiate a bill” than to send them time that is old and cold, regardless of the value you delivered.
- Don’t Let Your AR Age Past 60 Days– In all businesses aging A/R becomes less valuable by the day, andlegal servicesis no exception. If you do a profitability analysis of your law firm, I am confident you will find that your old A/R has a lower realization rate than your current billings. And in my experience, it’s the work we continue to do for clients whose existing bills are in the 90 day or 120+ day A/R column that are the most likely to be written off.
6. Find Leverage in Your Practice
Wall Street has given leverage a bad name, but it’s a concept that has been a part of legal services since the first associate was hired. There are only 24 hours in a day, and that means your income will max out if your business model is based upon billing your personal time. But if you employ associates, freelance lawyers, paralegals, and technology, you can increase your revenue without increasing your personal output. For law firms, the two fastest growing ways to increase revenue are virtual associates and automation. Leverage is the easiest and fastest way to improve increase your profits.
Virtual Associates (Freelance Lawyers)– As we have previously talked about (link), the decision to start LAWCLERK was based upon our experience moving from a big firm to a boutique and a desire to have all the resources of a big firm without the fixed overhead and cost structure. Profitable firms are disproportionately flexible firms. And the use of virtual associates with subject matter expertise has materially improved our bottom line. In our own firm, we currently use two subscription associates who work 50 hours a month each, as well as the intermittent use of freelance lawyers on a project by project basis. The virtual associates and freelance lawyers add thousands of hours of billable time and hundreds of thousands of dollars of profit to our bottom line each year.
Automation– We are constantly building intellectual capital in this business, and our prior work product is incredibly valuable. Among the fastest way to increase your profits is the use of document automation software to streamline the time you spend customizing routine documents that you often use in your practice (such as agreements, pleadings, discovery, and so much more). Our friends at the Lawyerist have done a nice survey of the best technology in the market HERE. With automation software, you can leverage your past work for efficiency with future clients to drive profit and deliver a better product (value) to your clients.
The work we do as lawyers is complicated and important, but the businesses we run are relatively easy. Most lawyers in our profession bill their time and hope their clients pay. But in my experience, there is a lack of focus on profit margins, efficiency, and business model refinement that can separate you and your law firm from the pack. Like many other professions, legal services are increasingly becoming a world in which there are winners and losers. To quote Bruce Springsteen, “Don’t get stuck on the wrong side of that track.” The business of law (as compared to the practice of law) is getting more competitive and quickly evolving. The most successful firms are increasingly employing new business models, using technology, and finding better and more profitable staffing models.