Back to basics: Why your firm needs to focus again on basic financial management

Previously, healthy growth in revenues and profits could be achieved by the firm effectively tracking market growth. But, when growth is more difficult to achieve, is this still a suitable aspiration?

Consider the alternative. A firm which is not growing may find it difficult to provide career progression to its best staff, who may give up waiting for others to retire or leave. Growth provides the fuel to seek higher quality, more challenging work as well as financial well being. It enables investment to improve the capability of the firm and to generate future success.

But, firms are now facing new entrants, some with deep pockets and an appetite to invest in new models, processes and technology. Commoditisation and the impact on market share and margins pose a risk. Demand has intensified for legal work to be good value for money, speedy and for its price to be easier to forecast and more transparent. Regulation and compliance have become more pressing concerns and bigger risks to manage.

The firm's stakeholders are faced with intense demands on their time and skills. Maintaining or improving performance in profit per equity partner, for example, means that partners have to more clearly understand where to place their investments of cash or time. 'Muddling through' will guarantee a decline.

One obvious answer is merger or acquisition. The frequency of mergers that fully meet aims and where all partners would declare it a success is not high. While it can unleash economies of scale, allow access to new client bases and build capability, the time and pain involved in a merger does not change the rules of the game.

The underlying key levers of sustainable growth remain unchanged. By better understanding those key levers and how to move them, firms can secure healthy growth in revenues and profits.

Leaks in the bucket

A standard model of revenue generation is provided in Figure 1.

The end result is cash collected. But, this is the outcome after a set of other factors or, in some cases, leaks from the bucket, such as the following.

• Not all of the work that is billed is collected. There are issues with credit control and client willingness to pay cause leaks. Interestingly, client dissatisfaction also has a direct correlation with non-payment of the full fee. Research undertaken by the agency Acuigen has identified that the risk of negotiation of the headline fee dramatically escalates when the client's satisfaction with the work billed falls below 7/10.

• Not all of the work in progress (WIP) is billed. This is because not all of the time spent truly adds value to the client and so the fee earner is uncomfortable with billing and justifying it.

• Not all of the hours worked become WIP. Inefficiencies in the firm's processes and staff productivity exacerbate this problem.

• Not all the prospects and pipeline reach the order book. This can be influenced by 'sales' performance not being fully effective. Fee earners may struggle to secure transactions and close the deal or results from proposals may be less than expected. The firm and fee earners may be less good at managing relationships with clients and prospects than is possible, or optimistic forecasting has occurred. The size and health of the pipeline is a function of the firm's ability to acquire clients, to maintain those relationships and to extend and develop them.

The challenge is for the firm's managers to understand how to reduce these leaks and to do so in a way which builds the firm's capability and future health.

Levers of profitability

At its simplest level, improving profitability is about increasing billings and maintaining (or reducing) costs.

Achieving this successfully requires efforts across the firm to improve alignment by understanding the key elements that build profits per partner and performance and pinpointing actions to improve the firm's performance in three areas:

1. improving the firm's ability to grow revenue by securing value for clients, extending client relationships and acquiring new clients;

2. improving the productivity of the firm's assets and resources, including making better use of its key asset - people; and
   using technology and processes effectively to manage costs and secure efficiencies.

Levers of revenue growth

Let's now look at the key levers of revenue growth. There are five key drivers of billings that contribute to a more sustainable revenue stream.

1. Write-offs. Reducing write-offs ensures an increase in the genuine receivables of fee-earner time.

2. Client acquisition. Improving the firm's ability to acquire new clients creates a greater pool of potential revenue.

3. Client relationships. Improving the firm's ability to extend existing relationships with clients reduces sales costs, increases billings with less effort and better locks in more sustainable revenue.

4. Client value. The firm needs to ensure that it secures value from clients and bills and prices work effectively. That means it has to deliver work which is valued by clients, in ways which are valued by them.

5. Referrals. The firm's ability to secure more productive relationships creates significantly increased revenues at often marginal cost. It needs to maximise this potential.

Not enough firms look ahead and manage or measure performance in these areas. There is a key opportunity to move these levers in the right direction.

Client retention

Unless the firm retains clients, it cannot sustain value from them or extend its relationship with them. It has no platform for growth. Every client loss that could have been avoided hurts the firm badly, as it represents compound revenue that has been forsaken (see Figure 2).

But, who is the final arbiter of whether you successfully retain a client? It isn't the firm's management and it isn't the individual fee earners. It is, of course, the client. Our research across clients of law firms shows a shift in the factors that clients say are most influential.

• Value for money is now more important. This does not always mean low pricing. It can mean more predictable or transparent costs, greater confidence that the client has achieved commercial value or greater services and advice over and above technical legal advice. It means different things for different clients and sectors. So, you need to know what drives value for your clients in order to secure it.

• Cumulative knowledge and expertise is also important. The cost/benefit of maintaining several law firms has become more questionable for commercial clients. Rather than maintain several relationships, they increasingly prefer to use one or two firms. This has profound implications for firms and individual fee earners. Now, if a fee-earner does not extend his relationship with a client into other firm sectors, he is not just reducing the potential of the firm but also risking his own future billings and work.

Our research suggests there is still potential for growth in the commercial client portfolios of most law firms. In around 30 per cent of a firm's key client portfolio, there tend to be opportunities to undertake further work for existing clients.

Conversely, there are risks that the client is going to reduce (or cease to) use the law firm in about 10 to 15 per cent of key clients. Again, the firm is, more often than not, unaware of this. Thus, in around 40 to 45 per cent of the key client base, there are unexploited opportunities and unmitigated risks.

If you increase the number of new clients you acquire, add the ability to extend client relationships and are better able to increase value to clients, you can achieve substantial improvement in performance.

Some activities improve your capability in all of these areas. For example, the work to make referrer relationships more productive will also improve your ability to generate greater value from clients and reduce write offs. The impact on billings will be direct and sustainable.

Client services

Clients decide how successfully you can grow billings. Thus, you need to undertake the right activities and measure the right things to improve your firm's capability to deliver value, extend relationships and acquire new clients.

Figures 3 to 5 provide some questions to ask yourself about your firm. Take a look at these questions, identify the level of activity that your firm undertakes and determine the gaps you should work on.

 

Costs control

The other side of the coin is of course reducing costs. More effective resource management and use of business development and fee-earner resources can reduce sales costs.

Using technology appropriately and discriminately can compound this benefit, provided investments are aligned and focused in the right way.

And, effective risk management and compliance, added to the ability to present the firm properly to insurers, can reduce professional indemnity premiums.

Approximately 50 per cent of a typical firm's direct costs are its people. Some of the issues therefore that firm management must review in the current environment include the following.

• Is work being done at the lowest appropriate level?

• Are staff surveys used to ensure people feel engaged and well led?

• Is a broad range of key performance indicators provided to help people to manage their own performance?

• Are heads of teams chosen and retained based on their leadership qualities?

• Is underperformance dealt with swiftly and effectively?

• Is training driven by business objectives (rather than just CPD points)?

Refocusing efforts

In summary, managing partners needs to more profoundly consider those things that build capability in the three areas which are core to driving their firms' revenues, productivity and costs control:

1. acquiring, developing and securing value from clients;

2. managing the performance of people and boosting productivity; and

3. effectively using technology to improve processes and costs control.

Robin Dicks is director of UK consultancy The Thriving Company (www.thrivingcompany.co.uk)