Thought leader

By Michael Roch

Welcome to the first edition of FD Legal.

The genesis of this publication is highly timely. Law firm profitability remains under continued pressure. And in light of the imminent reforms to the UK legal profession, only law firms that make the right strategic decisions and invest in the right resources will continue to survive and be profitable in the long-term as the market around them changes. The firm's finance director (FD) or equivalent is one of the central figures to help manage these changes.

Continued pressure on PEP

Profit per equity partner (PEP) is widely viewed as the singular sign of strength of a law firm's brand and market position. It has become the deciding factor for future lateral partners to join (and for 'rising stars' to leave), and is without question the threshold issue in the acquisition of bolt-on practices and full-blown mergers. Maximising profitability requires law firm FDs to continuously find new ways to fully leverage all drivers of law firm profitability as a matter of strategic importance.

Reforms to the UK legal profession as a driver of change

The contemplated Clementi-Falconer reforms to the UK legal profession will have a far-reaching effect on how law is practised, similar to the stockbrokers' Big Bang in the 1980s. Commonly '“ and mistakenly '“ viewed as impacting only already commoditised practices inside the UK, these changes will reach outside the UK and will affect traditional, full-service practices. Scheduled to become effective towards the beginning of 2008, these reforms allow UK law firms to seek outside equity investments or to be sold outright to strategic acquirers. Investors will require sustainable PEP and a clear value-add strategy, implemented through management systems that help drive this strategy as one of a singular business unit and not of a collection of partner practitioners. For those firms that decide to embrace these changes, many will have to radically change their operational structure, including the way they deal with '“ and compensate '“ performance. Those firms that choose to not embrace these changes will have to devise strategies to defend against competitors that do.

These changes are also relevant for non-UK law firms. For instance, US firms may buy a minority stake in a UK firm rather than undergo a full-blown merger, thus having a referral base in the UK as well as an asset that will increase in value. Continental European firms, meanwhile, could use a UK firm structure to raise funds for the necessary investments required to continue competing as an independent firm in their home market against the financially strong international firms.

Making the right investments

Irrespective of these changes in the legal market, we return to a law firm's ability to sustain and continually grow its profitability, which is possible only by constantly choosing the right investments. Lost among headline partner moves and mergers is the need to invest in the basics; at its most basic, the firm's intellectual capital is a sound place to start. Because of the intangible nature of intellectual capital (and since profits on it do not clearly appear as a part of PEP), investments in it are still viewed with a great deal of suspicion by both law firm FDs and managing partners; as a result, intellectual capital is often managed poorly '“ if at all. Outdated management practices must begin to give way to managing intellectual capital and its components as rigorously as PEP and cash flow.

All of this means that the FD will play an even more central role in managing the firm, addressing day-to-day financial management matters on the one hand and making strategic and investment decisions side-by-side with the managing partner on the other. Departmental thinking will have to give way to an integrated resource-management approach that makes the best use of the firm's financial and intellectual capital and that uses the best business-intelligence and market-intelligence-analysis tools available to help the firm defend against adverse market changes while making the most of market opportunities.

We look forward to accompanying you throughout these exciting times.

Michael Roch is a principal of Edge International, an international management consulting firm that advises law firms worldwide on strategy and management matters. He can be contacted at roch@edge.ai.