Legal Business

Learning the Leverage Game

Law firms are often criticised unfairly for relying unduly on leverage to generate profits. Visions of Dickensian sweatshops haunt the popular press and the imaginations of young, would be practitioners. Equally, senior partners are obsessed with improving their lawyer to partner ratio because they sense instinctively that such arrangements are more profitable.

 

Leverage, however, offers much not only to the firm but also to its clients and staff.

 

Firms need to focus very acutely on what can be delegated and do it as effectively as possible. The United States experience shows that delegation is literally being forced on law firms by in-house counsel. That is far from the worst of it, however, as companies are already beginning to outsource their work to reduce the blended billing costs of their matters.

Profit and Size

There is no doubt that there is a direct correlation between size and profit per partner. In a study recently conducted in Singapore, the profit per partner in the larger (>30 lawyers) firms was about seven times as much as in the smaller (<5 lawyers) firms. Scaled up to the size of Australian law firms, I suspect the figures are not too different.

 

Interesting enough, in Australia the partner to lawyer ratio of the 30 largest firms is 1:2.81 and that does not represent an average drawn from a widely diverse sample. Most firms operate at around that figure. There would undoubtedly be a paralegal component which is not counted in this figure, but this would not be large.

 

It appears counter intuitive, but smaller firms have higher ratios on average. In my experience the ratio is much closer to four. This is not surprising when the nature of their work is considered. We will talk more about the nature of their work later.

What Then are the Benefits of Leverage?

From a financial point of view, the benefits of spreading the infrastructure cost across more heads is clear as is the benefit from having more employees performing work with better margins.

 

This can be seen in the diagram below which plots the contribution made by each additional solicitor to the profits of the firm. The trend is steeply upward as the number of solicitors, and hence the leverage, increases.

 

The comparative result from pursuing different policies with respect to leverage is perhaps best demonstrated in the diagram. Three firms with the same number of lawyers drive out very different profits per partner depending on the extent of leverage.

The ‘Perfect Pyramid’

So why doesn’t everyone structure their firm in the form of the pyramid firm?

Most importantly the ability to structure in that fashion is very dependent on the:

1    nature of the work the firm is doing; and

 

2    partner’s ability to manage such a structure.

 

These critical factors are often overlooked in the rush to build leverage. It is widely thought that the ‘pyramid style’ can only be adopted for ‘commodity’ style or type of work, thus the concept has little applicability elsewhere. This is simply not the case. Studies I have seen coming out of the US show that most partners should be able to delegate up to about 50 per cent of the work they commonly perform. This not only enables better leverage but it also gives the partner time to properly supervise the group and importantly, find additional work.

 

Again my experience in the US indicates in-house counsel are dictating, that for much of their work, partners shall not bill more than, say, 20 per cent of the total fee for any matter. They are dictating the leverage! Their motive is to keep the bills to a minimum, but from the partner’s perspective, unless they delegate ruthlessly they will simply not be able to maintain their hourly rates. It is not a discipline most of us would enjoy but it is already a reality in some sectors in Australia.

 

Care must be taken therefore to carefully review the work the firm is doing and match the skills of the staff to what is required. In some cases an audit of the work and breaking down of the work into a series of ‘delegable’ steps will be required to ensure appropriate delegation. Again such break downs are common in the US.

 

It is but a small step to see how arguments in favour of outsourcing are being made by companies - it is ‘delegation by direction’ to overseas practitioners where there is no chance of the local firm making any profit at all.

Essential Skills

The skills to delegate and supervise are therefore vital. They have the added value of reducing costs for clients and freeing up the partner to get more, and hopefully, more complex work. It gives junior solicitors a chance to do responsible work and quickly introduces them to the skills they need to develop to mentor and instruct their juniors in turn.

 

Many partners who do not benefit from leverage are often very reluctant to delegate ‘their’ work and are only too aware that once delegated they are expected to head out to find more work. The latter is not always seen as an attractive option. Furthermore, many partners lack even the most basic mentoring and supervisory skills and avoid even becoming involved in hiring appropriate juniors.

 

Without appropriate leverage therefore:

1    partners are tied to their desks;

 

2    clients are charged partner rates instead of a lower blended rate;

 

3    lawyers are ‘starved’ of responsible work;

 

4    lawyers get scant supervision;

5    matters are handled inefficiently;

 

6    new complex work is not sourced by partners;

 

7    margins remain low and profits are depressed; and

 

8    clients may react by constraining partner involvement or worse still outsourcing the work altogether.

 

The days of the ‘Rumpole’ style practitioner have all but passed. For any firm with more than a handful of lawyers, the question of leverage and the discipline that go with it need to be squarely addressed. Leverage has much to offer client, partner and practitioner alike if applied with appropriate skill. It is not so much a question of the size of the firm but the nature of the work and the attitude and training of its practitioners.

 

Duncan Hart

Duncan Hart Consulting

E-mail: dh@duncanhartconsulting.com

 


Notes

1       Asian Legal Business 30