Recently, Thomson Reuters released the 2018 Dynamic Law Firms Study. I found some extremely valuable insights within the Study and wanted to go straight to the source to ask specifically about how business development impacts becoming either a dynamic or static firm. Bill Josten, Strategic Content Manager for Thomson Reuters Legal Executive Institute, author of the Study, and fellow attorney, has been kind enough to share his research and answer a few questions.
Bill, thanks for joining Minimalex for this interview!
Before we jump into some specific questions, can you give us a little background on the Study?
The Study is an analysis of the three-year compound annual growth rates experienced by law firms within the Thomson Reuters Peer Monitor sample in their overall profits, revenue per lawyer, and average profit margin. After each firm was ranked on their individual performance, we placed the firms in quartiles. Those firms with the best compound annual growth performances across these three metrics found themselves in the top quartile and became our Dynamic firms. Those that struggled to grow these metrics, or in some cases even saw contractions, became our Static law firms.
What key takeaways did you find this year?
We really focused in on three key takeaways. First, productivity is king. A lawyer’s time is the widget the lawyer has to sell. If a lawyer’s productivity declines, that necessarily means the lawyer is selling fewer widgets. Clearly, this is a problem.
Second, as productivity declines, this will have a ripple effect throughout the firm, particularly with regard to strategic investment. In our study, this ripple is manifest most clearly through the Static firms and how they chose to invest their money in 2017. We saw across the board reductions in investments on the part of Static law firms.
These reductions led to our third takeaway: lack of investment hurts future profit potential. That isn’t to suggest that any spending is good spending. But a lack of necessary investment to ensure a firm’s competitive ability and marketability puts a firm at a disadvantage in this highly competitive market.
I should also add that none of this is really revelatory. No firm should be surprised that productivity is essential to success in a law firm. But what this study reinforced for us is that execution is essential. Simply knowing something is true isn’t enough. You have to be able to act on it.
The 2018 Dynamics Law Firm Study clearly surmised that productivity is king. However, one of the difficulties lawyers face is balancing billing hours with bringing in business. Were there any clues on how a dynamic firm is able to do both?
The real key here is less about balancing truly productive time with business development. The true balance lawyers need to strike is between non-productive working time, that is, time likely to ultimately be written off or be otherwise non-billable, with time dedicated to generating new business. No lawyer will be willing to sacrifice time that they’re pretty confident they’ll get paid to work for the sake of seeking work that they hope to ultimately secure. Put another way, you don’t give up a sure thing for a hope. But lawyers spend a lot of time every year either on administrative tasks or on inefficient work, resulting in time that will ultimately be written down.
When we look at the Dynamic firms’ investment in technology, they told us that their top priorities were investments in practice and process automation, efficient knowledge management, financial management, and workflow efficiency. These stated goals speak directly to strategies aimed at reducing the “waste” in a lawyer’s day, the time spent on unproductive work or administrative burdens.
Reducing these areas of waste create additional capacity in the lawyer’s day, freeing up time to work on generating new business, or at the very least, engage in business development training. And it can be done without negatively impacting the truly productive time the lawyer is already spending on work for which he or she is being paid.
Was investment in business development & marketing a key differentiator last year as well?
It absolutely was. In fact, the “Dynamic” and “Static” nomenclature we adopted for these populations in our inaugural study last year was a direct reflection of the divergence in their investment strategies.
In our original study, Dynamic firms were seen increasing their investments in a wide variety of areas year over year, and in particular marketing/BD. They were putting their money where their mouths are, so to speak, regarding their stated strategic priorities.
Static firms on the other hand appeared to be trying to hold these expenses in check.
We saw the same thing in this year’s study, although to a more noticeable degree.
I should also point out that the two studies are not a time series of each other. They examine slightly different time periods. We use the same methodology, but we are not necessarily following the same firms through time. It is completely coincidental that we found the same sort of restraint on investment in the two studies, but I think it’s instructive. In both studies, we identified Static populations that were clearly experiencing difficulties. In an apparent effort to protect profitability, both populations chose to reduce strategic investment, and marketing/BD can be an easy target for quick reductions. It’s not a hard cost, it’s not set by contractual obligations, and it’s hard to determine the ROI, so you can’t really correlate a reduction of $X in BD spending is a potential reduction of $Y in potential revenue.
I’m all about removing limiting beliefs. If a law firm is in a “secondary” market, according to the Study, do they have any reason to believe that they have a more difficult road to being dynamic than firms based out of larger markets like New York or Los Angeles?
No, not at all. We closely examined the demographics of both our Dynamic and Static law firms to determine if there was a coastal or BigLaw bias among the firms that were seeing the best growth. We found that there really isn’t. Among our Dynamic firms, they’re divided almost equally between Am Law 100, Am Law Second Hundred, and Midsize law firms. Similarly, every region of the country was represented in the Dynamic sample in relatively similar proportion to their concentration of law firms. For example, of the 39 Dynamic firms we looked at, 11 were from the Northeast, and 7 were from the West, while 9 were from the Midwest, literally right in between the coasts. The bottom line is that firms of any size from any geography can find strong growth. It’s not about firm size or location, it’s about strategy and execution.
One of the concerns highlighted is rate erosion. Write-downs and discounts appear to be the driver more than client pushback. If rate erosion is happening prior to client pushback, do you have any thoughts on how it could be reduced?
Well first I should probably explain what we mean by rate erosion. We look at rates at four different stages: the standard rate the firm charges, the worked rate the client agrees to pay, the billed rate the firm actually puts on the invoice, and the collect rate the client actually pays. The amount of separation between each of these stages is what we call erosion.
As we look not only at our Dynamic and Static law firms, but at the market in general, what we’ve noticed is that for several years, the gap between billed and collected rates has stayed fairly consistent. This gap is the area most directly affected by clients’ proactive pushback because this is the stage where they ask for billing adjustments and write-offs. But it hasn’t been growing.
We still see collected realization as a percentage of standard rates declining, but the increasing decline is not happening between the billed and collected rates. Instead, it’s happening between the worked and the billed rates. In other words, the client has agreed to pay a certain rate, but the gap between what the client agreed to pay and what they’re actually being charged is widening. And this is a gap that is almost completely within the law firm’s control. This is the phase of the matter where the attorneys are reviewing their pre-bills and making adjustments or write downs. And a lot of this write down activity is due, frankly, to apprehension and fear.
Lawyers don’t want to risk upsetting their clients, so they’re proactively adjusting their bills to make them more theoretically palatable. It’s an open question how much of this reduction is necessary, but as we follow the data, it is clear that as billing realization improves, collected realization improves with it. Put another way, if a firm can take steps internally to ensure more of their billable time actually makes it to the bill, it is likely that the firm will not see an appreciable increase in pushback from the client. Now, there will, of course, be a point of diminishing returns on these efforts where clients will eventually ramp up their pushback on the invoices, but there is also clearly room for improvement on the part of law firms.
Whenever firms ask me what they can do to improve their realization, I always tell them to look internally first. It’s far easier to improve internal behaviors than it is to change your clients’ behaviors.
Do dynamic firms have a different composition of staff that is a differentiator from static firms?
In terms of allied professional or non-timekeeper staff, our study does not really get into that kind of an examination because it’s a bit more qualitative. However, with regard to timekeeper staff, and in particular attorneys, we did notice a difference between our Dynamic and Static firms in terms of their leverage. On the whole, Dynamic firms exercised better leverage than did their Static counterparts. This comports with expectations because the “RULES” of profitability for professional service firms, as articulated by David Maister, would indicate that a firm with better leverage has the ability to push more work down to lower cost timekeepers and thereby improve profit margins.
I found the trends in leverage to be interesting with greater leverage occuring at dynamic firms. Can you explain what the Study means by “leverage”?
We actually look at leverage two different ways, and I think that’s critical. The way leverage is typically defined is in terms of headcount: the number of other-than-equity-partner attorneys at a firm compared to the number of equity partners. While instructive, I’m actually not convinced this is the best way to look at leverage. A firm can be highly leveraged in terms of their timekeeper mix,but can have a partner population that effectively hordes hours rather than pushing them down as the model would presuppose they would do. In this case, you end up with a firm where leverage looks good on paper, but in reality most of their profit engine is sitting idle.
This bring us to the other way we measure leverage, what we call demand leverage. In this metric, rather than measuring leverage a function of FTEs, we measure it in terms of where billable hours are generated. A firm that produces 1 billable hour of non-equity-partner-timekeeper time to every 30 minutes of equity partner time would be a 2.0 demand leverage firm. Through demand leverage, you can get a clearer picture of whether the theory behind leverage is actually playing out in the firm’s favor. I’ve often said I’d rather be at firm with 0.5 FTE leverage but 2.0 demand leverage than the reverse. Yes, such a firm would have a lot of partners, but those partners would be more likely to be generating new work and passing it down for others to actually complete.
Do you think the leverage data says anything about opportunity to make partner at either a dynamic or static firm?
I don’t know that we would draw conclusions so much from the leverage data as we would from the market as a whole.
In this year’s study, we found leverage working in favor of the Dynamic firms. But I have to also point out that in last year’s study, it was actually the Static firms that had better leverage. This isn’t to say that leverage worked against the Static firms in the original study, but I think it does point out that there are far more important considerations.
On the whole, we see firms across the board tightening their partner ranks. Looking at the data from the study, we see both Dynamic and Static firms showing equity partner replenishment well below 1.0. For Dynamic firms, their equity partner replenishment was about 0.6. For Static firms it was about 0.5. That means that for every 10 partners leaving these firms, only 5 or 6 are being appointed to replace them. The strategy overall seems to be a reduction of equity partner ranks through attrition.
This isn’t to suggest that there will not be opportunities to make partner in the future. These law firms still need owners, and that can be found only by having sufficient equity partners. What I think we’re seeing today is a passive approach to reducing underperforming partners. Firms don’t want to take the PR hit that would come with de-equitizing partners, so they’re waiting for the problem to solve itself over time.
But as they’re looking at who they are going to elevate to partnership, I think firms will more carefully consider how individual partnership candidates meet the firm’s strategic goals and how those candidates have performed in terms of business development and rainmaking aptitude.
Thank you so much for your time Bill and for your thoughtful responses!
In summary, here are a few key thoughts to consider in relationship to Business Development:
- Investment in Business Development is a key differentiator among firms
- Efficiency can help free up time for Business Development while still meeting productivity goals
- There is no correlation on being a Dynamic Firm and whether a firm is in a primary or secondary market so don’t worry if you are in Indianapolis, Raleigh, Nashville, etc…
- With the partnership ranks tightening, Business Development aptitude is essential if you want to make partner
You can download the 2018 Dynamic Law Firms Study here.
For valuable content from legal vertical thought leaders on the business and practice of law, visit the Legal Executive Institute.
Connect with Bill Josten on LinkedIn.
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