Beware temptation: Is low-cost volume work right for your law firm?

 

Clients are putting us all under pressure and many now demand that routine work is delivered at a far lower cost. It is tempting to agree to these demands. It is also tempting to persuade yourself that, if you do enough of this work at a lower cost, you will make the same profit that you used to make from a smaller volume of that work. This is a very risky strategy.

It does not follow that your cost base can generate the same profit by doing more of the same work at a lower charge to the client. Some partners, fearing the loss of clients, may whisper in your ear that the firm must accept a loss on some work to keep clients happy. Beware these siren voices. If you take on work as a ‘loss leader’, you will find that your business is on a slippery slope.

Before giving in to temptation, take ?a blank piece of paper and have a careful look at whether you can deliver volume services without restructuring your business model. Below is a checklist of practical issues for UK law firms ?to consider.

Getting started

1. Review strategic objectives

The first step is to review your strategic objectives for the business. You should then draw up a detailed business plan that identifies your targets in the marketplace and has a detailed and realistic cashflow, together with a funding requirement, profit model and repayment/exit strategy.

Most firms do not have any significant practical experience of running a low-cost business model successfully, but with experienced support it will be possible to generate a plan supported by numbers.

You will then have to sell the idea to your firm, not just to the partners (who will be concerned about profitability, reputational issues, investment and risk), but also to those who may be part of the service delivery team.

2. Secure funding

Using the business plan, you will need to secure capital from those partners who wish to invest and/or external investors.

Law firms generally have very little capacity for investment from current resources since most follow the ?prevailing business model of drawing out all profits as fast as possible. This means that there is likely to be little appetite amongst most of your partners to invest either by leaving profit in the business or through a cash call.

The firm’s bank can be approached, but may require security or new capital from partners. So, if significant capital is needed, you may have to find it from external sources using an alternative business structure (ABS) company as ?the vehicle.

3. Set up an ABS

Next, you will need to set up a limited company and apply for ABS status.

You will then have a vehicle that can take on investment and that gives you the opportunity for it to be sold or floated.

4. Get professional managers

You should appoint professional managers who are experienced in low-cost volume work. Such skills will not necessarily be found in your firm, because the experience needed is in process management and cost control. Most partners have neither the training nor experience to undertake this work and, even if they could be trained up, they are too expensive to undertake this level of work.

You will need to create an incentive scheme for management and set targets for them. The scheme should be designed around performance-based bonus payments and exit awards.

You must give the professional managers the authority to run the business in order to meet their targets. Partners will have to accept that, for such an enterprise to be successful, the people who know how to run the business must be given the authority needed. That will include the power to hire and fire, as well as to set targets and rewards, without reference to the partners. Without appropriate authority, the managers will not remain in their roles and investors will not invest.

The firm’s management should have an oversight role to ensure the business ?plan is being delivered and targets are being met.

5. Choose a site

You will then need to identify a site to set up your business where overheads are low but there is a supply of appropriately skilled labour. This is a challenge for many firms because of the high fixed costs of the central city locations that they occupy.

Many competitors will have fixed costs up to 80 per cent lower than a London firm. If you believe that the service must be run from expensive premises, then either other costs have to be reduced dramatically or other areas of the business will have to subsidise the service.

If you can operate from bespoke premises in another part of the UK, ?the business will cover these overheads as it grows. But, if work moves from your current location to a new location, you will have to find new higher-cost work to replace the departing work in order to cover the reduction in revenues ?and profits.

6. Invest in technology

You should identify and cost the IT ?systems and the workflow system that will be needed. The legal services to be offered must be broken down into ?low-cost processes.

An important part of delivering a seamless low-cost system will be your workflow processes. Your current systems may answer some of these needs, but there will probably be a need to purchase bespoke software.

There are many systems available. While some elements of the services your firm offers may be bespoke and complex, as much as possible they will need to be based on standardised correspondence and documents so that they can be provided by lower cost, lower skilled staff.

7. Consider staffing

It is vital that the staff who will be delivering your new volume services have the requisite skills and experience. As many of the staff as possible should be paralegal or clerical staff with support provided, as needed, by lawyers. So, new staff may need to be found.

Your present legal staff, including partners, will be highly paid and have significant benefits and support costs (secretarial and other support), so your firm has likely had to charge significant rates to generate a profit against their cost base. These rates can be reduced if the common financial model of aiming to bill around 5.5 hours per day is increased to a much greater figure.

But, increasing hours assumes that there is work to do. Also, if one group of lawyers is expected to generate significantly more hours than another group with similar skill levels and rewards, the first group will be expecting higher rewards (pushing up fixed costs) or they may leave.

In reality, a volume service must be staffed by as few lawyers and partners as possible. The labour force must be engaged and you should ensure that employment terms are flexible and with minimum benefits and rights to ensure minimum cost. Some staff may need to be engaged on short-term contracts or part time or on a freelance basis. The employees will also need training.

People will be your main cost of delivering volume services. It will be necessary to bring that cost down significantly. Some high-value work could be brought in by the company from your existing lawyers and partners at agreed rates under a service level agreement.

But, to allow the service to generate profit within the existing structure, much of the work will need to be carried out by low-cost paralegal or clerical employees. There should be minimum supervision by your lawyers, because any time spent by lawyers pushes up costs. Staff will need to multi task, support themselves and use the workflow processes. This is a different way of working than most lawyers are used to, so your lawyers who will work in this service may need training so that they work more efficiently and economically.

8. Cost your services

Next, you will need to cost your services.

The general business model for law firms is for revenues to be broken down as follows: one third for the cost of service delivery; one third for overheads; and one third as profit.

A successful low-cost operation is more likely to work on ratios such as 60/30/10, with a low profit margin on volume work that only passes breakeven after a certain critical mass is achieved.

Thereafter, if managed well, your service can become highly profitable, but generally only for a small number ?of people.

9. Consider low-cost solutions

Tendering for support services such as HR, training and financial support is important. You will need to look for businesses experienced in providing low-cost solutions and in offering lower costs and flexibility. The individuals providing these services will often not be on your payroll, thus reducing your risk.

City support costs are high. You should find low-cost solutions from out-of-town contract providers. They will provide their services only when needed, often via a helpline.

Price will be more important than quality to you, as we have learnt from the approach of many clients. While your firm’s support staff may offer a better, more bespoke service, they may not be able to compete on price. This may then lead to redundancies in your support staff and service levels may drop, which may not be acceptable to other parts of your business.

10. Form a sales team

New business will be the lifeblood of ?your volume business, so you should engage a sales force on a self-employed commission basis.

There may be some of your lawyers who can sell the business and who will need to be the face of the service to the clients. But, a low-cost volume business will only thrive if new work is constantly being generated.

A sales team charged with ?generating and building leads will be needed. At present, few firms have this resource in house, so you will likely have to invest in a sales force. You should remunerate the sales force largely through commission in order to motivate them and keep costs down.

11. Use an ‘open book’ system

Be prepared to engage with your customers or tender using an ‘open ?book’ system. Many clients want to understand the business model of their suppliers and expect to work together on an open book model.

As the service grows, you can create further growth by finding efficiencies and economies of scale, and so reduce the rates charged to your clients and thereby win more business.

At the end of the day, what ?many clients are now looking for is the lowest possible price, on the basis that quality and risk are problems for you and your insurers.

12. Assess the risks

Finally, you will need to review the regulatory issues and negotiate ?insurance terms.

The current outcomes-focused regulation allows for greater flexibility in ?UK law firms’ business models. But, if quality is compromised, it can put more ?of that risk on you and allows the regulator to place the blame for quality failure on ?the firm.

In the same way, insurers will look closely at the new model being used by your firm to ensure your firm knows what it is doing, that the model is robust, is well thought through and is not going to cost the insurers any money. Insurers may seek a higher excess from you to reduce their risk profile.

Both of these issues add costs to the volume service and there may be a need for you to develop more sophisticated risk management processes to deal with these issues in an economical way.

Need for planning

The logical route for business planning is for you to: ??

1. decide which services your ?clients want;

2. design a model that will deliver those services; and

3. test the model against the marketplace and your existing model to see if it will fit within your current structure and the strategic aims of your business. ?

Having identified a business model for low-cost volume work that can generate profits, the challenge is whether your firm can replicate this model from existing resources and, if not, how much change is needed to deliver such a service.

Your biggest risk is that you fudge it. A major change in the way that you deliver services requires capital investment, strong management and teamwork. These are all challenges that many lawyers are not good at addressing.

If you succumb to the temptation to muddle through and you offer low-cost work as a defensive move, you risk doing so at far too high a cost to generate any profit and you may put your whole business at risk. Beware temptation.

?Guy Vincent is a partner and the former managing partner at UK law firm Bircham Dyson Bell (www.bdb-law.co.uk). He specialises in legal and management issues facing law firms