Improving Law Firm Profitability: Top Ten Cost Cutting Strategies

By John W. Olmstead, MBA Ph.D CMC

 

In my Illinois Lawyer Weekly Online Column – and in my blog – http://blog.olmsteadassoc.com I encourage the submission of questions concerning law practice management topics. I am receiving more and more questions pertaining to partner compensation. Here is a question that I recently received concerning partner compensation in a newly minted two attorney firm.

 Question:

 Our firm has been struggling for the past couple years. We have lost three key institutional clients, had partner defections to other law firms, and have suffered financially. We were a 40 attorney firm- six years later we are ten. We are getting deeper into our credit line and we simply don’t have adequate cash to pay our bills.

 We simply must improve our cash flow and profitability. What areas of our overhead should we attack first?

 Here was my response to the question:

 Cash Flow

 Sounds like you are caught in a cash flow trap as well as overall profitability problems. There have been many law firms and small businesses that were profitable – but failed due to simply running out of cash. While you cannot escape this paradox – by actively managing your cash flow (timing of the intake of cash against the outflow of expenses) you can minimize the impact of the following traps:

  1.  Lack of Attention Paid to Financial Management. Many law firms, especially solos, often give this task a low priority on their to do list. Servicing clients and new client development are given higher priorities. There is often a lack of understanding of financial reports and statements. Understanding financial reports such as income statements vs. cash flow statements are important is providing early detection of potential cash problems requiring corrective actions. Law firms should develop reasonable monthly, quarterly, and annual cash flow projections as well as income and expense projections. 
  2. Poorly Managed Accounts Receivable. Cash is king. Law firms need to improve client payment terms and cash collections by speeding up billing cycle, getting more upfront through initial retainers, requiring retainer replenishments, and staying on top of retainers. Use your billing software reports to review retainer usage weekly, if not daily. Billing and accounting software should be implement any potential delinquent accounts and someone in the firm, or outside of the firm, should be responsible for prompt follow-up to collect all outstanding invoices. Depending on the resources available, a law firm may decide to out-source accounts receivable management and collections to industry professionals and specialists.
  3.  Heavy Investment in Client Advances. Many law firms have large investments in client advances. For firms that book these expenditures as an asset – these items will not be reflected on an income statement as expenses. Be aware of their impact upon cash flow and look for ways have the client pay these directly, and bill sooner with cost only out-of-cycle invoices. Contingency fee firms will have to cover with additional working capital or line of credit.

 Paying Invoices too Quickly. Another way of improving cash flow is to slow down the outflow of cash by insuring that payables are not paid until they are due. I find many firms simply pay invoices when the invoice comes in the door – way before they are due. Monitor payment terms and pay when due.

 Revenue vs. Expense Control

 I am often asked to help law firms design and implement profitability improvement programs. In most of my engagements the real problem is insufficient gross income and lack of sufficient investment (spending and time) on marketing and initiatives designed to stimulate client and revenue growth. For most firms increasing revenues is the most effective way of impacting the bottom line.

 Many law firms waste considerable time trying to find ways to cut a pie that is too small up differently by implementation of new compensation systems or increasing the size of the pie by decreasing costs. While unnecessary expenses should be reduced – once they are reduced a repeated effort to slash costs proves fruitless as a strategy to increase the firm pie. The vast majority of law firm expenses are fixed or production-related. The percentage of costs that are discretionary is low, typically in the 20-30 percent range, and the number of dollars available for savings is small. The available dollars available for reduction disappear after a year or two of cost-cutting, leaving the firm with dealing with the effects of further cuts on production capacity.

For example:

 Expense/Overhead Control

 However, we do find that there is waste and unnecessary overhead that eats away at profits and a cost control program is also recommended and implemented. During recessionary times such as we are currently facing – drastic cost control are often the only option. Reducing overhead can immediately and effectively improve a firm’s bottom line.

 The first step in an expense control program is to identify those areas where potential savings exist. Review your profit and loss statement. Resist the temptation to arbitrarily cutting costs which could cut the muscle with the fat and result in revenue loss as well. You have to spend money to make money – so if cost cutting is the appropriate strategy – cut the right costs. Think strategically about cost reduction.

 After you have identified areas where savings can be made prioritize and develop specific strategies and implement action plans to achieve the savings.

 Here are a few ideas:

 STRATEGY #1:  Reduce Headcount

 This is the largest area for potential savings. Downsizing is a strategy that has been used by many firms this past year. However, it can have long term negative consequences for revenue and talent management. Consider all levels – non-productive partners, associates, paralegals, and staff. Be prudent and sensitive in implementation.

 STRATEGY #2:  Reduce Compensation

 Obviously one way is to cut salaries – a strategy to be used as a last resort. A better approach is to reduce fixed salary (paying people for showing up) and add a variable pay component which will allow employees to earn additional compensation in the form of bonus for results achieved. Another approach is to freeze salary increases.

 STRATEGY #3:  Benefits

 A major area for cost savings – especially health insurance. Determine which programs are most important to employees. Do your best to protect those and reduce or eliminate programs that are less important. Consider offering more than one health insurance plan. Pay the premium for the lowest cost plan and provide options for employees to “opt up” to the better plans by paying the additional premiums. Consider increasing deductibles and requiring employees to pay a portion of the base premiums.

 STRATEGY #4:  Outsource

 Examine potential for outsourcing – from copy services – IT management – to your legal team.

 STRATEGY #5:  Occupancy

 Review your lease invoices and question increases and escalators for which you have been charged. Consider renegotiating your lease and ask for a lower rate. Reduce excess space either through a renegotiated lease or through sub-leasing.

 STRATEGY #6:  Telephone Service

 Scrutinize your bills and examine rate tariffs as well as items that have been tagged to your bill by third parties. Negotiate and ask refunds for any discrepancies or abuse found. We have seen firms receive thousands of dollars in refunds.

 STRATEGY #7:  Virtual Office

 Do you need an office at all. Many solos are working out of virtual and home offices or a combination of same. Some larger firms are reducing the size of their primary expensive downtown offices by having some attorneys work from home offices or other locations.

 STRATEGY #8:  Marketing

 Many firms actually need to spend more money on marketing. However, this does not mean that it should be wasted on sacred cows. Review marketing investments, eliminate feel good items, and insure that they are producing results. Reallocate funds.

 STRATEGY #9:  Supplies and Other Purchases

 Eliminate waste and unnecessary expenses. Consolidate with fewer vendors and solicit discounts for exclusive relationships.

 STRATEGY #10:  Develop a Budget and Financial Plan

 If you don’t have one – develop a budget and financial plan and work the plan.

 Revenue Control

 Once a firm has eliminated wasteful spending and made appropriate adjustments to the budget, further cost reductions often results in the firm reducing the possibility of turning the firm around, improving financial performance, and increasing the pie.

 Increasing revenue, while maintaining the same expense structure, is the most powerful approach to improving firm profitability. Additional revenue goes directly to the bottom line and makes a significant impact on partner profits. If the firm is able to increase revenue by10% while maintaining the same cost structure, 100 percent of the additional revenue dollars will go to the partners.

 So think revenue – not costs!

 Good luck!

John W. Olmstead, MBA, Ph.D., CMC, is a Certified Management Consultant and the president of Olmstead & Associates, Legal Management Consultants, based in St. Louis, Missouri. The firm helps law and other professional service firms improve the operations and management of their practices and the lives of their practitioners. The firm, founded in 1984 serves clients across the Globe assisting them with implementing change and improving operational and financial performance, management, leadership, client development and marketing.

Dr. Olmstead’s assignments have covered the spectrum of management issues. However, in recent years most of his time is focused on engagements helping firms with:

Dr. Olmstead is the Editor-in-Chief of “The Lawyers Competitive Edge: The Journal of Law Office Economics and Management,” published by Thomson West. He is currently serving as Past Chair, Illinois State Bar Association Standing Committee on Law Office Management and Economics and as a member of the Legal Marketing Association (LMA) Research Committee. Dr. Olmstead may be contacted via e-mail at jolmstead@olmsteadassoc.com. Additional articles and information is available at the firm’s web site:

www.olmsteadassoc.com.

© Olmstead & Associates, 2014. All rights reserved.

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