This is the second in a little series of short articles, where we are looking at what is the best way to make law firms more profitable.
In the previous article, we mentioned that there are three main ways to increase profitability. They are:
- Increase fee earner numbers – just do more work
- Increase profitability per fee earner – increase the fee generated per fee earner
- Reduce overheads – cut the cost base
We examined the impact of increasing fee earner numbers, and we can see that, although it can increase profit, there is also an increase in overhead costs that corresponds with the increased size of the firm and that partly offsets the gains to be achieved from the increased fee earner cohort.
Furthermore, there is a serious problem, as the increased fee earner numbers create a cashflow and funding problem that needs addressing. So, it may increase profit, but it might damage cashflow – perhaps irreparably. Therefore, we need to look for a better way.
In this article, we shall look at another option.
Option 2 Increasing fee-earner profitability
Let us take a look at the law firm whose profit and loss account is set out below.
The firm currently has 85 fee-earning staff with average income per head of just under £60k per annum and costing an average £35k each. As shown above, the Gross Profit percentage is 40% and after deducting the Overhead costs of £1.4M, the Net Profit is 12%.
Let’s see what the Profit & Loss account would look like if we could increase the income per fee-earner and per firm. In our example, we shall aim to make the fee-earning staff 10% more productive. The only numbers that change are the top line – Income – and that change flows through to Gross Profit and Net Profit – the bottom line. Fee Earning Staff Costs and Overheads remain the same at £3M and £1.4M respectively. The figures that change are highlighted in white.
Our firm has increased its Income by £500k. Gross Profit has increased by the same figure, (from £2M to £2.5M) and in percentage terms is nearer to the 50% baseline that we are aiming for, (as mentioned in the first article in this series). Net Profit has increased from 12% to 20%.
What is the downside? Well, none really.
In the last article, where we looked at increasing staff numbers as an option to increase profitability, we modelled increasing staff numbers by a quarter. That increased the firm’s Net Profit by 60% to £960.
But it was not all good news. Adding 25% more people increased Income by £1.25M but Fee Earner staff costs also increased by 25%, which cost us £750k: and Overheads increased by £140k too, so the net effect was a Net Profit increase of only £360k – £140k less than the 10% productivity increase that we have modelled in this article.
As well as the increased Overhead costs, the bigger financial problem caused by employing more people, is the cashflow demands. In the last article, we showed that, depending upon assumptions about how quickly we bill our work and collect the cash, we would need a further £500k to fund the growth. It is hard to imagine that the partners or shareholders would find that cash easily.
By increasing productivity, as illustrated in this article, we don’t suffer from that increased cashflow or finance pressure and we don’t increase the firm’s Overheads. Our margins are greater, which adds to financial security, as we are a bit more shock-proof – in a financial sense.
How do we go about increasing productivity? The firm needs to have the right culture. One that takes on new ways of thinking and is open to change. It will not happen unless the people are open to doing things differently and to learning. It also probably requires training and especially in management skills. Management is hard. Managing well is even harder. To ensure the fee earners welcome the changes, understand what is required of them, can have someone to talk to if it isn’t working well for them and continue to drive the team forward toward the horizon set within the firm’s strategic plan, (yes, you need that too), the management needs to have the right skills. It is dangerous to assume managers are simply naturally talented.
The detail of how to achieve this is the subject of article but all the above will drive forward, and be driven forward by, techniques such as better pricing, supervision and management, automation and better workflow management, from which we get better income per fee earner per annum. You can add being more selective about the calibre of staff you employ and gradually increasing staff quality too. All of that contributes.
In the next article, I am going to look at the third option to increasing profit and largely debunk the myth that law firms don’t make money because their Overheads are too high.
Read more from this series…
Making law firms more profitable – Part 4: Real life profit improvements
This is the last of this mini-series on law firm profitability and how to effect serious improvements in Net Profit. The previous articles illustrated that there was only one sound way to improve law firm profitability, which is to improve fee earner productivity. You...
Making law firms more profitable – Part 3: The Fool’s Errand
So far in this mini-series, we have looked at two ways of increasing law firm profits. Firstly, by only increasing fee earner numbers, and Secondly by making fee-earning staff more productive, i.e., they produce more Income, per fee earner, per annum. We concluded...
Making law firms more profitable – Part 1: What are our options?
It’s a given that law firms would like to be more profitable. But how do we become more profitable? In the following series of articles, I shall point you to the key issues that you need to address to make your firm more profitable.What are our options? Luckily the...