So far in this mini-series, we have looked at two ways of increasing law firm profits.

We concluded that although both options work, increasing fee earner productivity was hugely preferable: because increasing firm’s fee earner numbers also led to increased Overhead costs and, even more significantly, added hugely to finance demands in paying for the new fee earners’ salaries before they start to generate cash.  That required borrowing or partner capital.

Increasing productivity had neither of those downsides.

There remains one option that is a common cry around the Partner or Board table, which is to “Reduce our Overheads”!

Well, I think this is a fool’s errand.  If you really want to grind someone in your firm into the ground, (and I question why you would), then please give them the task of “reducing Overheads”.  They will be zealous and detailed and go at it with gusto but I sincerely doubt they will achieve very much and I hope to illustrate this in this article.

Option 3 – Reducing Overheads

Throughout this series, we have used a financial model of a law firm. We have used it to show how the Gross and Net Profit values, and their respective margin percentages, have been improved by the measures taken to improve profit.

The two previous methods increased Gross Profit and Net Profit in absolute value terms and both their respective percentages, with the exception when increasing Fee earner numbers, of the Gross Profit percentage, which remained at 40%. We saw increases in Net Profit of

  • 60%, (from £600k to £960k), by increasing fee earner numbers by 25%, and
  • 83% (from £600k to £1.1M), by increasing fee earner productivity by just 10%.

On the left below, is the firm before we start attacking the “flabby underbelly” of the firm’s overheads. I have singled out three of the headings, (PII, Accommodation and Finance), because they are normally among the most expensive in the P&L. They also tend to be ones that the firm can do little about, so they will remain unchanged by the raging torch that is to be put to the firm’s expense base! Very few firms have the market power to argue with their PII insurer, their bank and their landlords – although some flexibility may be possible from time to time.

Consequently, we can only change the “Other Overheads” sub-heading. In doing so, I have assumed a total cut of 10%.

The only lines that have changed are the “Other Overheads” line, which has reduced from £800k to £720k, and, (ignoring the “Total Overheads” line), the Net Profit line, which has increased from £600k to £680k.  The impact upon the Net Profit percentage is to increase it from 12%, to 14%.

Neither of these outcomes can be considered a stellar result and neither of them achieve anything like the results of the two previous options.

You may think that you can reduce Overheads more than 10%, and maybe you can, but even if you do, you will not make as significant an impact upon Net Profit as makes the effort worthwhile.  If you put as much effort into improving fee earner performance as you do in trying to cut overheads, your return will be vastly greater!

I do not say you should ignore Overheads.  They must be controlled and monitored.  However, a major profit drive does not start with this option.

One small plus is that it has a marginally beneficial impact from a cash flow point of view: but I don’t think it makes the “war on waste” the priority.  There is more waste from fee earner time and that is where you should wage war – but that is another article.

In the next article, we shall sum up what we have learned in the previous three and take a practical look at how to achieve profit improvement in the real-life law firm.

Written by…

Richard Wyatt

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