Redwood Analytics

Very few firms today are 100% utilized. Almost all attorneys within a firm have free capacity, and depending on the firm, this can be a large cost. With profits dropping, layoffs and delayed start dates for first year associates have been seen as a short term solution to increase profits. This may be an effective way to address utilization concerns and bring profits back up to levels that law firms have experienced over the last five years, but it may also have some long term effects related to production.

Cutting nonessential costs and addressing inefficiency is necessary for a firm to produce higher profits, but inefficiency should be addressed at all times, not only when profits are down. Due to the recession and prices being much higher than equilibrium, clients are no longer willing to pay (or cannot afford) the rates law firms are charging.

So what is the solution? Firstly, although the economy may not turn around as quickly as we would like, it will improve, and the demand for legal services will too. The way I see it, law firms have two options in the short term to address lower profits and free capacity: increase revenue by bringing in more work, or decrease costs through a reduction in headcount. Both will result in higher profits in the short term, but let's discuss the long term impact of each.

Increase Work

No one will argue that demand is down for legal services - whether that is due to the current state of the economy or pricing. Clients can no longer afford (or are not willing to pay) the high rates that are being charged for an hour worked, especially non-partner work - thus causing capacity concern at most law firms. In order to bring revenue up, law firms can begin to accept lower rate work. If an attorney has capacity to do lower rate work, then what is preventing him or her from taking it on?  This can help cover a portion of their costs and bring more revenue into the firm. Even work that is only charged out at $100/hour is still better than having an attorney that is working only 60-80% of capacity and not bringing in that extra 20-40%.

Reduce Headcount

Since the basic model for profit is revenue minus costs, layoffs and delays in first year start dates can increase profits by reducing total costs of the firm. If this is the option you choose, it's important to remember that the best way to improve profits through this method is to address the inefficiency that is controllable by the attorney. A junior associate does not have full control over the work that he/she is doing - most of the time it is assigned to them by a senior attorney.  Take a look at all attorneys within your firm; are the utilization concerns being driven by the fact that Partners or more senior attorneys are hording work and not passing work down to the younger associates?  If this class of associates is producing quality work eliminating them may not be the panacea you are seeking.  Inefficiency occurs throughout all tiers of the firm, and in order to increase profits through layoffs, you should identify the attorneys that have the most revenue loss, not just attorneys with low utilization.  You may be surprised to find that your partners are driving more revenue loss than you thought!  Now I understand that letting go of a partner is not as easy as an associate, but advocating the illusion that partners will never be asked to leave will only encourage poor behavior.

Both solutions are short term strategies to increase profits, but if you are looking for a way to increase profits in the short term and setup an environment for future growth, accepting the lower rate work would be preferred. As I have stated, the demand for legal services is down - and mostly due to the economy and prices not being at equilibrium. Laying people off will decrease costs, raise PPP, and improve firm utilization...but what happens when demand goes up? The firm will no longer have the capacity to do the work out there. I realize the easy answer is to hire more attorneys, but attorneys are not like ingredients of a cake. You cannot go out and buy more attorneys like you can eggs if the demand for cakes goes up.

Recruiting takes time and effort.  Not to belittle the value of an attorney's credentials (grades, LSAT scores, school degree, etc.), but many factors that firms look to when hiring cannot be conveyed on paper: personality, charisma, people skills, and how he/she fits in with the culture of the firm. Many of these attributes can only be realized through personal interaction (multiple interviews or a summer associate program.) Not only will this raise recruitment costs in the future, but also cause a lag period (opportunity cost) from when the demand for work is up and the time the attorney is hired and producing quality work (and this is just for lateral hires. For new associates, it may be many years before you are getting the return on the investment.)

I am not suggesting a firm keep all of their staff when they are underutilized...merely suggesting that if demand is low due to market forces, it might be best to forego high profits in the short term in order to achieve higher profits in the future. Having underutilized attorneys performing lower rate work will help cover a portion of costs and allow them to practice law and further their expertise - increasing human capital. And if you are to look at the top firms in the country, they seem to support this claim as they are not delaying first year start dates.

That being said, it is also important to remember that underutilization should always be addressed. If you do not have the workload for the amount of attorneys on staff, the obvious answer is to trim the fat, but not just to increase profits. Cutting dead weight should be a way of improving efficiency, not improving profits by cutting costs. The byproduct will be more profit, but that should never be the goal when addressing capacity.

--Brian Taaffe

Brian is a Senior Consultant in the Business of Law group at Redwood/LexisNexis.