Law firms should resist the temptation to look first at what is hard to change and instead focus on things more within their control
I’ve been working on various aspects of law firm profitability for longer than I care to think about. Having worked closely with Thomson Reuters data for a great number of years, from the annual State of the US Legal Market reports to the quarterly Law Firm Financial Index updates, I’ve seen the wide variety of factors that can influence law firm profitability. And in that time, one concept has become increasingly clear to me: Law firms often overlook the easiest solutions to improving their profitability.
The tendency among law firms is to look at factors involving the client as their first option to improve profitability. As I speak with leaders from law firms of all sizes around the globe, I hear many of the same questions: How does speed of billing impact my firm’s profits? and What are the average write-off clients are asking for on invoices? or What is the average discount that firms are offering to arrive at their agreed-upon rates? And, perhaps most frequently, Do you have any suggestions for how I can get my clients to pay a higher percentage of their invoice?
Each of these questions have a common element — they all focus on the client. Now, it’s not a bad idea to focus on clients in any aspect of a law firm’s business; however, we must also acknowledge the reality that each of these questions must necessarily involve a change in the client’s behavior or mindset to affect a positive outcome for the law firm. That is an incredibly difficult outcome to make happen.
Of the common questions I listed, the last one is, perhaps, the most interesting. It’s actually the one that comes closest to what I think is the most direct solution to the problem.
Improving realization
Let’s rephrase the question. Instead of focusing on how to get clients to pay more, what if we asked, How do I improve my firm’s realization against the rates we charge? Now we’re on to something. This begs a return question, What kind of realization are you talking about? Do you mean realization against the invoice or realization against what the client originally agreed to pay you? Those two aren’t necessarily the same.
Why not? Because realization against the invoice only involves the client’s behavior inasmuch as they ask for a write-off or discount on the invoice. Realization against the agreed-upon rate involves a crucial and much more influential step in the form of pre-bill adjustments, more commonly known as write-downs.
We have written frequently on the topic of write-downs by law firms, including discussing the impact of write-downs on profitability at length. Write-downs by law firms present a much bigger impediment to law firm profitability than do client-driven write-offs or discounts. Yet law firms consistently look at the client as the way to solve the problem.
I have worked with law firms and their data closely, examining on a case-by-case basis what is impacting their ability to improve realization. In nearly every case, the amount that profitability is impacted by firm-initiated write-downs dwarfs the total amount of client-driven write-offs.
We can look at this problem in terms of fees worked (what goes into the time and billing system), compared to what is billed, and then compared to what is worked. It’s not uncommon for firm-initiated write-downs to account for between two-thirds and three-quarters of the total erosion from fees worked to fees collected.
Finding the easy button
And that is where we find the easy button for law firm profitability. By looking closely at the behaviors and mindsets that contribute to firm-driven write-downs, we can start to unpack a solution for how to turn this situation in the firm’s favor.
In fact, the legal industry as a whole did exactly this in 2020 and 2021, albeit inadvertently. During that time, firms became hyper cash conscious. Their close monitoring of the collections process led to an uptick in billing realization across the industry, and law firm collections followed in near parallel. By 2022, much of the intensity of that focus had softened and realization started to decline once again. But the precedent had been established — law firms could drive improvements in realization through a focus on internal billing practices rather than focusing first on the clients.
The importance of getting internal practices in proper shape first and foremost really can’t be overstated. First, improving internal practices has been shown in myriad examples to have a near-immediate and positive impact on realization rates and, therefore, firm profitability. Second, it’s far easier to influence behaviors within one’s own shop than to try and change customer or client behavior as an outside firm.
Let’s close with an analogy. Instead of a law firm, let’s think about a company that makes widgets. This company wants to improve the percentage of widgets it sells relative to the number it produces. More than 90% of what gets shipped to stores sells, but only about 85% of what gets made ever gets shipped. Wouldn’t it make more sense to look at why so many widgets never get shipped out of the warehouse?
You can learn more about law firm profitability here.
