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The Foundation That Guarantees Law Firm Survival |
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WILLIAM C. COBB(1)
The demise of well-established law firms over the past five years
has caused me to think about why these firms have disintegrated. My perception is that law
firms have not invested the time and effort necessary to build the foundation for a
viable, collaborative partnership. These are boom times for lawyers. Most firms that have
dissolved were making money, but something was broken inside. Firms have grown to meet the
demand for legal work but have ended up as loose confederations with agendas unique to
each constituency. In addition, there are major shifts occurring in the market that will
amplify the conflicts that now exist in many firms. Any contractor will tell you that you
cannot pour a foundation in the rain. Law firms must start now to build a strong
foundation that will make the firm work as a true partnership and enable it to adapt to
the changes in the legal services market. Change cannot be broadcasted or accomplished by a report or a memo. There are too many barriers built into the current cultures of law firms and general counsel. Constructive change must come through an evolutionary process that provides for continual improvement. But, without a foundation, any change causes disruption and flare-ups that may break a firm apart. Change comes very slowly at first and then finally accelerates. For example, at two recent conferences at which I was a speaker, four hundred out of four hundred sophisticated general counsel said they would spend their time and money on a system that would:
But, when asked how they were paying their outside counsel, 97 percent of them were still paying their outside counsel by the hour. Although books, articles, and speakers have been showing counsel and outside lawyers how to use alternative billing since 1989, few are using it. By using hourly billing to pay outside counsel, there is absolutely no way to achieve all four of the above benefits. Change does come slowly! In the late 1970s, the ABA published my first book on the
planning process in law firms titled A Planning Workbook for Law Firm Management,
which describes how law firms would have to use a planned process to deal with two
significant trends. The first trend was the tremendous pressure for law firm growth from
the high demand for legal services. Subsets of that trend included (1) extension of
service to new geographic areas through acquisitions and branching and (2) diversification
through the acquisition of lawyers and their portfolios of work. The challenge was going
to be how to assimilate those lawyers into the culture and vision of the firm. The second
trend was the need to recognize and position the law firm to adapt to the external,
strategic forces that would drive future strategic positioning. They would also have to
constantly assess the shifts in their markets and lead their firms through an adaptation
process. As leaders, they were going to have to make some tough choices on how they
allocated the scarce resources of their law firms to those clients and practices that
would ensure viability and continued profitability. Unfortunately, very few firms created
a process to deal with these issues and to make their foundations stronger. Firms today must face the changing competitive environment brought on by (1) the changing tactics of old competitors; (2) the increasing power of clients who will define service quality in their own terms; (3) the entry of new, low-cost and niched law firms into the market; (4) the introduction of a new mix of professionals with different views on what constitutes quality of life; and (5) the entry of substitute providers into the market that provide services law firms have historically provided. Michael Porter1 published an article titled "How Competitive Forces Shape Strategy." The article addressed the shifts in the market that were driving the strategies of companies in the 1970s. The shifts that affected companies have now affected the CPA profession and the medical profession and are now affecting law firms. Each of the forces will require law firms to shift their entire service delivery and compensation systems to be responsive. The shift will require a foundation built with a vision; the investment of time, talent, and money; and a disciplined, evolutionary change process. Vision In order to make some of the tough decisions in the allocation of resources and the evaluation of partners, firms must have a vision and strategic direction to which they can tie their leadership decisions and avoid personality conflicts that come when no vision is in place. Most firms have not taken the time to develop a vision that will hold the firm together during the tough times. As a result, when a few partners decide to leave, other key lawyers in the firm have nothing to glue them to the firm except the money and the lease-that is not enough. If a firm does not have a strong foundation, it will not be able to hold together during the tough times; when the tide rises and the rains come, the firm will wash away. What are the warning signs that indicate a lack of vision? Here are a few. Very little guts to deal with partners who are not making a contribution to the firm's vision. There are partners who are hoarding their clients and the work that comes from those clients. There are many constituencies in the firm pushing their own agendas and using political maneuvering to get their people on the executive and compensation committees. The executive committee seems to abdicate too many decisions to the whole partnership and/or, too often, produces a majority and minority opinion on its decisions. Partners in the position of leadership do not walk their talk. Investment Every firm must build not only cash capital but emotional capital. Lawyers must have a reason for working so hard for clients. If lawyers perceive themselves as simply cogs in the wheel, they will bolt at the first wave of adversity. Many firms have increased the hourly quotas for lawyers to increase revenues instead of investing in the training and project management skills required to increase revenues. As Dilbert phrased it, when truly honest professionals are faced with increased quotas every year to keep up with the demands for earnings, they will see only two options - deceit and treachery or the trailer park. And so files begin to get bloated with hours of work that add little value to the client. Evolutionary Change Lawyers will not embrace change until they have gone through a transition in their thinking. First, there must be a sense of urgency that convinces partners that doing nothing is far more dangerous than doing something. The second stage of recognition is when partners realize that the conditions out there apply to them and will affect their own practice. Third, they will try to assume the problem away when they weigh the pros and cons and see the concessions that must be made. Fourth, they will have to see examples that provide precedents they can follow. Finally, they must have a checklist that guides them through the change process yet allows them enough flexibility to adapt the process to their own firm's culture.
IS YOUR FIRM IN THIS STORY? Besides the natural paranoia that every professional feels about his or her future productivity, there is something else happening. The demand for legal services, which took off in the early 1970s, pushed many firms into a growth mode in which their culture and vision could not keep up. The firms ended up with lateral partners who brought their personal problems from their former firms, partners who grew up under the tutelage of partners who operated as solo practitioners or "shark" partners, who developed a warped sense of what creates firm profitability, and partners who could not or would not perform management tasks essential to the long-term viability of the firm. An example of the last type of partner includes the person who says he or she is too busy to train associates, manage projects to minimize write-downs, send out bills, set up engagement letters with clients, market for new clients, and fulfill other critical responsibilities of a partner in a successful law firm. Such a partner assumes that because he or she is a "big biller" that he or she should be exempt from having to perform these management tasks. Law firms should have gone through the same transition that Donald Clifford2 outlined in his article on the growth pains of an organization. Unfortunately, the crisis in the profession today is due, in large part, to the fact that most law firms did not pay attention to the principles described by Clifford and described below regarding five levels of maturity: (1) Growth causes an exponential increase in complexity, (2) that complexity requires the learning of new skills, (3) the new skills require coordination through a more formal structure, (4) the structure creates people problems when people do not perform as expected, and (5) tough decisions on evaluating contribution cannot be performed without a credible vision. Let's walk through each of them and their implications. 1. As a firm grows, the number and complexity of issues grows exponentially. The number of individual needs of clients, the partners, and the employees grows with each new addition. As an administrator with a law firm in the early 1970s, I came up with the following formula for dealing with committees: x ' 2y where "x" is the number of potential positions that must be argued and "y" is the number of people on the committee. Therefore, if you have four people on the committee, the number of positions that must be argued is sixteen. It doesn't take long to run out of time. Just ask a group of college professors who serve on collegial committees how long it takes them to make a decision and why they detest serving on them. 2. As the number and complexity of issues increase, new skills must be brought in to deal with the issues. Some of those skills included human resources, systems, finance, and specialized legal talent. But, growth also requires lawyers to acquire specific skills. Included in those skills are:
3. In order to get these skills to communicate and work synergistically, the firm must have an organizational structure that ensures that most tasks will be handled automatically and that the exceptions will be handled by those most capable. This organizational structure can also be called governance because it must incorporate who must do what within what authority and how those people will be measured in the performance of their responsibilities. For example, certain lawyers have to be accountable for practice groups, sections of lawyers, or client teams. 4. When a structure is in place and expectations are communicated and understood, problems will develop when people do not perform as expected. Some in the firm will not know how or will not be willing to commit to the effort required to fulfill their accountability. The structure and expectations will create problems in reviewing and evaluating performance. Of course, a system of evaluation that measures a lawyer's contribution based on the number of hours he or she bills frustrates the effort. Above a reasonable expectation of billable hours, the firm must ask lawyers accountable for critical tasks to perform to expectations. If they do not, then tough decisions must be made. 5. When people problems occur, leadership must deal
with them in the context of a common vision of where the firm is going and what a lawyer's
role must be to add value to the clients. It is hard to force a lawyer to do
anything. Only an agreed-on, common vision accepted by leaders of the firm can be used to
demonstrate where a lawyer is not pulling his or her load.
So what is a foundation? How do you know when you have one? The building blocks of a foundation are (1) a vision, (2) a collaborative partnership, and (3) an ongoing process to refine the strategic direction of the firm and the allocation of firm resources when resources include leadership time, firm reputation and credibility, experience and expertise, accumulated knowledge, the time of lawyers and staff, facilities, and money. VISION Karl Albrecht3 has done an excellent job defining what makes a vision statement valid and useful. A vision statement: 1. Is a focused concept. This must be something beyond platitudes. It must be a statement of how the firm creates value for its clients, its partners and its employees. 2. Provides a noble purpose for being in the law firm. The statement must be something that is really worth doing. It must be something that can create value, make a contribution, make the world a better place in some way, and win the commitment of people in the firm. 3. Has a plausible chance of success. The vision must be something people can realistically believe to be possible. Here is an example of a vision statement that is focused, shows a purpose for the firm, has a plausible chance of success, and shows how the firm will add value: To be the leading firm on the West Coast in providing management-oriented solutions to complex corporate legal issues faced by sophisticated businesses and industry in the region. This vision forces specific decisions. For example, to be the "leading firm," the firm had to, for its client base, be on the short list and be perceived as innovative and progressive. This meant that the firm had to anticipate and be out in front of the clients' needs. The firm set up periodic and meaningful interviews between client relationship lawyers, clients and the teams supporting the clients in order to propose solutions to client problems before the client had to ask for them. In addition, associates had to be trained to negotiate and manage the scope of work for client management. "West Coast" required the firm to build its credibility in that region and avoid spreading its resources all over the United States. "Management-oriented" meant that the firm had to provide the bundle of services that described problems as sophisticated management would describe them. For example, the firm could not define the problem in terms of a lawyer's specialty (e.g., tax law), but rather as the client would describe the problem. This forced the firm into multi-disciplined teams. Team performance, not individual performance, became the important measure of success. The vision also required the firm to allocate its critical resources to those services that were core to the firm services and compatible with where the firm already had credibility. The firm had to help its clients develop in-house capabilities for commodity and high-volume work. The firm also had to help the clients develop the in-house capability to deal with issues that were perceived to be core to the business strategies of the clients. By breaking the vision statement down into its smallest elements, a law firm should be able to continually ask the following questions. Given our vision, what improvements must be made to the firm's staffing and training, organization for delivering services, and accountability of client relationship lawyers and lawyers managing matters and lawyer performance evaluation? If this is our vision, how is the committee meeting or partnership meeting discussion moving us toward that vision? Collaboration What is a "partnership" versus what has it become. Partnerships are joint ventures with a common vision. In other words, they represent individual or individual entities who join together under a common vision and are accountable to one another for the accomplishment of that vision. The word for this is collaboration. Unfortunately, what many law firms have become is collegial, that is, a group of lawyers bound together by a common profession to share knowledge but independent in their actions in serving clients. True and successful partnerships are first collaborative and then, when that collaboration works, become collegial. In their efforts to stay collegial, firms have abdicated their collaborative responsibility to serve clients. A Planning Process Every firm with a strong foundation has an ongoing process that creates a forum for objective evaluation of where the market is taking the firm's clients and the relationship between the firm and its clients. The process is used to refine the strategic direction of the firm and set criteria for the allocation of firm resources. The steps addressed in the planning book include the following. First, objectively assess the current environment of the firm including the client perceptions, emerging client needs, and trends in the market served by the law firm. Second, reach an understanding of the positive and negative implications of the changes in the environment on the firm's competitive position, practices, and economics. For example, a question that must be asked is: What would happen to our competitive position with clients, our practices, and our economics if trends were to continue? What should be done to capitalize on the opportunities and counter the threats? The next step in the process is to select those strategies and efforts that will produce the highest returns on the investment of firm resources. Finally, the process calls for core coalitions of people to address and create a precedent for the solutions including a demonstrated set of benefits for lawyers and staff members, the firm, and the client. Leadership of the firm uses the planning process to evaluate progress, sustain the change process, and integrate positive change into the fabric of the firm's culture. At the end of a designated period, usually one year, the process begins again.
BUILDING THE FOUNDATION IN PHASES There are seven phases of effort that build foundation that will hold a law firm together during the coming storms. Each is discussed in detail below. There is no quitting point in the phases of effort. Each phase follows the one before it for each major change the firm is seeking. When Phase 7 is finished, go back to Phase 1 to reinforce the vision and start down the path again. Building and maintaining a foundation is a never-ending effort that will require constant attention from leadership. Phase 1: Creating and Refining the Vision Create a vision that the leaders and then others in the firm buy into as the firm's purpose and the value the firm adds to its clients. The efficient way is to ask your key partners to tell the stories of the values they respected in their mentors in the firm. Add to this their perceptions of what the most significant and loyal clients of the firm desire in both technical and service quality. The final questions to the most respected lawyers in the firm are why do they practice law and what is the role of the firm in the community. From these stories, we pull down fragments that fill in the short vision statement. Fig. 1. SKILLS AND TOOLS: CRITICAL ELEMENTS IN DISTRIBUTABLE INCOME
Phase 2: Understanding the Nine Elements of Firm Profitability Teach the partners and then others to understand the basic elements of economics in the firm. There are only nine and they must be addressed in the context of vision. The nine elements of distributable income for partners may be shown in a simple tic-tac-toe chart. The three elements in Figure 1 that create accrued revenues are leverage (L), pace (P) (i.e., billable hours) and benchmark rates (BR). The benchmark rate is different from the standard rate. The benchmark rate is the expected return on an hour of a timekeeper. The accrued revenues for a law firm of 100 time-keepers with 50 partners, with an average pace of 1,800 hours and a blended benchmark rate of $150 would be $27 million [100 x 1,800 x 150]. On a per partner basis, the accrued revenue would be $540,000 [(1+L) x P x BR]. The bottom line of Exhibit 1 shows the cash flow out of distributable income. The line contains expenses (E), investments in assets (I1), and investment in work-in-progress and accounts receivable (I2). For example, if expenses are $10 million ($100,000 per time-keeper), expenses per partner would be $200,000. If investments in assets were $400,000, that would be $8,000 per partner. If the balances for work-in-progress and accounts receivable had gone up by $2 million that would be $40,000 per partner. Total flow out of potential distributable income per partner would then be $248,000 (E+I1+I2). The middle line of Figure 1 reflects the real leaks in the system. These numbers represent realization on benchmark rates. R1 is the leakage from giving discounts to clients off of benchmark rates. R2 is the leakage from writing down or writing off time during billing. R3 is the leakage from discounts given to clients to get them to pay part of the invoice. For simplicity, I have not included the time value of money in this example. If R1 is 95 percent, R2 is 90 percent and R3 is 97 percent, the overall realization rate would be 82.94 percent (R1 x R2 x R3). The result is that the net revenues would be $540,000 times 82.94 percent or $447,876. Distributable income per partner would be $447,876 less $240,000 or $207,876. The emphasis is on improving realization. For example, an improvement in realization in the above example to 90 percent would have meant $486,000 in net revenues and an extra $38,024 per partner. Volume means nothing without realization. A law firm can have a high volume of hours, but if realization is only 60 percent, the firm above would have produced only $324,000 in net revenues and $84,000 in distributable income per partner. Phase 3: Selecting the Investment Areas With an understanding of what can be changed, the leadership can identify where the firm is going to invest its time, talent, and money to improve the nine elements through the next four phases. The "watershed model" has been developed to help law firms select where they will invest their resources. This model shows the impact of change in specific areas over which the firm has some control. In Figure 2, I have created a picture of the flow of processes that affect realization. Think of the flow of work to a client as a river of services into which flows all those efforts that add value to the service and make the stream pure. If the river is perfectly clear and the firm meets the expectations of the client, realization will be 100 percent. Every time something upstream in the watershed pollutes the river, realization goes down. Using the watershed analysis, a firm's leadership can assess where the biggest polluters are upstream and correct them in an evolutionary, nonthreatening way. Fig.2. THE WATERSHED-IMPROVING DISTRIBUTABLE INCOME
Improving the value added in each stream of effort in the watershed improves the purity of quality legal service and client loyalty, improves realization, and lowers overhead per revenue hour worked. For example, in one $50-million firm, realization went up by one percentage point and generated $500,000 of additional distributable income. To the surprise of the firm, overhead was also reduced by $60,000 through reduction in salaries and overtime. Selecting where to allocate leadership resources in cleaning up the stream must be based upon a strong vision and strategic planning process. Looking from the client upstream, the pollutants closest to the client are more visible and the easiest to correct. But their impact on realization in the long term is much lower. Moving upstream, it is harder to visualize and fix the polluter. Yet, the long-term impact is much more significant. For example, partner accountability is very difficult to improve but it significantly improves intake. Effective intake ensures higher realization by confirming that financial arrangements with the client are understood and reduces overhead by eliminating the number of financial people required to chase bad accounts. The following is a small sample of the areas from Figure 2 that will make the quality of service go up, realization go up, and overhead per revenue hour come down. Starting at the spring in the watershed and working down the stream:
Phase 4: The Learning Organization The firm must move from Phase 4 and continue through Phase 7. A firm cannot start at Phase 7. Any firm that starts there is doomed to the same failure as those firms that created "eat-what-you-kill" compensation systems. Such firms have degenerated into a confederation of independent law firms in which the most powerful partners run their own firms to the detriment of client service and long-term firm success. In order to demonstrate these phases, I have provided several examples. There is one common thread in these examples. Each is tied into a program selected from the watershed model to improve realization of the firm's competitive position. The starting point is a learning organization, one that is willing to innovate and take the risk of change. Some examples of law firm actions will help illustrate what a learning firm is supposed to do. The first firm encourages and rewards lawyers who take risks and, inevitably, make mistakes. In this firm, every associate was encouraged to make at least one mistake a day in marketing efforts. That way, as associates became partners, they had gained the experience to be very effective in their marketing efforts. As with snow skiing, "if you're not falling, you're not learning." Another firm asked lawyers to spend at least 10 percent of their time in planning the project they have been assigned. Those hours are counted as billable and, more importantly, value added. Of course, some fake it but the measurement of their realization (return on standard rates) immediately identifies those who are not performing. As lawyers become more accomplished at planning and managing projects, the return on the rates of those on their team has continued to increase, producing higher income to the lawyers and staff. A third firm created a project team to focus on raising the realization rate of the firm to improve client service and to improve client relationships. This required the team to spend time formulating an action plan, selecting specific matter-type processes that could be redesigned, and then creating the models required to improve the efficiency. The team had to overcome barriers of resistance from others who could not see how the team could be focused on efficiency if it would drive down their billable hours. Leadership supported the team by giving them a bonus on the improved realization they were able to create. A New York firm has a strong enough culture to allow all employees in the firm to evaluate their summer associates. Although a lawyer may be impressed by a summer associate, the staff has insights into the way a summer associate may fit into the culture of the firm and has the opportunity to evaluate those associates. One partner reported that up to 20 percent of the summer associates are eliminated by staff evaluations. A fifth firm has the executive committee review and evaluate partners with a copy of the vision in hand. When evaluating a partner throughout the year, the partner's performance is evaluated based upon the objectives the partner set in improving realization of time-keepers who work with him or her. Those objectives were set within the context of the firm's vision. When the partner discusses his or her contribution, the executive committee asks how the partner's actions contributed to the vision of the firm and bores in on specifics. Phase 5: Demonstrate Internal Improvements Identify and demonstrate internal changes that improve the quality of the practice to all in your firm; from partners to interoffice mail couriers. Everyone in the firm must recognize the benefits from Phase 4. Here are some examples. The process of change employed to improve realization through quality management of work produced real and documented benefits for those on the team. Members of the project team could see that the management of their work effort was more directed and focused. They could see their roles in the overall project plan. Drudgery work was put into a substantive system and done by others with lower rates and less experience. Team members felt they were tied into the overall project plan and could see the value they added in solving the client's problem. Knowing where a firm is going gives confidence to people. The fact that someone of greater experience is leading provides security. Through a planning process, a firm set its vision. The vision and its implications on how the law firm would serve clients with collaborative efforts of everyone in the firm provided a sense of why people were there to provide legal services. Everyone became focused on efficiency of effort that drove client fees down and realization on rates up. Enthusiasm was up and the mutual support among people in the firm became part of the culture. The changes demonstrated in the firm began to change the attitude of lawyers who would not have invested time in the firm before. Now they saw a future. Emotional equity went up and the ability to get partners to invest their time and money in the firm increased. Phase 6: Client Recognition Identify and demonstrate the changes that improve the quality of service to clients. Clients must recognize and appreciate the changes that come from Phase 5. Clients would see the benefits through lower fees, lower cycle times, and lower internal budgets and the use of resources. The enthusiasm of people in the firm to perform for clients based on the firm vision, and personal missions that supported that vision, translated into benefits immediately visible to the clients. In addition, the improvements in realization through the re-engineering of the way in which services were delivered came from a team effort. Those efforts, outlined in the paragraphs above, created the following demonstrable client benefits.
Phase 7: Demonstrated Financial Rewards The clients felt that the firm was far more responsive to their needs and believed the firm was working to improve the position of the client. Clients had fewer arguments about rates and the time invested in a file. As realization increased, the distributable income per partner went up. Because this firm did not move to some quick-fix financial performance measures such as an eat-what-you-kill-system, it avoided the disruption and internal competitiveness that come with such a system.
SUMMARY The situation is urgent for law firms. They must begin to rebuild their foundation for the coming changes in the legal services market. Without a strong foundation, the tides of change and the storms of crises created by the movement of lawyers and the individual demands of lawyers with different visions of their future will wash away the firm. A true foundation will contain building blocks of vision,
collaboration and a disciplined process for constantly improving the quality of service
provided to the clients. Building that foundation will take time. Building that foundation
must be done in an evolutionary way that will produce revolutionary results without
shocking the culture, core values and vision of the firm. NOTES 2. Clifford, Donald K., Jr., "Growth Pains of the Threshold Company," Harvard Business Review, September-October, 1973. 3. Albrecht, Karl, The Northbound Train, AMACOM, American Management Association, 1994. 1. William C. Cobb
is the managing partner of the WCCI Inc. (William Cobb Consultants) based in Houston,
Texas. Since 1978, he has been a consultant in strategic issues affecting law firms and
general counsel and helps them improve their competitive positions. That counseling
includes the assessment of the impact of trends in the market; pricing services and
alternative billing; practice management; firm governance and structure; partner review,
evaluation, and compensation; and similar subjects of critical importance to law firm and
legal department leadership. E-mail: cobbwc@msn.com All rights reserved.
For further information, please contact William C. Cobb at the address below. WCCI, Inc. v Cobb Consulting Group Send E-mail to: CobbWC@msn.com |
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