Why Law Firms Mismanage Their Profit Margins

Too many lawyers don’t know how much profit they generate from different kinds of work they do on behalf of clients. When I ask potential clients questions about their margins, most say that they can track that information down for me. And most lawyers don’t understand why I think that they should know that number on a pretty much weekly basis. The basic reason is that business owners and margins should at least be aware of their profitability. You can’t begin to manage your profit margins and make appropriate management decisions if you don’t know them in real time.

The billable hour is partly to blame. Almost every lawyer can tell you their annual billable hour requirement. And even lawyers who work on a contingency basis tend to be focused more on revenues than expenses or profit margins. This focus is understandable. For many small firms, and for a majority of individual lawyers, the most common complaint is that they don’t generate enough of a book of business. But an excessive focus on revenues can be debilitating to law firm growth and to proper law firm management.

In my experience as a business consultant, I often see that law firm leaders tend to under invest in infrastructure and marketing. This is in part a result of insufficient attention to profit margins. Companies that properly understand profit margins are steeped in understanding the potential return of an investment. This in turn leads companies to conclude that certain substantial investments are justifiable. Well-run companies take calculated risks.

Too many law firms, however, take an unnecessarily restrictive approach to investing in projects that would substantially grow their margins. They tend to focus on the absolute level of expense rather than its potential return. They are often reluctant to spend much more on a specific budget item than they did before. But such a backward-looking approach can be fatal to growing a practice. For example, a solo practitioner with whom I started working about five years ago initially sought to generate $20,000 in monthly revenues. At the time, he was essentially a solo practitioner. Now four lawyers work for him and his monthly payroll expense exceeds $50,000. A hallmark of any rapidly growing enterprise is that its present expenses dwarf its past revenues. And that is desirable so long as the enterprise’s margins remain healthy.

Moreover, you can’t make intelligent and strategic decisions about potentially profitable investments if your financial information isn’t current and accurate. This is another benefit of focusing on margins. It will help lawyers and their key staff members collect and maintain more accurate financial records.

So how about you? What expense that you have been reluctant to incur would generate the highest return over the next year or two?