Law Firm Cost Cutting Led to Greater Profitability in 2020, But That’s Not a Sustainable Business Development Strategy

Thomson Reuters’ Peer Monitor Index, issued earlier this month, draws attention to the root of the strong profit growth with which law firms ended a turbulent year. With some practice areas, including corporate and tax work (as well as bankruptcy) experiencing around 4% growth or more, reduced demand in areas like litigation was partially offset. But those practice areas that continued to thrive despite or because of the downturn did not account for the rise in profits. The determining factor was decreased expenses.

In response to the rise of the pandemic, firms were quick to reduce staff sizes, especially when a work-from-home model made it more difficult for administrative personnel to communicate and coordinate with attorneys. Going into the second half of 2020, lawyers began to be hit by layoffs as well. Thomson Reuters notes a 1.6% reduction in attorneys, mostly at the associate level, which is comparable to lawyer job loss during the great recession.

Without conference fees, travel expenses, and other costs associated with entertaining clients, it’s unsurprising that firms could easily create a short-term dip in expenses. Overhead costs related to office space, on the other hand, might decrease on a permanent basis as firms choose to adopt partial-remote models that allow for fewer lawyers in the office at any given time.

As demand grows, firms will rebuild their ranks, and the bottom line is that cutting costs can only go so far toward increasing profits. For law firms and individual attorneys determined to not just weather the storm but continue expanding, the real triumphs will come from building their books of business. Reducing expenses may have resulted in favorable profits per equity partner last year, but it won’t carry firms forward. Each firm’s ability to bring in new clients, grow in additional practice areas and specializations, and maintain its position in the market will be the truer test.

Running A Law Firm As A Business

Many lawyers are urged to run their firms more like a business.  But what does that mean?  It can be confusing to know given the variety of scenarios in which business owners and executives justify a decision by saying “It’s just business.”

Maximizing behavior is often justified on the grounds that it’s needed to run a business.  For example, CEOs of pharmaceutical companies that have dramatically increased the prices of life-saving drugs have defended themselves by arguing that they “have a business to run.”  Likewise, the managing partner of a law firm could pay a paralegal $15 an hour and bill clients $125 an hour for the paralegal’s time and chalk up the difference to “running a business.”

In my experience advising law firms on business issues, I have rarely come across this kind of maximizing behavior.  Lawyers who struggle to run a firm as a business are dealing with a different set of problems.  They aren’t trying to identify the fullest extent to which a certain matter can be made profitable.  Rather, they are more likely not to know how profitable they are or how different practice areas differ in their profitability.  Their problem is akin to the restaurant owner who doesn’t know how much she pays for the food that is served on the $25.00 entrée.

Too many lawyers don’t know basic information about their firms, including how much money they brought in that month and how profitable they were (or not).  Likewise, they often don’t know how much money is in their operating bank account or whether that balance has increased or decreased over the last quarter.  By contrast, lawyers invariably do know how many billable hours they have billed.  This is understandable given that law firms tend to set hourly targets for hours worked more commonly than they set specific targets for revenues generated.  This is a perverse practice to the extent it causes lawyers to ignore critical issues such as cash flows and profitability.

At its heart, the admonition for lawyers to run their firm’s like a business is the desire for them to pay attention to business fundamentals.  In today’s competitive environment law firms’ continued existence depends on the ability to sustain profitability.  Nothing about paying attention to cash flow, avoiding clients who are unlikely to pay, or taking prudent steps to collect from delinquent clients, will cause a law firm to gouge their clients.  There is a critical difference between maximizing profits in a predatory manner and ensuring that the firm can serve its clients, employees, and other constituents.

So the next time you are urged to run your law firm more like a business, please take heed.