How can you improve your firm’s profitability when you can’t charge by the hour?
Well run firms know what financial levers to pull to improve profit when they are able to charge by the hour. But where fees are fixed or capped, the financial levers are different. Firms need to stop pulling the old levers and learn to pull the new ones.
Fixed fees – are they relevant to us?
Very likely, yes. Some types of work are self evidently fixed fee, some less obviously so. Examples:
- Fixed fees as a normal method of working – such as the residential conveyance or the corporate deal where the firm agrees a fixed fee for a fixed transaction.
- Fee fixed by the market . Here, even if the firm works on an hourly basis, there is recognised to be ‘a going fee for the job’. However many chargeable hours the firm runs up, it can’t charge more than the going amount. This is a fixed fee job masquerading as hourly charging.
- Publicly funded work . Increasingly this is moving towards fixed fee. It is an extreme case of the fee fixed by the market. There is only one buyer who, therefore, has a dominant position.
- Fee fixed for part of the job . A fixed fee is agreed for parts of the job and the remainder is done on an hourly charge. For example, a company purchase where the due diligence work is done to a fixed fee but other aspects are charged on a time basis.
- Fixed fee work with a bonus or conditional element . The basic fee is fixed. Although the bonus isn’t certain, it is fixed in the sense that the amount does not depend on the quantity of hours worked.
So, firms from the smallest to the largest face fixed fees in areas as diverse as corporate finance, residential conveyancing and commercial property.
What do we mean by ‘levers’?
It’s a picture. You, the law firm manager or partner, are in a railway signal box or the cab of an excavator. Lots of levers. Confusing. Which do you pull to get the results you want? If you pull the wrong ones, will something go wrong?
Most law firms have operated mainly in an hourly charging environment for 20 or more years. David Maister identified what drives profit when a firm charges by the hour. Stephen Mayson further developed Maister’s ideas and put them into a picture – the levers of profitability (see box below).
Mayson’s levers work well for hourly charging. But not for fixed fees. The bigger the proportion of fixed fee work you do, the less you can pull those levers.
RULES
When you are charging on a time basis, the levers are R-U-L-E-S. This acronym was devised by Stephen Mayson. These letters stand for
- Rates (the realised hourly rates that the firm actually recovers, not the ones it says it charges)
- Utilisation (how many chargeable hours the fee-earners work)
- Leverage (the ratio of equity partners to other fee earners)
- Expenses
- Speed (how quickly the firm converts instructions to bills to cash)
These levers don’t work well when you are dealing with fixed fees.
What are the levers of profitability when fees are fixed?
The levers of profitability in fixed fee work are P-R-I-C-E-S:
- P is for Price. This is critically important. One extra pound on the price is an extra pound on the firm’s profits. One pound less is a pound off the firm’s profits.
- R is for Repeats. The number of times the firm does the same type of job controls how fully the firm uses its available capacity. In the short and medium term, that capacity is already committed and paid for. Repeating the job too few times is like running an airline with the aircraft partly empty. Each additional repeat – for the airline it’s a ticket sale, for the law firm it’s an additional job of the same type – costs very little. So the profit on each new job – the marginal profit – vastly exceeds the firm’s average net profit.
- I is for Per Item Variable Cost. For most law firms, the variable cost per job is low – just the stationery, phone calls and any unrecoverable expenses. This lever works, but doesn’t have an enormous effect – unless the firm has chosen to outsource, or can pay its own staff on a piece-work basis.
- C is for Capacity. This lever has a big effect but can’t be pulled quickly. In a law firm, capacity means people, sometimes combined with technology and always requiring office space and support services. Usually you can’t increase or decrease capacity quickly as it means hiring and training, or firing, skilled staff. This lever is linked to Repeats above. If you have too little capacity, you can’t repeat the job as often as you might, so you lose the profit on the work you don’t take on. If you have too much capacity, you may not be able to find enough jobs to fill it – which is like buying a bigger, more expensive aircraft and flying it with seats empty.
- E is for Expertise (not Expenses, as it is in RULES). The implications of the other levers are that you need expertise, and bags of it, in some areas that may not have seemed too important until now. See the box below for some examples. We’ll look at these in more detail, and at how you can build the necessary expertise, in the second article.
- S is for Speed. Speed, in the sense of working for a shorter time on each job, is an efficiency improvement, helping you to do more jobs with the same capacity. If (a big if) you can do the job faster with no decrease in client satisfaction, you have the financial equivalent of a free lunch – more work for no more resources. In addition, speed in the sense of doing the same amount of work but within a shorter time frame from file opening to getting paid, brings you the same benefits as when hourly charging.
New skills for fixed fee working
In a fixed fee environment, a firm needs expertise in new areas. Some examples:
- Taking on the work, both agreeing the fee and how the job will be done. This should not be left to an untrained or junior person. A large part of the profit or loss is already fixed by the time the file is opened.
- How and when to vary capacity. Mainly, this means the hiring and firing of lawyers and support staff who are both part of the firm’s productive capacity. This shouldn’t be left to ad hoc departmental decisions. It is the responsibility of the firm’s top management.
- Reducing Per Item Variable Costs and increasing Speed require expertise in knowledge management, IT and training.
- Billing is important but simpler. Finance expertise should be moved out of billing into pricing and cost management . We’ll come back to this in more detail in the second article.
In the second article, we will look at the practical steps you can take to equip yourself and your firm to pull these levers effectively, so improving your profitability in the world of fixed fees.
For further information please contact Julian Boardman-Weston
This article first appeared in Managing For Success, the magazine of the Law Society’s Law Management Section, and is reproduced with permission.
