STRATEGIC THINKING IN A DOWNTURN

Effective management in a downturn requires a combination of strategic thinking and sensible financial management working together. Alan Hodgart provides some timely guidance.

The last serious downturn in the UK economy occurred in the early 1990s. While the bursting of the dot.com bubble in the early 2000s severely affected some firms, its overall impact was short in duration. Following the early 1990s downturn, it took six years before the average profit per partner of the 25 larger law firms reached the peak prior to the downturn: it took two years in the early 2000s.

Is the UK heading into a minor downturn, a serious downturn or a recession? No one is quite sure at the moment, although opinion is favouring a serious downturn rather than a recession. (We define recession here as a real decline in GDP over four successive quarters). Most managing partners of UK firms were not in that role in the early 1990s and there is a concern, and a real danger, that the mistakes made back then will be made again.

There is a view prevalent in business that economic downturns are inevitable. In each boom, the major decision-makers are generally not the people who managed their businesses in the previous boom. The same mistakes are made again and the cycle turns down: the problems are sorted out and it starts all over again. While this may be an over simplification, there is some truth in it. The same can be said for a downturn; businesses take longer to come out of a downturn because the mistakes made in the previous downturn are repeated in the next.

Effective management in the down-phase of the cycle requires a combination of strategic thinking and sensible financial management working together. This is true even for firms who enter this part of the cycle in a somewhat weaker position than competitors: think strategically before implementing any financial policies.

Two over-riding points that run through our advice in this phase of the cycle are: first, do not embark on a cost-cutting exercise until a strategic game plan has been developed; and, second, be prepared to spend more money on some things while reducing other costs. Both of these points add up to the need to consider how to add value to the business even in a difficult market.

The starting point is with the firm’s strategy. This is where firms with a clear strategy for building a competitive market-position have an advantage over those that lack strategic clarity. The former can embark on an assessment of the risks to that position by a downturn as well as assess the opportunities it creates. This is the vital first step to managing a downturn effectively. This assessment might suggest that there is a high probability that a particular market position is still valid in the longer term, but the actions required to pursue it have changed due to current economic conditions. It might, however, suggest that the position is not tenable given the changes in the economy, in which case an urgent strategic re-think will be essential.

An example, in the present climate, is real estate. At the moment this would appear to be one of the areas worst affected by the economy. A firm whose strategy is based around real-estate transactions work might face a radical strategic re-think if it wants to avoid a major loss of business and profits. A firm with a strong mid-market M&A, litigation and real estate focus might need to shift within the focus but not undergo a radical change in strategy.

A firm without strategic clarity must undertake a crash course and develop an in-depth understanding of its existing market position: where it is positioned in the market; the nature of its core client-base; its practice-area strengths relative to peer group competitors; and, the internal issues associated with the strategic development of the business. Only then can it make the same assessments about the likely effect of economic conditions over the business and the actions that need to be taken.

The biggest mistake that many firms made in the 1990s recession was to slash costs without taking a strategic focus. This did irreparable damage to many firms and eventually forced them into a strategic position that differed fundamentally from where they had been prior to the recession. Actions taken reduced the value of the business instead of, at least, sustaining it.

Our first recommendation is, therefore, to review the likely effect of a downturn on the firm’s strategic position and strategy. Assess the areas most likely to be affected and devise specific actions to minimise the impact. Also consider opportunities that might arise and assess how these can be realised. In other words focus actions on the areas where attention is crucial for strategic reasons rather than adopt a firm-wide ‘slash and burn’ approach.

Marketing and business development expenses are often an early casualty in a downturn. There is an assumption that a reduction in these expenses is warranted given the reduced amount of work: the alternative is that a lot of money is wasted in an upturn and then cut out in the next phase of the cycle.

Marketing and business development expenses do need to be carefully examined to ensure the cost is justified by its effectiveness; however a general reduction appears to fly in the face of logic. There is less work available in many areas in a downturn, but there is work and it will be even more competitive to win it. More should be invested into marketing and business development – not less.

A downturn is a good time to increase a firm’s market share with key clients. There might be less work but the goal should be to win more of the work that is available, squeezing out a competitor where a key client is using three or so firms in an area of work. Winning 50 per cent of £500k is better than having 30 per cent of £700k.

Following on from this, partners in many areas will be less busy due to the drop-off in work: too many partners sitting around with time on their hands complaining about the downturn. More time spent on client meetings, thinking of ways in which to win more work from existing clients and finding ways to get to potential clients is essential in a downturn. So step up marketing and business development – don’t reduce it.

Fee-earner performance is a key area on which to focus in a downturn. Most firms tolerate people who are on the cusp of under-performing in a boom because it is usually difficult to recruit. So while clear under-performers will be dismissed in the up-cycle, others are kept on even though they are borderline cases. Do not fall into the trap of only dealing with fee-earning staff. Start at partner level as they are the most expensive resource. It certainly helps if there is already a defined performance-assessment process in place; even if there isn’t, this issue must be tackled.

There are many firms with partners who are good, dependable lawyers but who do not fulfil the role of a business owner: some never will. Tackling this issue is tough but it must be done. There are plenty of good, dependable lawyers at the assistant/associate level and a firm cannot afford to keep on partners who are doing no more than what some of the best fee-earning staff can do (particularly so in lockstep firms).

Tackle the issue at staff level next. Reducing fee-earning staff without tackling partners first has two negative impacts. The first is the obvious one of leverage. In a climate where clients are keen to drive down prices and where work is being commoditised, it is essential that work be pushed down the pyramid as far as possible. Increasing leverage is the ideal way in a downturn: have fewer ‘all-responsible’ partners and more fee-earners and larger revenues rather than the other way around.

The second issue is psychological and concerns staff morale. In our experience, staff members are usually aware of those partners who are not up to the required standard. Dismissing staff without tackling similar (or worse) issues in the partnership creates a cynicism amongst staff and will quickly undo any efforts made to demonstrate how people are valued. Firms that state ‘our most important asset is our people’, and who then appear to make staff the first casualty in a downturn, are creating a self-serving culture, where people seek to look after themselves and worry less about helping others.

The crucial issue when looking at partner and fee-earner performance is to be tough when making the decision about performance. Time and time again we hear discussions, particularly (but not only) about partners, and it is obvious that the performance of the individual being discussed is not going to improve. All sorts of excuses are made so as to avoid dealing with the problem; however, it is in the interests of both the individual and the firm to address it and not allow it to drag on. Be tough in the decision and compassionate in implementation, not the other way around.

This is where boldness comes in. Firms with a clear strategy might seek to recruit people into their core practice-areas during a downturn, provided they are also increasing marketing and business development. Strengthening core practices while others are letting good people go is a counter-initiative approach but one that allows a firm to ride out the downturn and hit the ground running when the market improves.

Undertaking a general review of expenses is essential, but be guided by the firm’s strategy. Cutting some expenses without understanding both the importance of the activity it is funding and the level of expense required for the activity to be effective, is dangerous.

In one case we know of, a firm had recruited a number of lawyers as professional support to practice groups. They assisted the practice-group head, allowing that person more time for client matters. They also ensured precedents and standard documents were updated along with providing other support to fee-earners. A decision was made to cut this role; the result was that practice-group heads had less time to spend with clients, and fee-earners were taken away from client work to handle support tasks. It would have been better to have kept the professional support (assuming they were performing) and allowed fee-earners to focus on client work, marketing, business development and building client relationships.

Midsize to larger firms will have built up sizeable business service units covering marketing, finance, IT, human resources and so on. There are two tasks that can be undertaken here. The first is concerned with effectiveness. We often find that business services are carrying out tasks that are no longer relevant, producing reports that no one looks at or where the information is contained in another report, collecting information that is not required, and undertaking projects that are not going to add value (or sufficient value) to the firm. Our suggestion here is to have a small task-force in place, comprised of partners and people from business services, to review each unit, examine what is being done and eliminate activities that are no longer effective.

The second task is concerned with efficiency. Unless the processes of a unit have been examined in the past two years, it is almost certain that efficiencies can be achieved. In one firm we found that there were significant savings to be made in the finance unit if partners followed the rules on time-recording and billing. Partners had been very lax in these areas for years and, rather than tackle the problem, the head of finance had built up a structure to compensate. Making partners aware of the cost and management enforcing the processes resulted in significant savings.

We have also found that in many cases the use of technology is low in the service units. IT projects are focused on fee-earning rather than what is being done in the service units. Applying technology to the service units can also achieve significant savings.

The IT department is one that requires special attention. IT expenditure in many firms is a bit like the old quote about marketing: “We know half is wasted, we just don’t know which half.” It is essential that all projects undertaken with the IT department be appraised as to their value to the firm and effective project-management installed.

Each business service-unit should be asked to identify its key outputs and then develop a plan showing they could produce the same outputs at the required quality level with (say) a five, a seven and a half, and a 10 per cent saving. Ensure that the outputs are unchanged in each case and that those involved re-think how they are doing everything.

Finally, consider whether outsourcing some or part of business services has a role. Even if there is no saving in direct costs, there may well be indirect savings as an outside group has to manage the unit reducing the time spent by management.

Our underlying approach to a downturn is to keep cool and act logically rather than to react by telling everyone to get costs down by 10 per cent. Acting in a more rational and strategic manner will allow a firm to ride out the downturn while remaining in good shape and be in far better position than otherwise to move forward as the economy recovers.

Alan Hodgart is the founder of H4 Partners Ltd. He can be contacted at alan.hodgart@h4partners.co.uk