Is the current recession the best thing that could have happened to the legal industry?

Was anybody really expecting a recession of this severity?

Shocking headlines about the worsening state of the global economy have been inescapable for nearly a year now, and journalists still seem able to find increasingly depressing news stories on a daily basis, regularly assisted by government and the banking and finance sector.

The impending deregulation of the legal industry will have become, for many firms, a very secondary issue to short-term survival in this fast-moving economic downturn. The relentless contractions in all aspects of business that require access to bank funding have confounded the predictions of even the most pessimistic forecasts.

As the UK’s economy descends headlong into an ever deepening recession, many will be asking: have law firms been taking year-on-year growth, easy revenues and spectacular reward levels for granted?

Is legal business about law or business?

The origins of most law firms are as traditional partnerships founded by like-minded individuals motivated principally by the desire to practise law and serve clients and communities in this capacity. The uneasy relationship in most law firms between these emotive principles and less professionally satisfying commercial objectives is, therefore, quite understandable, even in a soulless modern world.

The commercial drivers and management processes accepted, without question, by professional managers and finance professionals working in professional services firms, are in many ways just a question of people happily accepting what they have grown up with. Selection for promotion and long-term career progression within non-legal business is generally based on the development of the individual beyond core professional skills and competencies, focusing far more on managerial and commercial capability.

Until quite recently, relatively few legal businesses genuinely drove programmes to develop practising lawyers’ commercial-management skills with equal importance to their legal-practice skills. Invariably, commercial management skills have been ‘bought in’ by most firms from outside the profession and almost always quarantined from practitioners through management and administrative structures.

Carefully constructing a dynamic tension between practitioners and commercial managers has been an architectural marvel replicated by many firms over the past 20 years. By fuelling the myth that non-lawyers constitute a servile underclass motivated purely by commercial greed, and that their only justification is a preparedness to undertake tedious administrative tasks too demeaning to the lawyer class, many managing boards, managing partners and strategy committees have engineered an undeniably important position for themselves.

With this background, it is unsurprising that many of the frontline battles fought between practitioners and non-lawyer managers observe two distinct positions: quality of client care and excellence in legal service, pitched against commercial return and adherence to management processes.

It is fascinating, therefore, to consider the possibilities of what a truce between these two opponents might achieve. Who knows, if both sides accept the common goal of generating sufficient returns on investment to guarantee a sustainable long-term business, perhaps everybody’s needs would be met and everybody’s efforts directed to that which they individually do best.

Is there scope for a lasting truce between practitioners and managers?

It was always going to take a change in the economic landscape as serious and prolonged as the current credit crunch to encourage a meaningful long-term dialogue between practitioners and managers in law firms. Relatively easy trading conditions have meant that rigorous commercial management practices have been deferred in most firms, opting instead for softer and more flexible approaches, less challenging to the sensitivities of practitioners.

The abundance of turnover available to most firms during the past decade has required few really hard commercial conversations about margin, reward structures and returns on investment. Where firms have found themselves in short-term financial difficulty, they have generally been able to trade out of this position without taking on too much real commercial risk.

With many law firms now experiencing significant reductions in work rates across most core disciplines, reviewing personnel levels, reward structures, efficient working practices and meaningful business development activity have become the full time occupation of many senior lawyers who lead teams. Not that long ago, these topics were only being paid lip-service by practitioners, safe in the assumption that any short-term imbalance in the team’s financial structure would be managed through increased work volumes that in themselves would easily be found.

Historically, the concept of predicting and then measuring a genuine return on investment within law firms had, in most cases, been restricted to capital expenditure projects, such as IT and general infrastructure investments. Few firms will have extended this practice to the core economics of the business lines themselves and almost never to the firm’s most significant investment – personnel.

The good news for firms that have invested in robust management structures, however underutilised they may have been in a soft market, is that this force can now be mobilised to tackle the challenges of a hard market. Simple principles such as ensuring business lines deliver a target gross contribution to profitability, that actual team level run rates are consistent and above target, and that reward structures are flexible and linked to performance rather than just expectation, have been the mantra of managers for some time now. These are the tools that will assist practitioners in scaling their teams and maintaining profitable business structures in this radically different market.

Familiarity with these concepts and an ability to deploy them in practice will empower the practitioner who has theresponsibility to lead and manage a team through difficult and changing times. Few will find the perfect solution in the first draft plan, but the structured approach created by these tools will ensure successive iterations deliver increasingly effective solutions and possibly more importantly, a means to manage an uncertain future.

The evolution from a situation where management processes are designed to dictate behaviour and sanction performance, to one where management influences empower individuals and generate performance, is surely the basis for a lasting truce between practitioners and managers. Working with a pool of skills to build solutions rather than constantly re-drawing lines of demarcation between these groups will finally deliver a real synergy.

Is targeting performance a good thing?

With varying degrees of sophistication, most legal businesses have approached the past ten years as a period of uninhibited growth. Whether through merger or acquisition, diversification or simply organic growth, few difficult obstacles have really existed for those committed to growth.

Generally, these conditions have led to a fairly simple approach being taken to financial planning. How much would we like to grow by, in which sectors and what will it cost to provide the infrastructure to do this? As long as care is taken in achieving a minimum actual growth figure, the costs are controlled within budget, and everybody else in the firm performs, the profits are delivered and everybody is happy.

The repetition of this approach year-on-year by most ambitious firms in the past decade has seen spectacular increases in size for many legal businesses – but have these businesses been prioritising turnover and market share over profitability and scalability?

The ability to upscale a law firm in a truly profitable way is a fundamental challenge offered to the industry by the Legal Services Act. The invariably complex issues that surround structures of ownership, income and control are all brought to the fore when a genuine attempt is made to upscale a successful firm, rather than just make it bigger in turnover terms.

The value of the business, as determined by the post-Clementi investment market, will be influenced far more by views formed on profitability and scalability than on size of turnover. Indeed, a rapidly contracting market, such as the one currently being driven by the credit crunch, makes it difficult for any firm or potential investor to predict with any accuracy what the bottom line might be in terms of reductions in turnover. A re-scalable business model is invaluable in this situation as profitability and effective control of the assets remain within management control.

A targeted approach to growth and the arithmetic modelling of law firm economics has been in many ways the ‘no man’s land’ between practitioners and managers in many firms for a number of years. The acknowledgement that work volumes can fall as well as rise, and the recognition that the size and shape of the teams deployed to do this work must be able to change fluently in line with this, may well be the challenge that brings practitioners and managers far closer together on future business planning exercises.

What can legal businesses learn from other industries?

A genuine understanding of both the macro-economics of the firm and how the micro-economics of the individual business line or team play their part must be a fundamental achievement of progressive law firms during these difficult economic times.

Targets in themselves are neither the whole explanation of business success nor the sole cause of failure. Acceptance of the need for a structured and visible means of measuring, communicating and, above all, managing performance is the objective that, once attained, will become the real driving force behind the choices a business makes.

For many years, these simple principles of sharing key performance metrics with the workforce and ensuring that these performance features are clearly understood in context of the business’s overall performance and state of health have been a feature of the world’s leading manufacturing businesses. This level of integration of the workforce with the commercial interests of the business has underpinned efficient, cooperative and thoughtful working practices and delivered scalable business models capable of operating effectively in markets where demand for products is constantly changing both in terms of volume and nature.

This approach does not require hugely sophisticated management reporting systems, ‘pain of death’ secrecy clauses or lengthy education programmes to implement. In most respects, the simpler the picture that is presented, the better – the key ingredient is openness. A culture that promotes openness and consistency supports a meaningful two-way dialogue. This ‘open door’ approach to recognising that everybody has an interest in the business succeeding offers some serious challenges to the traditional roles played out in most law firms.

If we are to accept that the ultimate owners of the business have a set of priorities aligned to their ownership objectives, we must also accept that those whose interest is largely centred on earning an income from the business will have priorities around their personal security in that role. Similarly, those who exercise control of the business must be acknowledged as serving the interests of both these groups with equal integrity, the two group’s interests having been clearly identified.

Most law firms have historically confused these three roles (owners, workforce and managers) to a spectacular level. Recognising that a legal business needs a clear perspective on these roles, and how they respectively influence the business, will not only be crucial to managing the commercial challenges of the current economic landscape, but also fundamental to building a competitive business that is capable of realising the opportunities and surviving the threats of the post-Legal Service Act world.

What lies ahead?

The management teams of practically every commercial law firm in the country will currently be sitting amidst a mountain of complex planning spreadsheets, performance reports and revised projections, all full of red and bracketed figures. The conversations taking place on the back of this will be around downsizing the workforce, taking stock of specific market demand and in many cases, critical financing issues.

Despite what Gordon Brown has been consistently telling us, the truth is that we all knew that one day his claim to have tamed the boom and bust economic cycle would be tested.

The rapid and continuing reduction in the volume of commercial work available to law firms is likely to be a very testing experience for even the firms that consider their approach to management to be sophisticated.

Whether sophisticated or not, surviving this economic downturn and preparing effectively for the challenges that lie ahead will depend on firms’ general dexterity and commitment to a goal of delivering a level of service that meets client expectations, at volumes that do not exceed demand. This must be done from a cost base that meets the clear objectives of the owners, workforce and managers of the business.

It may be that the unrelenting commercial pressures created by the credit crunch will in future years be recognised as the wake up call that the legal industry needed in order to apply its considerable resources to building more sustainable businesses for the future.

Patrick Harwood is the chief operating officer at Watson Burton LLP. He can be contacted at patrick.harwood@watsonburton.com