A good year for most firms

The 2003 Survey of Law Firms in Scotland indicates a healthy increase in profits for many firms. Table 1 shows a rising trend in profits in recent years with most firms experiencing a good year in 2002-03:

Once again the Survey saw a large number of participants. 271 firms took part, representing a quarter of firms in Scotland. This year saw a particular increase in the number of larger firms taking part, with 17 of the 55 firms in Scotland with more than 10 partners participating.

The improved results are confirmed by anecdotal comments from a selection of firms:

“We had a record year to May 2003, but it’s a roller coaster as you try to keep costs under control. We are already 9% up on fees from last year but 17% up on costs, mostly staff.” Edinburgh – 10+ partners

“Our profits have been higher due to conveyancing – not court work. We are also more aware of the need to keep our cost base down.” 2-4 partners – Country

“Income generally has been stronger in 2003. Continued heavy investment in IT and business development has meant profit levels have not risen accordingly, but they are still at satisfactory levels.” Glasgow – 10+ partners

Not all firms however enjoyed such success:

“I have to say that we had no increase in legal aid fees last year (for the work I do is almost completely legal aid based) so I could not improve the service that I was able to provide, nor was I able to improve profits from that point of view. Wages had to go up, costs of equipment being replaced were significant, supplies for the office all increased in cost etc, yet none of the fees that I could charge increased which made last year all the more difficult. I am sure it is fine if you can charge £100 plus per hour for your fees and indeed I have a client who told me that her London solicitor was able to charge her £340 per hour plus VAT! Here in the Borders we would get no business at all if we chose to charge at the Law Society approved rates for most of our clients, and therefore we have to cut our cloth accordingly. There are no time recording regulations for private client cases charged at ridiculous sums, yet we have regulations that we have to slavishly follow for legal aid cases, paid for at the princely sum of £42.20 per hour!” Sole principal – Country

Chart 1 summarises the overall profitability of the 271 firms. As in previous years, a wide range is indicated – at one extreme, a quarter of sole principals earned under £27,000; at the other, a quarter of firms with more than 10 partners achieved average profits per profit-sharing partner of over £170,000.

Keys to the money box

The profitability of a firm of solicitors is determined by a wide range of factors, but the most important generally are:

The type of work undertaken – commercial work and better quality private work will command far higher hourly fees than areas such as legal aid and routine personal injury work;

Fee earner and staff ratios – in particular “gearing” or “leverage”. The more profitable firms tend to have more lawyers who are not profit-sharing partners. This will include solicitors and also unqualified fee-earners;

Effective financial control – in particular the ratio of salary costs (including a notional salary for the profit-sharing partners) to fee income. In the most profitable firms this is under 50%.

The firms that tend to combine these most effectively tend to be the larger firms in Edinburgh, Glasgow and the other cities. They tend to attract the most lucrative commercial work and have sufficient volume to develop teams with good gearing. Their better profitability, as illustrated in Chart 1, is therefore likely to be due to these factors rather than simply the fact that they are larger.

Smaller firms make good too

Smaller firms who may not be able to attract the same quality of commercial work are sometimes also able to achieve good profits by adopting the same principles – gearing and financial control.

This is illustrated in Chart 2, which analyses salaries as a percentage of total fee income according to whether their profit per profit-sharing partner is:

Below the 25% point;

Above the 25% point but below the mid-point;

Above the mid-point but below the 75% point;

Above the 75% point.

This chart includes a notional salary for each profit-sharing partner with salaried partners included at their actual salaries. For financial years ending in 2002 notional salaries of £43,850 and £39,000 were used for “senior” (aged 35 or more), and “junior” (aged 34 or less), profit-sharing partners respectively. For financial years ending in 2003 the corresponding notional salaries were £53,000 and £47,000 respectively.

This measure is a very useful starting point for any firm wishing to increase its profitability because it brings together a number of underlying factors including:

The type of work done;

The level of lawyer doing the work;

Salary levels paid;

Support staff numbers;

The cost of central support staff.

It is interesting to note that the smaller the practice, the greater the variation – possibly reflecting the relatively low profits of some firms.

Firms can start by calculating how they compare against the benchmarks in the Survey and could then move on to examine profitability on a departmental basis. If, overall, salaries in the most profitable firms are under 50% of fees, at departmental level they may be under 40% – i.e. before any central staff such as accounts or reception.

In arriving at the profit available for the profit-sharing partners, non-salary overheads would also have to be deducted, and these represent on average 29% of fee income. This will be considered in our second article in next month’s Journal, together with the working capital requirements of firms and the amount partners invest as capital.

All participating firms receive a free copy of “The 2003 Survey of Law Firms in Scotland”, the detailed report upon which this article is based. They also receive a free confidential individual report. Other firms can purchase a copy of the full report which contains a wide range of useful statistics and performance indicators. Priced at £80, this is available from Lisa Hamilton at the Society on 0131 476 8164.

In April the President will be writing to all firms inviting them to participate in the 2004 survey. Participation is free and carries a two hour CPD credit as well as a copy of the survey report. In recent years there has also been a prize draw. This year the prize of a theatre break in London was won by Alistair MacRae of A & JC Allan. The Society is again grateful to Alex Quinn and Partners for sponsoring the prize in 2003.

Andrew Otterburn is a management consultant and for many years has run practice management seminars on behalf of the Society. He has helped in the development of the Cost of Time Survey since 1999, working initially with Professor John McCutcheon and now with Dr John Pollock. His book, Profitability and Law Firm Management, is published by the Law Society in London.

Dr John Pollock, a consulting actuary, was responsible for the administration and statistical aspects of the Cost of Time Survey in 2002 and 2003 having taken the place of Professor John McCutcheon on the Law Society of Scotland Remuneration Committee in 2001. John is well known to personal injury, employment and family law solicitors in Scotland through his expert witness work at Pollock & Galbraith Consulting Actuaries.