Cost in a competitive market

The 2007 Cost of Time Survey once again saw a good response, with 255 firms participating – over 20% of all firms in Scotland. These firms comprised over 2,000 fee-earners and had a combined fee income of £256m. The survey remains one of the largest law firm benchmarking surveys in the UK. The 2006 Law Management Section Survey published by the Law Society in London last March attracted 269 participants, representing just 13% of LMS membership. The proportionately larger sample makes the Cost of Time Survey more representative of the profession as a whole, as measured by size and location.

One of the most interesting features of the Cost of Time Survey is the calculation of average hourly cost rates, something which has become especially useful since the withdrawal of the Table of Fees.

The Survey analyses the average hourly expense rates by level of fee earner and size of firm, as summarised in tables 1 and 2. (The rates in the tables are based on each firm’s overheads and salaries, together with an allowance of £69,000 for each profit sharing partner.)

It should be noted the rates shown are not chargeout rates, and firms will add an amount to these in order to arrive at a chargeout rate. A partner’s expense rate may be £139 an hour, but he or she may charge out at, probably, a much higher level.

Living with competition

This information becomes especially important as markets become more competitive – you need an understanding of the cost of your fee earners’ time. Many firms in Scotland already face pretty intense competition; however the likelihood is this will intensify over the coming years. The recently enacted Legal Services Act is likely to bring new entrants to the market in England & Wales. Firms who up to now have only competed with each other will face a new breed of competitor that is likely to be well resourced, focused and able to develop low cost, volume operations that will force price, and very probably quality, down.

The Society has recently consulted on the possibility of such reform in Scotland, and if future legislation were to permit it these organisations would very probably extend their operations into Scotland. Firms need to be very clear therefore about their cost base and what it costs to undertake typical pieces of work. In order to do the latter they need to time record, and many firms of course still do not.

The right model?

In considering your firm’s cost base, and the cost of undertaking typical pieces of work, the point to be conscious of is that the cost of doing something and its profitability is directly related to the level of fee earner doing it. In many firms work is done at a level that is too senior and too expensive. Table 1 highlights the problems this causes – if the matter needs three hours to complete and it has been done by a partner it would have cost £465 (3 x £155). If on the other hand it had been done by an assistant solicitor under the partner’s supervision, it might have taken, say, four hours for the assistant and 30 minutes for the partner, giving a cost of £377.50  (4 x £75 + 0.5 x £155). If the fee was £400 the firm made a loss in the first instance and a profit in the second.

This issue is likely to be especially relevant to smaller firms, for whom the business model has for many years been that of a small group of profit sharing partners, supported by secretaries. There are normally relatively few other fee earners in such firms, and the partners work very much on their own. This structure is generally high-cost compared to firms with better levels of gearing. This is highlighted by table 2, which indicates that the average cost of solicitors in smaller firms with under four partners was around £140, compared to just £112 in larger firms with more than 10 partners. The key point is gearing – in the smaller firms most of the fee earners are partners; in the larger firms they account for a smaller proportion of the firm’s fee earners.

Revealing comparisons

Tables 3 to 6 illustrate how average cost can fall with increased size, by looking at three hypothetical firms in the same town. Each has three profit sharing partners, but firm 2 also has an assistant solicitor and firm 3 has two assistants and an associate.

Obviously these are hypothetical firms; however they illustrate how average hourly cost declines with increased size. If these firms were in a competitive market, firm 3 would be the more successful – provided work was correctly allocated to the different levels of fee earner, there was sufficient work available and there was effective supervision.

The message for smaller firms is that over time, if at all possible, you should try to grow the size of your firm – not by adding more partners, but by adding more non-partner fee earners. These people may not always be solicitors; they may well be paralegals. Over time your firm’s gearing improves, and your average hourly cost – the minimum hourly fee you need to charge to make a profit – falls.

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. The second edition of his book, Profitability and Law Firm Management, is published by the Law Society in London. He is a founder member of the Law Consultancy Network of independent law firm consultants.

Dr John Pollock, a consulting actuary, has been responsible for the administration and statistical aspects of the Cost of Time survey since 2002. John is well known to personal injury, employment and family law solicitors in Scotland through his expert witness work at Pollock & Galbraith Consulting Actuaries.

[Please see printed magazine or PDF download for tables]

TAKING PART: THE BENEFITS

• All participating firms receive a free copy of “The 2007 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 obtain a copy of the full report, which contains a wide range of useful statistics and performance indicators, from Libby Boid at the Society on 0131 476 8164 (email: libbyboid@lawscot.org.uk).
• In April the President will be writing to all firms inviting them to participate in the 2008 survey. Participation is free and carries a three-hour CPD credit as well as an individual report on cost rates in the firm and a copy of the survey report. In recent years there has also been a prize draw. Last year the £700 prize was won by Campbell Riddell Breeze Paterson, Glasgow. The Society is again grateful to Alex Quinn and Partners for sponsoring the prize in 2007.