Feeing: the elephant and the black hole

“The leaves are falling, and so are profits.” This recent headline in The Lawyer highlighted what to most is now starkly clear – the reporting season has been characterised by a “revenue up, profits down” narrative.

And no-one is picking the next two years to be anything but challenging as the revenue side dips and inflation and a tight labour market continue to grind margins to fine dust. Well, that’s perhaps an overstatement, but the gloss is certainly coming off many firms’ profit lines.

So, what to do? Everyone knows the pack drill: cut costs, shrink the workforce, and generally batten the hatches. “Redundancies” has made a reappearance in the legal press.

As pricing advisers, my company is sometimes asked, does clever pricing (however defined) only work when things are going well? Well, no – the acid test is, “Does a sophisticated approach to pricing work in fair weather and foul?” If done properly, the answer is yes, otherwise it isn’t very “clever”. Any idiot can make money when demand exceeds supply.

This isn’t a major strategy treatise on how to survive a downturn, but there is an elephant in the room that could usefully be attended to, long before rate increases, redundancies, general costcutting and so forth. That is, recovery or realisation – the delta between the value of time recorded and the time that gets invoiced and turned into cash in the bank. And in large measure that in turn depends on having a coherent approach to pricing from the start.

Write-offs and growing debtor days? They’re your fault

Well, that’s a great way to alienate the audience before getting to the point. I thought about smoothing it out a bit but, nah, let’s call it how we see it.

First, a vignette. While in private legal practice in New Zealand, I agreed to serve on a cost complaints panel convened by the Law Society there, which had a statutory responsibility to deal with fee complaints from the public. This was 1984.

The Society delegated that responsibility to panels of experienced practitioners. After several years, I was asked to chair the panel. In that capacity I either personally adjudicated or signed off over 300 assessments. I upheld the fee in 93% of them. Indeed, in many cases, the fee was less than I would have charged in my own firm or approved on assessment.

So if, in most cases, the fees were fair and reasonable on objective criteria, why were there so many complaints? Somewhere into those 300 assessments, the fog started to lift. By the time I gave up the role after 25 years, I was convinced that there were three overarching contributors.

What does this have to do with write-off and debtor days, you might ask? Well, they are all inextricably intertwined and have their genesis in those three factors.

(1) Poor pricing at the outset

How many of us commit to buying anything of any consequence without knowing pretty precisely what the cost will be? Clients crave budgetary certainty, not unreasonably or surprisingly, but we still aren’t great at it.

The legal profession has made an art form out of differentiating itself from other service providers by trying to retain a measure of opacity around the cost, because of uncertainty about what the ultimate cost might be.

Having been in practice for 30 years, I have considerable sympathy for the argument, “How can we price something with precision when we don’t know with precision what will be required?”

But the fact that it is difficult is no excuse for not even attempting it. This is after all an exercise in expectation management. The better you can manage clients’ expectations from the outset, the less grief you will have later.

How do you do that? Not with a band-aid, piecemeal approach, that is certain. The only way is a holistic, coherent, and well thought through strategy comprising what we usually refer to as the four pillars of pricing:

1. Pricing governance. The importance of this is seriously underrated. I have blogged separately on it. When pricing discretion is regulated through informed, strategic protocols, law firms are better poised to navigate the complexities of the modern legal landscape, thereby maximising profitability while preserving the collegial culture that is intrinsic to their operations.
2. Pricing analytics. There is often a fundamental misconception about the data required to drive strategic decisions (factors such as client payment habits, the profitability of different practice areas, and market competitiveness) versus the data required by a partner engaged in tactical pricing (which clients are more responsive to price fluctuations, which ones pay their dues promptly, and which ones are typically more profitable).
3. Pricing execution. The paradox here is that while most lawyers are both confident and competent in dispensing legal and commercial advice and support, frequently the same cannot be said of their ability to have a pricing conversation with the client and fully monetise the value they are delivering.
4. Pricing technology. Technology built by lawyers for lawyers holds the other three components together. Technology on its own fixes nothing, but a holistic approach can deliver spectacular results. There is now very clever, lawyer-friendly software which makes this process much easier and more accurate.

In combination, these four components have the potential to reduce write-offs significantly, and correspondingly increase the firm’s bottom line without the faintest hint of rate increases or redundancies.

Put simply, we owe it to clients, and to ourselves, to bring a little more sophistication and a little more rigour to the pricing process. Whether we like it or not, we must spend time on pricing. The only decision you can make is whether you spend that time at the beginning of the job, doing your best to come up with a sensible scope and a sensible/realistic price, or at the end, when dealing with the complaint, write-off discussions and internal consequences.

(2) Poor ongoing expectation management

It’s great to get a thoughtful proposal out to clients, but it needs continual monitoring. There are so many ways that the anticipated cost can run away with us:

• We set ourselves up to fail from the outset with an unrealistically low price.
• Genuine scope creep.
• A fee earner decides to thrash the file to meet their billable hours targets, or simply lacks any sense of commercial proportionality.
• Too much partner time because we won’t delegate enough.

Failing to keep clients informed of anticipated or anticipatable cost increases in a timely manner because we’d rather kick the can down the road and adopt the lily-livered strategy of “having a chat at the end”, comes back to bite us something terrible. In our experience, more than 50% of end-of-matter write-offs are attributable to this failing. At that stage, the only option available to the partner to appease the aggrieved client is a financial mea culpa by offering a discount/partial write-off.

Appalling client relations, and appalling commercial management.

(3) Wrong collection processes

That brings us to lockup, which comprises two elements:

Unbilled work in progress. I can add nothing to what every partner knows – bill regularly. Why? It is important for law firm cash flow, and it keeps clients informed (see (2) above).

Debtors. That is, clients invoiced for work done, who are very slow to pay. From my experience with the 300-plus fee complaint adjudications, there are only four reasons why a client doesn’t pay on time:

1. They didn’t get the invoice. Rare, but possible given some clients’ finance functions. Easily resolved.
2. They are using you as unsecured, interest-free supplier credit for as long as they can. That is unacceptable and needs to be called out.
3. They genuinely can’t pay. A payment arrangement needs to be put in place, monitored, and adhered to.
4. They are unhappy with something – the invoice, your advice, your service or all three. The real reason for non-payment needs to be flushed out and dealt with appropriately.

And here’s the kicker – in more than 90% of the adjudications I undertook, the reason for late payment was the fourth one – they were unhappy about something but didn’t want to raise it and just sat on the bill until someone brought it to a head, usually many months later.

The solution to all four of these? The firm’s credit control department should take control of the process and, with one exception, partners should be kept as far away from the process as possible. Let’s unpick that with a few observations.

Partners dislike pricing generally, and loathe chasing clients for payment. Hats off to counsel, who have maintained a sensible separation of roles. It works.

Partners invariably refuse to mandate the application of penalty interest for late payment per the Ts & Cs. So, there’s interest-free unsecured credit while the firm’s overdraft bloats. Why pay the lawyers on time when there are no consequences for not doing so?

Partners continually make excuses as to why everyone should leave their “good client” alone and the normal terms of trade (which the client signed up to) shouldn’t be enforced. Why? Because apparently, their precious client will get a bit upset if they are asked to pay on time and might take their business elsewhere.

The only time a partner should be involved, other than at the point of invoice, is if there is a genuine complaint that needs to be addressed, or in mandating enforcement once all other options have failed.

The £5 billion black hole

How big is that elephant I mentioned? Gross revenue in 2022-23 for the UK top 100 was in the region of £34 billion. This is just a back-of-a-napkin exercise, but going by our work with this sector, realisation averages 86%. That means that in round figures the UK top 100 wrote off some £5 billion in billable time last financial year.

What makes it worse is, that is all profit that has gone down the gurgler. If the firm has a net profit margin of say 35%, then on a turnover of £50 million, a 1% improvement in realisation will throw an additional £500,000 straight to the bottom line, which is a 3% improvement in profit – without breaking sweat. Yet for many, the focus is still on cutting costs.

Before looking to increase revenue, might it be better to focus on plugging the leak and recovering as much of the billable time we are currently generating as possible?

But credit control is the ambulance at the bottom of the cliff. If the partner has done a good job of the original pricing, and continued to engage with the client regularly, transparently and honestly on the subject, there should be little for credit control to do.