Bruce MacEwen, whose long-running blog, www.adamsmithesq.com, is subtitled “An inquiry into the economics of law firms,” recently made provocative comments about where the profession’s economics are heading.
As quoted in the American Bar Association Journal, MacEwen declared that more Wall Street and middle-market firms are quoting “suicidal prices” for legal fees simply to get enough work to keep lawyers occupied and cover their fixed costs, and attributed it to firms paying too much money to too many attorneys.
“A law firm cannot really lose money for even one year and remain viable,” MacEwen said, “because that’s what they pay their partners with.”
High compensation for many lawyers is definitely a Big Law phenomenon at large firms with hundreds or even thousands of attorneys. The problem of “too many lawyers” is really an imbalance of supply (jobs) and demand (many former clients have been hit by the poor economy and disappeared).
Demand for Big Law attorneys among Main Street folks is low because they can’t pay anywhere near $1,000-an-hour legal fees. Certainly, this other 99 percent of the population, which includes individuals, families and smaller companies, needs their skills, but just cannot afford to pay high prices for legal services. They’re still contending with tough economic conditions and are more inclined to either put off using a lawyer or turning to the many do-it-yourself legal services available on the Internet.
For law firms of any size, the old advertising cliche “we lose a little money on each sale but make it up in the volume” can be a suicidal course. While the law of supply and demand is important, the cliche ignores the fundamental lessons that every firm should have learned since the financial crisis broke nearly five years ago:
1) Firms cannot indiscriminately add lawyers. The work must be there for any attorney added, at rates that can cover the lawyer’s fixed technology, staffing and training costs.
2) Firms cannot pay compensation out of scale with what clients will accept. Associate pay has already moved down the scale, and partners should not share in a firm’s profits until all other obligations to clients, staff and vendors are met.
3) Firms cannot unthinkingly pursue mergers with each other. Because size inevitably creates inefficiencies, and firms are slow to eliminate redundancies, poorly conceived mergers are a zero-sum game.
4) Firms cannot automatically raise rates. The billable hour may not be dead, but alternative billing is here to stay. Choosing the right alternative has become a business matter for both the firm and the client. The casualty in the process is unilateral rate increases by the firm.
5) Preparing a budget for a matter is a practical necessity. Client involvement in the cost equation is here to stay.
6) Firms cannot be banks that carry their clients’ expenses. Firm after firm has had to deal with financial crisis even as literally millions of dollars in receivables sit on their books. Setting and enforcing payment terms is essential.
These lessons do not constitute an exhaustive list, but they do carry a comprehensive message. Like every other profession and trade, the practice of law is a business. That means firms are governed by the same formula that defines all business success: Profit equals revenue collected less expenses.
Ignoring that message, no matter how innovative the methodology or trying the times, is suicidal for any firm.