In support of data-driven crisis management
Last week we published an article on ‘partners panicking’. Based on the amount of feedback, it seems that this topic has struck a nerve. Across the legal industry law firm partners have started to panic. So, what should law firm leaders do to calm down their partners?
The answer lies in adopting a data driven crisis management communication strategy.
What makes the present situation unique is that for the first time in history we have to navigate a crisis while all being confined to our own home. The absence of being in a communal office absolutely adds to the anxiety.
People sitting at home are permanently exposed to unsettling news about the pandemic and the fast deteriorating state of the national and global economy. Given the severity of both crises there is hardly any other topics in the news these days. On top of that the news updates seem to only get grimmer by the day: more people dying from the virus, lock-downs extended, businesses in distress and the economy entering the most severe recession in our lifetimes.
Working in isolation from home we check the news more frequently that we would do when working from the office (information overload). If at the same time we see the number of billable hours at our own practice and firm-wide starting to drop, it is hardly a surprise that partners will experience a sense of panic.
It is the task of law firms’ wartime leadership to calm partners down and prevent anxiety from getting out of control. In order to do that, war-time leadership should restore the balance of information by implementing a data-driven approach. Today the information balance between what is happening in the outside world and what is happening in the firm is distorted: there is a tsunami of information on the outside and only droplets of information on how the firm is doing.
Starting with the basics: the notion of fixed costs
We at TGO Consulting work with some of the best law firms in the world. One might assume that this type of highly profitable, high quality, high reputation institutions must have an in-depth understanding of the key metrics for running a law firm. We know from experience that this is often not the case and that even those with a professional CFO have blind spots in their reporting.
For any partner in a law firm it is paramount to understand the notion of fixed costs. Unlike many other forms of businesses, for a law firm cost are fixed and not influenced by production. As is shown in the diagram above, any drop in revenue will have a leveraged effect on profitability (PEP). The impact of this leverage depends on the profit margin.
At a profit margin of 50% there will be a 1-2 impact and a 10% drop in revenue will lead to a 20% drop in PEP.
At a profit margin of 25% the ratio is 1-4 and a 10% drop in profit will lead to a 40% drop in PEP.
This means that the effect of a decline in revenue will depend on the profit margin of your firm. The most successful law firms will typically have a high profit margin of 50% or above. This makes them more resistant to the crisis.
So, your partners need to fully understand the notion of fixed cost and the leverage effect of the profit margin. It is also important for management to make revenue projections for the entire fiscal year 2020. Profit will effectively only be calculated after the whole year has ended.
For most law firms 2020-Q1 has been strong and above target. Q2 will likely be weak. Traditionally Q3 is a bit slow due to the effect of summer holidays. If the economy starts to re-open in Q3 (this is what we at TGO Consulting expect) and people will not go on holiday en masse (we do not expect summer holiday as usual due to restrictions), production in Q3 might in the end be close to target. We do not know what will happen in Q4 as some businesses will be strapped for cash and cut on external spending.
When we take all this into account, it seems unlikely that 2020 will be an Annus Horribilis for the business of law. Law firm leaders should communicate this wider perspective with the partners.
Let’s assume Q1 has been 10% above target, Q2 will be minus 30% and Q3+Q4 will be minus 10%. Then the cumulative effect would just be a 10% drop in revenue over the whole year: 110 + 70 + 90 + 90 = 360 (= 90% of 400).
This is without any corrections for seasonal differences. The end of Q2 and the whole of Q3 in any normal year tend to be weaker and this will further dampen the effect of the lower production. So, unless your firm has a very low profit margin, there is no reason to panic just now.
Making adequate projections
If there is no reason to panic just now, that does not mean that the situation could not turn for the worse in the future. Therefor it is imperative that law firms implement a solid data driven monitoring system. Even though partners are not always aware of this: revenue is created by the associates and not by the partners. In any law firm there will be more associates than there will be partners. The utilization (billable hours/day) of associates is one of the key indicators to monitor. This monitoring should be done on a daily basis. Associates (and partners for that matter) should therefor be obliged to enter their time-sheet accurately at the end of each day. This should be communicated, checked and enforced. With penalties for those who do not oblige.
In order to make reliable production projections we will need accurate data. It is not unlike the Corona pandemic: if the authorities do not have accurate numbers, hospitals can not accurately predict what to expect next. So, make sure every fee-earner closes the time-sheet at the end of the day.
Secondly, you need to estimate how much future billable hours are still to be expected on the running mandates. For firms that have professional project management in place, this will fairly easy to accomplish. For those firms who do not have firm-wide project management, estimates should be made by each responsible partner. This should be done on a weekly basis and be adjusted as things develop. Looking at similar matters in the past might be helpful. We will need these data to make accurate workload projections.
Thirdly, you will need to look at the pipeline. As this is looking at the future, the data will not be that reliable. Still an educated guess, based on conversations with clients, will be better than having no data at all. Combining step 1, 2 and 3 in a dynamic model will provide management and the partners with a pretty good picture of how production and revenue will develop over the next few weeks. Having these data supported insights, will help prevent partners from panicking. Things become less scary if you are not stumbling around in the dark.
Index your clients
It goes without saying that revenue does not materialize out of thin air. You need clients that trust you with mandates that will create billable hours. That is why, besides focusing on production, we need to look at the client base. Analyzing your client base will provide a valuable insight in where revenue has been originated so far. Different industries and businesses will be affected by the crisis in different ways. If Microsoft, Facebook, Google or Zoom are your client, the workflow will not be affected in the same way as when Marriot hotels or Lufthansa are your client.
Some industry sectors are still doing well whereas others are in an existential crisis. Some companies have lots of cash, little debt and a good opex to revenue ratio, others are strapped for cash, heavily indebted and have a poor opex to leverage ratio. What we are saying here is that you should map your clients and attach a risk and opportunity profile to most of them. This will help you tremendously in making projections on how business might develop. The more data you have, the less your partners will panic.
TGO Consulting has developed models and templates that are ready to use to help you get better grip on your production data and pipeline. If you have any question or would like to have access to these models, please inquire.
We are here to help
TGO Consulting is there to help you navigate the crisis. We are currently writing a book on this topic that will be finished by end April. This book will be made available for free to all our clients. We will also continue to publish weekly articles on topics that are most relevant to you right now.
Our experience with law firms in China gives us a two-month head start in knowing what best to do. There will however remain many important unknowns and things can change really fast. This is where our unparalleled creativity has proven to be extremely valuable. We have a proven track-record to find effective solutions faster and better than anyone else. In the meantime, our TGO Consulting Research Team keeps to monitor the state of the economy literally 24/7 to ensure that our approach always remains fact-based.
Please do not hesitate to contact us to find out how we could help your firm navigate these challenging times.