The market in which firms operate has gone through major changes over the last few years, reflecting change in the UK economy as a whole.
But the implications of these changes have not been grasped by many lawyers yet, particularly with respect to the ending of inflation as a significant influence on the legal firm.
In the 1980s inflation was accompanied by economic growth and the development of new market opportunities. Many of these related to asset financing and corporate transactions such as management buy-outs. But the end of inflation has co incided with a recession followed by modest economic growth. Firms had become used to making decisions against a background of inflation, which caused nominal profits to rise consistently. In these circumstances, bad decisions on cost structure, whether on levels of remuneration or the cost of office accommodation, were relatively risk free, because of the masking effect of inflation. At the same time, the growth in real net profitability combined with a generous tax regime provided two valuable sources of partnership finance.
The resulting favourable cash flows, combined with inflation, made increasing borrowing a low risk for both borrowers and lenders. Borrowers were both the firms themselves and, sustained by the cash flow, individual partners.
Since the boom, though, recession has had a severe impact on many firms, causing a significant reduction in the demand for services, an increase in competition and a disproportionate reduction in the volume of one-off, high margin transaction work.
The intensification of competition, added to the overtures firms must make to attract new business, has also made clients more aware of the options they have to use different advisers and obtain lower prices. In effect, firms have trained clients to want more for less, and the time spent bidding for new business rather than on performing chargeable work has risen. Also, those partners and other fee earners who are relatively poor at looking after their clients' requirements or who are ineffective at winning business, have been exposed.
For many firms the effects of these dramatic changes in business conditions have been unpleasant. The extent to which management has been competent to handle the challenges has had a direct impact on firms' profitably and finances.
As a temporary measure, some firms have been able to disguise the underlying weakness in their business by billing work in progress more quickly. Then they report improved profits and disguise poor underlying profitability. This practice has been supplemented by optimistic accounting, for example by failing to provide fully for defaulted debts. However, the realities of business will catch up with any firm which has not adapted to the new circumstances. This realisation is placing demands on all partners, but particularly those involved in management.
The challenge for managers is to achieve three key objectives. First is a cost structure consistent with the volumes and quality of business that the firm can attract. Second is a combination of pricing, productivity and seniority which will produce satisfactory profit margins. And the third objective is capital management that provides sound finance.
To achieve these, firms must take stock of the capabilities of each partner and develop a plan of action which is in the interests of the business as a whole. For many partners, this will involve a realistic appraisal of their strengths and weaknesses and plans to improve their skills. This in turn will require the implementation or improvement of partner appraisal and the identification and development of an appropriate training programme.
It is clear to all but the most blinkered that partner skills can be improved and that such progress is one of the most crucial aspects of increasing the competitiveness and success of a firm.
Beyond this, business circumstances will force a recognition that the minimum standards to justify equity partnership have risen, and some individuals may not meet them. Where this is the case, management has a responsibility to respond to the delegated trust of the whole partnership and work with individual partners to improve their skills and give them opportunities to achieve minimum standards.
However, over the last few years, it has become clear that some partners are no longer able to rise to new challenges and therefore cannot justify continued partnership status. Moreover, their continued remuneration as partners risks diluting the reward of higher achievers.
It is this recognition which has driven the reality that partnership is no longer for life and that in certain circumstances the partnership must be able to ask individual partners to retire from the equity.
The inability to recognise or tackle these issues may be sufficient to jeopardise the viability of a professional firm. For this reason alone, dealing with partner improvement and retirement, which is one of the most difficult management tasks, is also one of the most important.