Fee incomes and profits slowdown sends warning signal to law firms

Despite firms recording bumper fee incomes, a report reveals worrying trends. Ryan Dunleavy reports.

Ineffectual managment and clients demanding lower fees and better service are beginning to affect law firm profitability, according to a survey published by The Lawyer and PricewaterhouseCoopers.

The underlying trend for law firms' profits and fee income shows that increases have slowed considerably over the last 12 months.

Though The Lawyer 100 revealed that total fee income broke through the £5bn barrier this year (The Lawyer, 30 August), the survey of financial management in law firms indicates that despite the increases in total gross fees, profits and fees have risen less than in previous years.

Julie Walker, director of the professional partnerships' group at Pricewaterhouse-Coopers, says: “The slowdown in improvement in profitability is alarming.”

This year sees an increase in profits for 69 per cent of firms, but in 1998 the figure was 81 per cent. This reverses a trend of increasing profitability that began in 1996.

The amount of fees billed follows a similar pattern. Firms that record an increase in fees billed is 80 per cent this year, but it was 93 per cent in 1998 and 87 per cent in 1997.

Walker says: “What we have been seeing is that although firms are recording record profits since 1996, fewer firms are saying that profitability is increasing.

“We had a steep increase for a while but the curve is flattening off.”

She says the reason for the slowdown is that clients are demanding greater value for money and law firms are not as well organised as they should be.

She says: “There is far more client pressure for cheaper bills than before, particularly for the insurance firms.

“Big institutions are cutting down the number of firms they are using and pressurising firms to offer better deals.”

She adds: “Firms need to alter their working structures. It is really important to analyse how they transfer fee income into profit. If a firm is making £1,000 in fees but only getting a £100 profit it is not very healthy.”

PricewaterhouseCoopers recommends a benchmark equation to maximise profitability.

The percentage of fees should balance out as 40 per cent on staff costs, 10 per cent on property costs, 20 per cent on other overheads, and 30 per cent on profit before interest and tax.

The amount of profit that firms are making in comparison to fees is dropping.

Last year 29 per cent of firms said the proportion of fees spent on profits was more than 30 per cent. But this year it has fallen to 26 per cent.

Walker says: “It is about maximising income. The biggest problem is staff costs. It is all about how the staff are used.

“Firms need to look at staff costs and make sure that investment in staff is delivering a benefit.

“Firms need to control the head count of both chargeable staff and non-chargeable staff and then use teams properly, and they should make it quicker for people to do their jobs.”

She gives another example of how firms often fail when managing their finances.

She says: “Eighty-eight per cent of firms do not know if they get any benefit from their IT.

“I continue to find this surprising as it is a substantial amount of expenditure.”

More than double the amount of firms spent 5 per cent of their overheads on IT this year in comparison to 1998.

But there are indications that many firms are beginning to realise the need for sound financial management. The number of firms that say they have a formal business plan increased from 66 per cent to 70 per cent.

And firms are making themselves more competitive by lowering the amount of partners they have in comparison to other staff.

More than 30 per cent of firms have a ratio of 4:1 or better in comparison to 24 per cent last year.

Walker says: “This means people are paying less for legal advice.

“It costs less to employ an assistant to do a job rather than a partner. Partners should be building up teams and using them effectively.”

Partners are also increasingly being rewarded by performance-related pay structures rather than lockstep.

Walker says: “Given the greater mobility at equity level firms are looking more at the role of their partners and how they are rewarded.

“Firms are now more competitive when it comes to retaining the rainmakers.”

This year, 43 per cent of firms reviewed their profit sharing arrangements and 18 per cent made changes.

Now 64 per cent of firms use a performance based, partial lockstep or an ad hoc system. Last year it was only 56 per cent.

Copies of The 1999 Financial Management in Law Firms Survey are available for £80 each. Contact Susan Melluso of PricewaterhouseCoopers on 0171 213 854