When we were in the midst of a deep recession, profits and cash flow were tight, and law firms reacted by looking at their operations and taking management more seriously. Many of the actions taken were reactive, defensive and focused on survival – more short term than long term – but changes were made, management practices tightened up and firms became more disciplined.

The economy is now recovering, with professional services growing more than other sectors, and as a result many firms are enjoying better financial results and feeling less pressure. One consequence of this is that managing partners are finding it harder to maintain their firms’ self-discipline as other partners are asking “can we go back to normal?”

However, surveys show that whilst the average profitability is improving, many firms are in fact falling behind. The average can mask the detail due to the bimodal distribution and survivorship bias that are statistical features of the market (see our previous article).

The New Normal

The “old normal” will not return. The forces of deregulation, globalisation, technology and a changing political environment will create a “new normal”. Adam Smith Esq has described “The Great Reset”; while Beaton Capital talk of “New Law vs BigLaw”. Whatever we call it, the commercial pressures on firms will be relentless.  All markets over time have a tendency towards an hourglass shape, and we have spoken over the last 4 years about the squeeze on mid-sized firms as a “gastric band”. Adam Smith’s more recent work has focused on the “Hollow Middle”. These processes may not happen overnight, but they will continue unceasingly.

Given the fixed cost nature of most law firms, the recent upturn has provided a welcome and disproportionate boost to profitability. Much of this has come in the nature of quick turnover (short lockup cycle) transactional work types, such as property and corporate deals, leading to improved cash flow and, for many firms, reduced levels of debt. The flipside is that staff who have had little or no pay rise for some years now want to catch up – or look for better opportunities elsewhere.

We are entering a dangerous time in the business cycle. Historically, insolvencies have peaked as the economy improves and firms that have focused on survival have found themselves unable to raise the capital to fund the increased activity of the upturn.

Fit for the Future

Law firms have historically been poor at balancing their time and resource between the needs of today – attracting, servicing and billing today’s clients and transactions – and the requirements for sustained success. However, unless serious attention and resource are put into making the firm fit for the future, it will be competitors who benefit from the upturn.

The evidence from the LMS survey in particular is clear. Law firms are more focused on profit extraction than on financial strength and stability (see our article on this subject).

Many firms are now enjoying a benign environment with improved profits and stronger cash flow, but the stormy winter of relentless competition will follow – fostered by deregulation and its associated influences. Firms must attend to management, client requirements and internal disciplines in order to make sure that their structures are fit and secure for the tougher times ahead.

The time to fix the roof is when the sun is shining. There is no conflict between capitalising on current conditions and investing in processes and systems that will set the firm up for longer term success – indeed, necessary and desirable changes can be made with more time (and resource) for considered implementation. Now is the time to start preparing for the competitive winter to come. 

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