An eye to the future

Market conditions are looking more favourable and firms are hoping this will herald a return to higher levels of profitability. For some this may be true, but not for all. David Temporal, a partner at Temporal Consulting, examines the basic requirements to ensure long-term profit performance.

Over the past few years, the market slow down has resulted in reduced fee growth and profitability. Under adverse market conditions, the primary focus of management has quite properly been on short-term actions to protect profits, appropriate reshaping of resource capacity, streamlining the organisation to enhance value and cut waste, and delaying investments in all but the most critical areas. Too often, however, they are one-off initiatives, necessary moves, but limited in their impact on boosting the firm’s long-term position and performance.

Economic downturns present an opportunity to ‘clean house’ for the benefit of the firm. Those firms that took the right actions in the downturn will benefit more than those that failed to do so. Naturally, striking the right balance in cutting costs but not undermining competitiveness in strategically important areas is key to building the leaner and stronger platforms from which to grow. Achieving that, however, is a real challenge.

Now that the level of corporate activity is picking up, optimism has grown that bumper profits will return. For some they will – but for many, the issue is more demanding as we enter a period of intense competition. Growth across the market is unlikely to accommodate the requirements of all firms. The prizes are there only for the fittest – it’s a demanding market-share and positioning game where fitness really counts.

Winning and/or fortifying rich and privileged market positions will be even tougher than in the past. Clients will be more demanding, continuing to re-evaluate legal work and utilising greater bargaining power to secure better value for money. They will be more discriminating in performance and in their selection of law firms, setting higher expectations and ‘burden of proof’ requirements to win their trust and confidence, especially for higher value work. At the same time, competitor firms will be fighting even harder to win the attention of highly prized clients and to win a larger share of their most profitable work.

That strengthening demand should result in improved profits is not in doubt for most firms. The real issue is relative profitability in a more demanding and competitive market context. Higher relative profitability is a strategic imperative for several key reasons:

It enables the firm to compete for, attract and retain the best talent;
It provides a fatter and fuller wallet with which to fund such strategic investments as opening new offices, growing practice groups or strengthening relationships with key and target clients;
It creates a virtuous circle for success – better people, richer clients, higher value work, higher profits and so on.

It goes without saying that in highly competitive times, the drive for superior-service performance and profitability is paramount. This will be achieved only by ensuring that the firm builds powerful positions in appropriate practice, industry and geographic markets. Failure to do so can well lead to the vicious circle of less profitable clients, attracting lower value work, generating lower profits and losing better people to stronger, fitter and better-positioned competitors.

The strategic challenge facing firm management is to focus on areas in which a strong position can be built, and effectively deploy the firm’s limited resources and best effort behind them. The corollary to this is to reduce investment or even withdraw from certain practice areas, industries or geographies that are less profitable and/or have weaker strategic fit.

The winners will not shirk from this challenge – those that delay might well live to rue that failure. There are a number of foundation stones that must be firmly in place to win rich and fortified market positions and thereby drive higher profit performance.

Managing the business mix

Firms must understand where and how profits are generated across the firm in terms of client, practice, industry and geography to pin-point how the current business mix drives or impedes profit. It is surprising how many firms have still to fully understand their profit mix, so they lack the sharp insights needed to drive decisions about where to cut, shift or invest. Experience shows that, typically, 20 per cent (or even less) of clients generate 80 per cent of fees. More importantly, 20 per cent of clients typically deliver 120 per cent of profit. In today’s competitive market, many firms continue to retain ‘unprofitable’ clients simply to generate fee volume, without fully appreciating the true impact on their profitability and, therefore, competitiveness.

Shaping focus

Firms need to ensure they are effectively focused on market segments so that a targeted leadership position can be won. Many firms continue to operate across too many markets in which they are poorly positioned, lack brand image and are insufficiently resourced for profitable advance. When demand outstrips supply, operating across a range of market segments in which a firm is only ‘middle-market’ can generate reasonable returns, but in tough times, it inevitably leads to under-performance and falling profits.

Structuring the resource pyramid

It is critical to ensure that a firm’s resource pyramid is appropriately structured by size and shape to ensure critical mass and an appropriate leverage and skill alignment to ensure performance objectives are reached. The required resource pyramid must reflect the target practice, industry, geographic and clients. Therefore, each business-building block must be analysed, the appropriate resource pyramid defined, and consequent changes carefully planned and effectively managed. This is managerially challenging and time consuming, since it involves hiring, firing, training, promoting and redeploying. But it is crucial for moving forward. The alternative is falling back.

Managing performance

The firm’s performance management must be aligned with its positioning and performance objectives. The performance metrics and management information at individual, group and firm level must reflect the critical-performance areas and their relative weightings. In many firms, however, performance is either inadequately explicit or measured, or the focus is on the less important elements of the performance mix. Too often, firms use individual billable hours and fees as primary measures of performance, while other metrics, such as the gross margin on jobs, client profitability, relative share of a client’s high-value work or realisation, are unaligned or unmeasured. Ensuring that the appropriate performance metrics are clearly defined and communicated across practices, industries, geographies and strategic client/accounts is essential in managing the required teaming, resource prioritisation, performance delivery, management development and reward drives for position build and profitability.

Teamwork

Demonstrating to clients the firm’s real depth, breadth and edge across key practice areas, married with demonstrated experience and expertise about the client’s industry, or industries, together with relevant geographic capability and teaming is a key requirement to win rich and privileged positions with the most prized clients. No one individual can cover all these aspects, so effective teaming across the firm is a pre-requisite to harness, package and deliver the firm’s overall knowledge and expertise.

The synergy of practice, industry and geographic skills are key to building image, impact, best-value delivery and pricing, knowledge transfer, and cultural cohesion. This is at the heart of competitive distinctiveness, strength, client leverage and value, fortified market position, and profitability.

Developing coherent strategic actions

To ensure that the firm is most effective in its strategic choices, it is critical that the firm has a clear analytical framework and process.

This requires realistic positioning and performance objectives in the context of market trends and competitive dynamics, and an honest evaluation of the firm’s current practice-market-resource position. Only then will firms have a realistic view as to the ‘capture’ requirements of its chosen target market and an understanding of the resources and effort needed for success. Without sufficient rigour in the strategic-planning process, it is unlikely that a coherent set of firm actions to move forward can or will be identified, shaped and implemented. Keeping competitive and busy people focused on the strategic objectives of the firm always presents a major challenge.

Clear priorities, communication, appropriate performance measures and management example will be necessary for success.

Breaking the cycle of weak market positioning and lower relative profits to create a virtuous circle must start with a detailed analysis of the current practice-industry-geographic mix in terms of fees and profits. This is no longer an option but an imperative.

There are four areas of management action to best position a firm to deliver superior profits:

1. Analyse the firm’s current practice, industry and geographic business mix in terms of the income and especially profitability, to better understand where and how profits are earned and lost and where potential may exist for future growth and fortified position;

2. Develop a deeper and realistic understanding of the firm’s current market position, competitive strengths and weaknesses. Use client research and competitor analysis to determine the requirements for attaining the firm’s desired objectives;

3. Identify, define and communicate the key market segments on which to focus. Assign appropriate strategic priorities around these, and deploy specific resources accordingly;

4. Establish key milestones and measures against which to monitor progress.

The road ahead for powerful market positioning and strong profit performance will be demanding but rewarding for those firms with the appetite to take up the challenge and deliver. Some firms are unlikely to ‘make the cut’, ironically finding their competitive positions weakened just as the market is recovering. The rewards for those firms that understand the rules of the game, adapt to lessons learned, and manage delivery of an effective market-resource-driven strategy are those best placed to win the richest prize.

David Temporal is a partner in Temporal Consulting, which specialises in strategic and management consulting services for law firms. He can be contacted at dstemporal@temporalconsulting.com