Cutting overhead can be painful procedure

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Published on 1/12/09

The cost represented by people is the largest expense at all law firms - those with hundreds or even thousands of lawyers and staff, and the small firm or even the solo practice.

There is no question that lawyers and law firms need people. Yet in periods of recession, such as firms face today, one of the first responses to the downturn is to lay off staff and associates.

Underperforming partners also are either eased out or more summarily asked to depart, with no graceful segue into "of counsel" status.

For any law firm, eliminating people is a slippery slope that the firm must tread carefully. That's because the cost represented by hiring and terminating people is the largest and least understood expense at any law firm.

The issue is not necessarily the dollar amount involved in the hiring and turnover; it's that firms generally don't know what those costs are, have no idea how to calculate them and don't see their impact on the bottom line.

Too often, when driven by perceived or real economic pressures, firms can make hasty and harmful decisions by cutting people, and the overhead expense they represent, too far too fast.

The news stories about law firms laying off or terminating associates and staff, and de-equitizing partners, raise the question of why these people can't be transferred from their current practices to other practice areas that are still growing. After all, these lawyers are trained in the culture of the firm, presumably are good lawyers (otherwise they shouldn't have been hired) and should be capable of learning new technical skills.

Cutting first, without a measured assessment of what and where to cut, eliminates muscle and not just fat. It will likely cause a problem when (not if) the economy recovers and firms must scramble to catch up with client demand after their layoffs.

"Retrain and gain" is the motto that may make most sense.

If firms measured the costs of termination and replacement, particularly where lawyers are concerned, they would find they have many more measurable metrics than they care to admit.

These include training costs (not to mention the cost of compensation, benefits and lost productivity while a new person is trained) and client service costs (measured in reduced or lost business due to dissatisfaction while waiting for a new hire to get up to speed).

There are also direct termination costs from exit interviews, severance and other administrative expenses.

That said, a case can sometimes be made for termination. Law firms increasingly try to change the financial dynamics of their team through leverage: hiring and using associates as a cost effective way to do billable work in a team setting while boosting partner profitability. But associates should not remain with the firm unless it is profitable to keep them on an ongoing basis. While the new associates may not earn more than they cost the firm in the beginning, at some point that situation must change.

In fact, large-firm managing partners agree that it takes, on average, from three to five years to break even on the investment in a new lawyer.

All attorneys ought to be able to assess the impact that they have on firm overhead and, thus, firm profitability. The calculation can be expressed as a simple equation: Billings - Compensation + Direct and Indirect Overhead = Net Profit.

Each lawyer represents unique overhead. Yet such analysis can point out those attorneys who do not generate the profit to cover their cost and therefore may be candidates for layoff. Cutting overhead may thus sometimes be necessary.

But between the cost of hiring new lawyers and the ill-will generated among existing clients if the firm cannot meet future demand, cutting overhead too sharply can cause the firm considerable harm.

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