Down with Revenues, Up with Profits: What the 80/20 rule means to law firms, consultants and others (As Appeared in World City Business May 20, 2003

After spending over $18 million on external lawyers, Juan Pablo Cappello, a well known lawyer and pricipal of the Private Advising Group, gives his insights on the business of the law business.

Over the past several years I generously spread my companys sizeable legal budget across the Americas, from New York to Patagonia and across Europe from Frankfurt to Madrid. We spent over US$18 million on outside counsel and advisors. I traveled to a lot of cities, met in a lot of conference rooms and talked a lot of shop with lawyers in all sorts of law firms.

In retrospect, my most surprising observation was how similar the economics at law firms are, regardless of their size, reputation or geography.

Whether you are dealing with a leading 800 attorney Wall Street firm or a 15 lawyer firm in Chile or a 125 lawyer firm in Barcelona, the economics of law firms are about the same. Just as physics has Planks Constant", just as technology has Moores Law", the law has the 80/20" Rule. Simply stated the 80/20 Rule is:

•   The top 20 percent of any given law firms clients represent about 80 percent of the firms margin.

An important colliery to the 80/20 Rule is:

•   The bottom 40 percent of any given law firms clients are not profitable.

I do not know if it has always been this way, but I do suspect that the 80/20 rule is true, not just for law firms, but also for most consulting firms.

What can we learn from the observations that the best 20 percent of a law firms clients make the firm 80 percent of its profits??

While I do not have an MBA or am a Harvard Business School professor, the 80/20 Rule dictates that law firms need to focus on developing and maintaining that top 20 percent of their client base. Most law firms and partners do the opposite. They focus on growing their total number of clients and total billings.

Think about the measure of success in the legal profession, the AmLaw 100--American Lawyers list of the 100 largest grossing law firms in the United States. The list is not of the 100 most profitable law firms, just the 100 firms that generate the most revenues. This year the cover of the AmLaw 100 issue read Revenue Up, Profits Flat". Oddly, most lawyers would actually be more uncomfortable if the trend were Revenue Down, Profits Up."

Lawyers focus on revenues and volume rather than profitability, and that is why the bottom 40 percent of a firms clients either makes the firm no money or worse, costs the firm money. How many times have we all heard a partner bragging about his firm by saying: We have over 1,250 open matters." The answer should be, That is too bad since you are losing money on 500 of those matters."

It may be that lawyers are so tied to the billable hour as a commodity. Much like they begin to see each billable hour as the same, they view each dollar that a client generates as the same. They forget that some dollars you generate cost you a nickel to service and other dollars you generate costs you a buck and quarter to service. You can be making or losing a lot of money depending on what it takes to service that client.

So what do law firms need to do to succeed given the 80/20 rule??

1)   Law firms need to realize that their current best clients are their greatest assets. Rather than focusing on trying to grow their business, law firms need to focus on identifying the best clients they have, and give those clients the best possible service.

All law firms will say they do this, but from personal experience I can tell you that is not the case. You give most partners the choice of a meeting with a prospective client or a good current client and almost every partner will choose the meeting with the prospective client. Wrong. Your current clients are your best assets both in terms of future billings and in terms of future referrals.

Many firms have embarked on a If you build it, they will come" mentality. Attorneys often think that the road to increased profits is more leverage. That is to say hire more associates, pay them less than what you bill them out at and keep the difference.

Simple logic tells you that if you have more and more associates, with more and more leverage, a law firm should make more money. In theory this logic seems to work. In the real world, hiring more and more associates dilutes the strength of any high margin practice—the excellence of its advice. Clients are drawn to firms, practice groups and attorneys who can provide excellent advice at a reasonable value.

I often felt the best value in the law was the $900 an hour partner at the top New York firms and often the worst value was their $400 an hour mid-level associates. The best partners at the best firms often can provide invaluable advice or a solution to a business problem. Their associates cannot. Get too many associates under a partner and the partner is faced with a terrible choice: either i) he can spend the time he should advising his clients or ii) he can supervise each of the associates working under his charge—he cannot do both in a 24 hour day. So too much leverage may in the short-term increase revenues (and perhaps profits) but in the long-run it dilutes the excellence and in doing so will reduce the margin a lawyer can charge for work.

2)   Law firms need to realize that many of their clients do not generate them any profits. If I work at Legal Aid, it may be alright that we dont make money on many of my clients. But most for profit firms happily take on and retain clients that will likely never make them any money.

There are always excuses to keep an unprofitable client or a client with a low firms margin/realization rate. We get a lot of P.R. value from that client." That client is going to be a good client someday." That client is opening up that practice area for the firm." It is the foot in the door to that relationship." Occasionally, there are valid medium-term business reasons to keep a client that is bad" in the short term. But at most law firms, the de facto decision is to keep all clients regardless of profitability, as long as the client pays the bills sent to it.

Most firms would be better off firing the bottom 40% of their clients. Servicing those clients keeps the firm too busy to develop and go after better business. If one day, the partners and associates came to work and found 40% of their clients gone there would be an unprecented focus on business development. This would likely be healthy for any firm.

Firing 40 percent of a firms clients might be extreme. All firms should implement a process of evaluating the firms clients and constantly culling the bottom 10% of its clients. This advice is nothing new, for instance in the 1990s General Electric launched its "20-70-10 plan" identifying the top 20 percent, the middle 70 percent and the bottom 10 percent of its 100,000 managerial and professional employees. The bottom 10 percent of professionals were let go every year.
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Juan Pablo Cappello, the CEO and founder of The Private Advising Group Law Firm, has been well known in cross-border transactions throughout Latin America and Spain for the past ten years, both in the media and financial services industries. He is a balanced bilingual, who has worked at major law firms both on Wall Street and in Santiago, Chile.

The Private Advising Group Law Firm is a full-service, boutique corporate law firm located in Miami. It specializes in handling complex cross border transactions, mainly for Latin American clients. The Private Advising Group has a unique approach to the practice of law. It represents a roster of Latin American economic groups and individuals in their cross border transactions. It also focuses on financing transactions.

Juan Pablo, before founding the Private Advising Group, was the Executive Vice President, Corporate Secretary and General Counsel of Patagon, with retail brokerage and banking. He helped to structure the sale to Santander Central Hispano of a controlling interest in Patagon for $525 million plus a $250 million capital increase.

Prior to joining Patagon, Juan Pablo was General Counsel and Senior Vice President of Sky Latin America, an over $1 billion joint venture of News Corp, Televisa, Globo and Liberty Media.
Earlier in his career Juan Pablo was an associate at Cleary, Gottlieb, Steen and Hamiltion in New York.

Juan Pablo began his career at Philippi, Yrarrazaval in Santiago, who is part of the Uria y Menendez Spain law network.

Juan Pablo received a J.D. degree from New York University Law School and an undergraduate degree from Duke University. He was an Articles Editor of the NYU Bar Review. He is a member of the Bar in New York and Florida.

Juanpablo@private-advising.com   
www.privateadvising.com