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The People Paradox: How Can You Cut the Cost of Your Firm's Greatest Asset?

As firms lose business, many are turning their cost-cutting sights on their greatest asset and biggest expense: their people. But out of serious challenge comes the opportunity to examine the entire spectrum of talent management and compensation—and to restructure the firm’s business model in overdue ways.

Traditionally, law firms have been slow to adopt the types of operational processes and cost efficiencies implemented by other businesses. The current economic crisis, however, is accelerating the pace of evolution. Challenged by the recession and faced with slowing business across multiple practice areas, many firms have already addressed ways to manage costs in such key areas as real estate, equipment leasing, technology, storage and copying, travel allocations and to some extent outsourcing. But as economic projections continue to look bleak, more firms are seeking additional ways to balance the bottom line. For many firms, unfortunately, this means turning their cost-cutting sights on their greatest asset and biggest expense: the firm’s people.

In such unpredictable times, firms are struggling to identify an appropriate size for the organization. In the process, they have begun to reexamine their approaches to the entire spectrum of talent management and compensation, from assessing staffing needs to evaluating current employees’ roles to structuring the benefit plans offered to retiring lawyers. All of this presents serious challenges—but it also presents a unique opportunity for firms to restructure their business models in overdue ways.

Is It the Right Time to Right-Size?

Many law firms, especially larger ones, typically have a natural hedge against economic volatility. Strong markets generate a high volume of banking and transactional work that keeps firms busy, while weaker markets tend to produce bankruptcy and litigation work that carries firms through economic slowdowns. But in the current crisis, the bankruptcy work has been slow to develop and litigation levels have remained low as businesses hesitate to assume the cost involved and instead explore alternative dispute resolution options.

To compound matters, the onset of the economic crisis caused attrition rates to drop much faster than firms were willing to modify associate compensation, which had grown at an exceptional rate during prior years. Added to that, many firms just extended offers for the fall of 2010, so the firms are now forced to balance the twin challenges of maintaining productivity levels as business slows while also accommodating not only those lawyers already on staff but those on their way in the door.

In response to this increasingly urgent need to right-size their operations, some of the nation’s top law firms have made the painful choice of laying off both staff and lawyers, with associates being particular targets. But in addition to being detrimental to a firm’s reputation, layoffs are difficult to execute properly. They must be handled very carefully, done fairly, communicated well and completed all at once, rather than in gradual rounds. Layoffs also carry the risk of leaving firms understaffed when markets rebound and business returns. So ultimately, if a firm cuts too many associates today, it will be burdened with the cost of rehiring those associates in the future—and likely at a higher cost.

As a result, many law firms, like other types of businesses, are exploring alternatives for reducing workforce costs. Some are taking a page from the larger business world and offering carefully crafted sabbatical programs and reduced workweeks to employees. Others are deferring employment offers to a later date and adjusting compensation, whether through salary freezes or salary reductions. And it won’t be surprising to see the salaries being offered to first-year associates decline by at least 10 to 15 percent.

But how, in the face of today’s erratic market factors, is it possible for a firm to proceed wisely in exploring the various options for reducing its people costs? Let’s answer that question next.

Knowing What to Do—And Doing It

As with all business management efforts in this rough economy, successful right-sizing will depend heavily on the management team’s ability to walk the tightrope of addressing short-term needs while positioning the firm for long-term success. Therefore, when considering cuts in their workforces, firms have to look at all levels of the organization, not just the lower levels. This means management should not cut lower-level associates or administrative staff as a means of keeping the higher-end people. All cuts related to talent should be approached on the basis of performance.

To that end, law firms will need to develop new performance frameworks—a move that for many is quite overdue. Because many firms were reluctant to address performance issues robustly in the past, many of the cuts made since last fall were, to a certain extent, essentially deferred maintenance. In other words, the urgency of the economic climate has allowed firms to make reductions they probably should have made earlier, owing to the lawyers’ underperforming or otherwise failing to fulfill firm needs.

At the same time, law firms continue to advance associates in a lockstep manner that pegs compensation levels directly to the number of years with the firm, rather than on a performance basis. But in the new economic environment, firms will need to develop more disciplined approaches to all lawyer evaluations, as well as a more process-oriented approach to implementing and communicating any subsequent merit-based decisions.

Formalized, evaluation-based frameworks need to be introduced to clearly communicate all performance expectations and the corresponding rewards. This incentive-based approach to talent management will benefit firms both immediately and in the long term by controlling compensation and headcount and enabling a leaner organizational cost structure going forward.

Funding the Future of Retiree Benefits

Retirement benefits are another area where firms have generally been slow to keep pace with what other businesses have done. While most nonunion-based businesses began replacing defined benefit plans with defined contribution plans at least a decade ago, many law firms have continued to offer defined benefit plans to their people. But these plans, by offering specific benefits to retirees rather than simply contributing to employee-managed retirement accounts, are much more expensive to fund, primarily because they expose the firm to market volatility.

The consequences in the current economy are evident. Given the recent declines in the stock market, a number of these defined benefit funds are now underfunded and placing a considerable financial burden on the existing partnership. Moreover, they present a particular burden for the younger generation, who know they will have to assume additional, longer-term responsibility for funding these plans, which causes generational fairness issues within the firm.

Hence, any law firm seriously considering strategic cost-cutting initiatives relating to its talent should also consider curtailing these plans—enlisting the appropriate actuary expertise, of course, as navigating this area can be challenging.

Paying Due Heed to the Basics

As daunting as the current challenges are, management must be careful not to overreact. Each firm’s management team must carefully decide what measures will best enable the firm to continue to compete in the case of any eventuality. That means engaging in scenario planning to develop strategies that will maintain the necessary and appropriate staff, compensation and benefit levels, whether the market increases or decreases in the short- and medium-terms. In the long run, the market will turn around, and when it does, the firms that have carefully prepared ahead of time will be in the best position to benefit.

First and foremost, firms must continue to service their clients to the best of their ability, to differentiate themselves, to look for more work in the marketplace, to carefully consider the level of risk involved with that work, and to price it accordingly. Despite the dramatic changes in the economic climate, the basic principles haven’t changed, and for every firm that loses focus there will be another that doesn’t. Those firms that continue to apply the basic principles while also responding to the immediate challenges of the economic climate will be the ones that emerge with the competitive advantage when the economy recovers.

About the Author

David E. Gaulin is a partner in PricewaterhouseCoopers and Co-Chair and National Assurance Leader of its Law Firm Services practice. He speaks nationally on risk management strategies for law firms and is a co-author of Law Firm Accounting and Financial Management (Law Journals Seminars-Press).

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