Putting Profit First in Your Firm and for Your Clients

As a simple example, Paul loves chocolate ice cream and dislikes vanilla. Mary loves vanilla and dislikes chocolate. They have each been handed an ice cream cone. Unfortunately, Paul got vanilla and Mary got chocolate. As they are deciding whether to throw away their cones, they bump into one another and discover their mutual dilemma. Not surprisingly, they exchange cones. They each give up a thing of lesser value for a thing of higher value. Both have experienced profit.

There is some thinking that profit for one person or entity must come at the expense, or to the detriment, of another. That is manifestly not the case. Profit that comes at another’s expense is unsustainable. Indeed, law firms making their way with this kind of one-sided profit will find it difficult to maintain their businesses—and it will probably be a pretty lousy place to work.

In the context of a well-run, sustainable law firm, profit works the same way. A client has problems (or opportunities) for which it does not have the skills, knowledge or time to effectively solve. These problems are affecting the client’s financial, personal and/or reputational well-being. What the client has is money, or the means to get it. In this circumstance the client values the money less than having a good solution to its problems. To make a profit, it is essential that the client have a thorough understanding of the value of the lawyer’s contribution to solving the client’s problem, and that value must exceed the value of the money the client pays to the lawyer.

Part of the lawyer’s job is to educate the client as to the true value of—rather than solely the expense of—his or her services. This is best expressed as the difference between where the client will be if the problem goes unresolved versus where the client will be with the lawyer’s help. This enables the client (and the lawyer) to evaluate whether working together will be profitable for the client.

The lawyer, on the other hand, has the skills, knowledge and time to work on the client’s problem and to deliver the solution that the client values so much. The lawyer must then first determine, with specificity, the cost to his or her business of delivering the solution to the client. How much of whose time will go into the solution? What direct costs will there be? As a baseline, the lawyer must know that he or she can deliver the solution for a cost that is less than what he or she charges, so that he or she can also make a profit.

The goal then is for lawyers to work with clients that can profit from working with them while the law firm also makes a profit. This is the way in which every sustainable relationship perseveres. When only one side profits, typically it is the result of one of two things:

1. An   inequitable power relationship, that is, the stronger party is basically taking from the weaker. This may be successful in the short term but is far from satisfying, involves questionable ethics and, in the end, is unsustainable.
2. A desire for one party to get something else from the relationship. For example, lawyers frequently seek to derive self-esteem from engaging in transactions that are not profitable to, or sustainable for, the law firm. This is not meant to disparage pro bono work but to distinguish the work that lawyers agree and decide to do pro bono from the cases that they allow to become unprofitable without that decision.

There is no question but that it is in both sides’ best interests to be sure each makes a profit in the lawyer-client relationship. The lawyer must ensure that the firm and the client have all the information necessary to enable each to make this decision and engage, or not engage, in the relationship.

Profit... First?

What does it mean then, to put profit first?

The traditional calculus of a business goes like this. Money comes in (i.e., revenue). Then the business pays its employees, rent, utilities and other overhead (i.e., expenses) as well as taxes. What is left over (if anything!) is profit for the owner(s) or shareholders of the business. Profit is an afterthought. This is displayed in the following simple equation:

Revenue
– Expenses
– Taxes
= Profit

Yet profit is always the prerogative of the owner. Using the results you have been getting in your law firm over the past year, you can reconsider your finances in a very different light.

1. Last year, what was your profit as a percentage of revenue? That is your profit allocation (PA).
2. What was the total amount you and/or the business paid in federal, state and local taxes in the past year? What is that amount as a percentage of total revenue? That is your tax allocation. (TA).
3. Finally, what amount was then used to run the business (i.e., expenses)? What is that amount as a percentage of total revenue? That is your operating expense allocation (OpXA). (See Table 1.)

Next, make a decision that, from this moment forward, when money (revenue) comes in, you will first take the PA and set it aside in a separate account. You then take the TA and set it aside. Now, the OpXA is what remains after you secure the PA and the TA. This is illustrated in the following equation:

Revenue
– Profit
– Taxes
= Expenses

Remember, this is the exact amount on which you ran your business last year!

Mentally, however, this is a huge shift. Now you must address the fact that the business must live within its means from this pot of what is left over. This will immediately clarify decision making around new expenses as well as wasteful, old ones. This will highlight the need to increase revenues when the business wants to increase expenditures. Most of all, this will secure the owner’s profits and future taxes!

Once this is done, the owner can then decide to (slowly) change the profit number to meet his or her desired income as a business owner. (See Table 2.)

The effect this will have on the OpXA will be made clearer. To sustain profits will sometimes involve eliminating waste and, more frequently, increasing revenues.

Most importantly, the owner will gain a much greater sense of control over the results the business provides to him or her, which in turn will allow the owner to focus on his or her clients. Which, after all, is what clients really want, and why we all went into this business in the first place!