Based on the Citi Client Advisory Survey, early 2015 showed tepid growth (0.1% increase) in demand, with firms benefitting from a 2.3% increase in revenue driven by a 2.8% increase in rates. While the overall revenue growth was positive, according to the recent survey, those gains were offset by a 3.9% growth in expenses which starts to chip away at Profit Per Partner and cash flow. Compensation grew by 5.8% which was the key factor in the overall increase in expenses. However, operating expenses were up 2.5% which is slightly higher than overall revenue growth, and highlights the challenges firms are facing in managing their non-revenue based expenditures.
As you think about the second half of the year and prepare for the 2016 budget cycle here are few items to consider:
- Costs follow revenues: During the recession, firms took aggressive steps to reduce expenses, including deferring investments, to offset the drop in revenue. Over the last 12+ months, firms are moving quickly to catch up on the operational gaps created by deferring those investments. Some of the items include addressing obsolescence (technology, etc.) while also dealing with shifts in the industry’s operating environment (cybersecurity threats, business intelligence tools, etc.). This has caused a jump in expenses that has been noticed by opportunistic vendors who see it as a way to increase revenue and margins.
- How to address: Firms that take a proactive strategic approach to address their operating expenses experience slower expense growth versus firms that take a more reactionary approach. Trends in areas such as Telecoms, Software, Library, Managed Services, etc. (often equating to tens of millions of dollars) can be and should declining as efficiencies within those sectors take hold. Success in negotiating with vendors comes from taking a holistic view and engaging in a collaborative strategy that focuses on increasing transparency and visibility. As part of that approach, firms need to have a good understanding of their short-term requirements (changing needs and contract pipeline) and consider what their future (18+ months) might look like. Taking that those steps provides firms the ability to maximize leverage on pricing terms but also ensure they structure an agreement that provides coverage for future purchases or growth.
- Change is here to stay: To be comfortable with the status quo is avoiding the reality that change is the new operating norm. That impact is being felt across all areas in a firm. Technology groups are working to understand the true impact of cloud computing and increase in mobility requirements along with how these areas align with software and hardware strategies. Real Estate considerations are shifting as rent/lease costs continue to rise and firms focus on the most efficient space design which will have an impact on furniture and CapEx investments. Libraries are shifting to more on-line access instead of books, and are taking a pragmatic look at content (unique vs. redundant) and how services are delivered (local vs. centralized support). Finally, information governance and records management is being carefully reviewed to determine the best approach to properly managing, controlling and protecting all types of information. Structuring vendor agreements that find the right balance between cost, flexibility and future considerations is key to maximizing value.
- Food for thought: Vendor Governance strategies are starting to move into the spotlight as more law firm clients, especially financial institutions, are requesting specific information on how firms monitor and manage their vendor community. Traditionally, this isn’t an area where firms focused or had standardized processes and policies, but the potential risk exposure is increasing thus forcing firms to focus on this space. Developing a sound Vendor Governance program address a couple of key components including Vendor Onboarding, Information & Physical security, Contract Management, and Audit / Compliance. Going forward, firms are taking steps to formalize their approach to managing vendor relationships which includes starting to develop and implement supporting processes and policies.
Citi’s survey highlights one of the long-term challenges facing firms: the overall market continues to have flat or very low growth in demand. Successful firms will find ways to not only increase their market share but also find ways to effectively managing their operating expenses. In the end, the bottom-line impact of $1 in cost savings via effective expense management can yield the same benefit net as $3+ net new revenue (assuming a 33% profit margin).