Saturday, December 01, 2007

Newtonian Physics and Law Firm Collections

My entries of late have stimulated a flurry of responses from my colleagues in the corporate world. To them, the practices of law firm collections are completely unfathomable. It wasn’t until the trailing end of last week that several conversations triggered my analysis into, why behaviors of law firms are the way they are and why they will continue without change. On November 26, the thought provoking conversation took place. My colleague said, “Precedence has been set and it takes one (firm) to break away from the pack, to make change...” That single statement had two very powerful elements. Firstly, the precedence has been set and secondly, the concept of breaking away, which in itself bears with it a question of the effect of breaking away.

In dealing with the first part of the statement, “the precedence has been set”. We have to realize the practice of law, like any other profession is steeped in tradition; for which many practices have continued through generations. With such tradition, there was and continues to be no compelling need to change. Essentially historical practices have set the stage; to be the mold that shapes the present and the future. The second key concept questions, what if there is some stimulus or reason for a single firm or firms to break away from the status quo and undertakes change, what would happen? With such a radical change, will other firms follow suit or will the firm breaking the status quo be alienated from the market? The answers to these questions, I feel, date back to the mid-1600’s during the inception of classical physics.

To sum up briefly the questions to which we seek insight, are: (i) the precedence is set and what is needed to break away from the status quo, and (ii) how will the break away affect the firm and market as a whole? Insights into these were first postulated by Sir Isaac Newton in 1687 in his treatise, Philosophiae Naturalis Principia Mathematica. At the time, Newton was simply examining the physical world, seeking to understand why the world behaved as it did. This treatise later became the very foundation of some of the most pivotal laws in physics.

Newton’s First Law of Motion states that every object will remain at rest or in uniform motion in a straight line unless compelled to change its state by the action of an external force. Well isn’t that today’s law firm, when it comes to collections practices? Each year we do the same thing! January to March we assess the wounded and close the year. April to July we are into reporting. July to September we are talking to our partners about WIP and AR. October to December we are manic trying to make the ‘budget’ number! Basically, we continue to do what we have because there is no force providing the impetus to change. Our inertia propels us forward on a pilotless trajectory; it has always been this way and we have done well, so it will always be this way and we will always do well.

Unlike the Laws of Physics, the pilotless inertia of current law firm collections practices needn’t go unchecked or unaltered. It is our own failure to make change that is at fault here and not the environment. Ed Poll in his “holy grail” of law firm collections, “Collecting Your Fee”, explicitly states that firms have only themselves to blame for their collections woes. I feel this is partly the case, Newton’s First Law suggests the reason why these bad habits perpetuate – there is no external force to change! Borrowing from the medical profession, at one point in history, they (doctors) too were poor collectors, just like law firms. But what happened, an outside force got involved – insurance companies. The insurance companies took over the financial management of medicine and left the practice of medicine to the practitioners. The actuaries of the insurance companies did what they did best – profit management. The practitioners were left to do what they did best – practice medicine. I feel it will take some extraordinary outside stimulus to corral the legal profession into a more refined business model. One where financial management has been stripped away from the firm and placed in the hands of a body who has such expertise and leave the practice of law to the lawyers! (For those who have been following my posts, I suggested this direction several months ago.)

Let’s say for the sake of argument that one firm, on January 1, decides, “we are going to break away from the pack behavior and do things right”. We will have solid engagement letters clearly outlining our terms, we will have our dockets done by the end of each business day, bill all WIP by the end of the month in accordance with the engagement and our collections team will be on the client by the 35th day; what will happen? If your immediate answer is, that firm will be grotesquely profitable and everyone will get enormous bonuses. You are wrong!

A firm that engages in such a ‘radical’ departure from the status quo will not get the results, as theory would suggest. No Newton’s Third Law of Motion states that for every action (force) in nature there is an equal and opposite reaction. It is the client’s ‘reaction’ that is not being considered, that would lead one to believe the firm would be immediately grotesquely profitable. Any action that the firm undertakes will be received by and reacted on by the client and often in opposition to what we expect. If you don’t believe this third law, let’s deviate for a second to aspects in life to which we are familiar. Let’s say, the government hikes up interest rates. The effect, everything for the average person gets more expensive. They lower interest rates, everything gets cheaper. This impact affects our discretionary income and therefore our spending. Another good example, but complex, is the effects of taxation. In the simplest sense, the government needs more money. So they raise taxes, that begets them the government more money. Where does it come from? The taxpayer’s pocket, which then through the multiplicative effect of taxation, the population’s discretionary income decreases and so does spending!
Returning to our firm that undertakes a full 180-degree change to become more in alignment with better business practices of the corporate word. I postulate such an avant-garde firm will endure a very rough and rocky financial future. For the clients who have become used to a 120-day plus collections term and are now faced with 45-day terms, will seriously rethink their engagement with the firm. To these clients, up to that point of change, the law firm was their banker through interest free credit. The problem is further compounded since lawyers have commoditized the practice of law. Any radical move in client management, I feel, would drive clients to the other firms that offer more palatable practices. Personally, I would like to carry interest-free debt for 120+ days, oh and negotiate a deal at year-end instead of paying my bills in 45 days. Imagine how wonderful it would be to carry your MasterCard bill, interest free, for 4-6 months then within the last couple of weeks of the year get a 10-20% discount. Who wouldn’t think that is great and who wouldn’t get upset at the departure from that ‘status quo’!

Does this spell doom and gloom for today’s legal practice? I don’t believe so. I feel that eventually firms will hit the glass ceiling on profitability. It may be this glass ceiling that is the impetus to change. Until then, firms will continue to settle in on what they have had instead of what they could have. However, if they were to stretch to what they could have, through small incremental changes in their business practices, they will achieve immense success. The refreshing reality is, some firms have undertaken the journey. I personally know of six. One of which I met last week. On Friday, November 30, I had the privilege of speaking with the CFO of one such firm, an eastern United States firm, who has been in existence for over 100 years. Throughout our conversation I was amazed how the CFO and the collections manager were so calm. I asked if they had a December 31st year-end and why they weren’t completely manic like all of their U.S. counterparts. To which she (CFO) answered: “if you batten down the hatches all year long, there is no need to go ‘manic’ in the last few weeks of the year”. She was referring to a consistently applied methodology for running the firm that achieved profits throughout the year, not in the last 22 deposit days. Anything is possible, there simply needs to be an external stimulus to change and then management of the cause/effect of the stimulus.

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