2022 has come to an end, the 10 year long bull market has come to a close, and the ominous word “layoffs” is reverberating in the heads of employers and employees across industries. Mass layoffs have come to several sectors of the American economy as employers scramble to rebalance their costs due to losses in revenue.

In October alone, Meta slashed its workforce by 13 percent (11,000 employees) and Twitter fired half its staff. The question becomes: should law firms take a page out of big tech’s playbook and rapidly downsize their staff? Our answer is a resounding “No!”—fire-drill mass layoffs leave firms both unsustainable and stunted when it comes to potential growth. The modern American law firm can trim the fat without sacrificing talent by pulling a variety of other levers—smart business practices that will drive significant efficiency cost savings, shorten and make more predictable several parts of the revenue cycle. One of these levers is optimizing their collections processes.

By eliminating collections inefficiencies, organizations can better survive the bear market—positioning themselves for new growth when the economy once again turns bullish.

The current anxiety stifling the air at law firms isn’t just the result of slight present losses in revenue, it’s from the threat of significant losses to come. While unprofitability plagued large swaths of the pandemic era market, counterintuitively, law firms were spared. After enjoying 13 percent growth in revenue in 2020, law firms grew again by 14.8 percent in 2021. Profit per equity partner rose 19.4 percent last year as well. However, many worry that this sudden rise in demand isn’t sustainable. Those in the legal profession see the tech sector’s plight as a foreboding omen—an exuberant rise can produce an equally devastating crash.

What Goes Up Must Come Down

The rapid expansionist moves taken by law firms during the period of surging demand make the projected fall of revenues all the more challenging if demand starts to slip drastically. An Increase in demand equals an increase in demand for talent. However, a sector-wide increase in demand for talent equals an increase in competition for said talent. As a result, lateral hires dramatically increased at both the partner and associate levels during the post-pandemic period. Compensation also rose dramatically—growing 16.3 percent in 2021, and 22 percent when accounting solely for senior roles. Compensation doesn’t just mean raising base salaries—the structures of annual, retention, and signing bonuses all need to be altered dramatically to lure top-tier talent as well.

The first dominos are already starting to fall—after revenue grew a modest 5 percent during the first half of 2022, these figures slumped 3.6 percent in the second half of the year. Compounding this softening of demand have been soaring operating costs, which grew 13.5 percent in 2022 alone. A return from the virtual-work nature of the pandemic has been devastating for the balance sheets of law firms, as renting offices and funding business trips once again eat into profits. While this may be one of many expenses out of law firms’ control—factors such as inflation, instability in Eastern Europe, and supply chain issues—a significant portion of operating costs can be blamed on overly optimistic moves made during the period of rising bullishness.

One such aggressive move has been the incorporation of new, innovative technologies into firms’ outdated infrastructures. While technology costs have skyrocketed by 13.5 percent in 2022, these costs are justified—law firms should view these expenditures as investments that position their organizations for long-term growth. Because these investments in cybersecurity, cloud computing, and other digitization efforts will attract a more diverse client base and streamline data collection, it would be shortsighted for organizations to backpedal on these investments, sacrificing their future for better short-term profitability. While spending aggressively on tech and talent may have been overzealous, reflexively reversing these expenses risks more in the long term than simply eating the costs or cutting corners in over-bloated departments.

Collections: A Long Overlooked Target for Increasing Efficiency

One area that has the potential for massive return is collections, especially considering that the current state of law firm collections is a mess, marred by inefficiency and outdated technology. The problem here is only getting worse—in the first half of 2022, there was a 4.2 percent lengthening of the collections cycle. In 2022 as a whole, firms have also seen an increase of receivables outstanding by nearly 10 percent. Megafirms especially are leaking revenue—AmLaw 100 firms miss out on 12 percent of billable invoices they send to clients, which lags behind AmLaw Second Hundred and mid-sized firms in this area. Unfortunately, as many firms expand, their collections departments are the last to catch up with other upgraded, sophisticated sectors. Bull market-induced complacency can be blamed for the decay of collections practices—indeed, when law firms have a lot of work coming in, the last thing they’ll worry about is operational hygiene.

The first step to revolutionizing collections practices is breaking down the systems into its four key components: matter and client acceptance, matter intake and setup, delivery, and invoicing and collections. By connecting and streamlining these four links in the revenue chain, law firms can save an enormous amount of time while still driving profitability.

By taking on a new approach, helped by introducing data analysis and cutting-edge technology into the collections sector, law firms can both expedite the collections process and eliminate human error. For example, organizations that invest in collections dashboards that automatically score each invoice based on the client relationship, number of days the bill is outstanding, size of the bill, and concentration of outstanding accounts receivable the overseeing partner has, will have much better visibility into their collections problem. This approach will help the CFO and progressive layers of leadership prioritize profits in an efficient manner. There is immense value in integrating a toolkit that can locate holes in the company’s infrastructure rather than blaming poor margins on individual clients. A client’s outstanding payment is symptomatic of a firm’s poor collections practice—they aren’t the root cause of the problem.

Collections can’t be overhauled without firms looking within and auditing their collections process to pinpoint inefficiencies. Process mapping is key in identifying flaws in the revenue cycle. Rates applied, proposed team profitability, prompt time capture, decreased pre-billing write-offs, timely billing to clients, accounts receivable (A/R) procedures, clear A/R accountability, coordinated A/R status, avoiding post-billing write-downs, write off and collections decisions—all these facets must be analyzed to locate where firms are leaking revenue. Many lawyers describe from anecdotal experience that what starts the vicious cycle of delays, debts, and deteriorating attorney-client relationships isn’t a late payment on the client’s end, it’s a late bill sent on the attorney’s end. Sending prompt bills is a preventative measure—it sets a precedent, establishing that the company values professionalism while eliminating unpleasant surprises on the client end.

After identifying any holes in the collections infrastructure, senior management must be ready to hold members of the organization accountable for their oversights. Perhaps the associate didn’t remind the client consistently enough about the payment. Maybe the associate didn’t put enough effort into the client relationship. Leadership must also ask the following questions: does the collections team need additional members? If so, how many? What level of resourcing gets us to “good enough,” and avoids diminishing returns? Is the tech worth the investment, or could we get to “good enough” without significant investment in digital?

Legal collections can be a delicate balancing act—in seeking payments, firms must be careful not to alienate valuable clients, yet still be clear about their intentions. As reported in an American Bar journal article, Darlene Maronge, Collections Analyst at Galloway, Johnson, Tompkins, Burr & Smith, says: “When I have to contact a client for payment, I speak to them the way I would want someone to speak to me—especially when trying to collect payments. I always listen to the client. To me, it is important to be respectful and be responsive as soon as possible regarding issues with invoices.” Empathy is usually a more effective approach than detachment or anger when dealing with outstanding payments.

Payments will be received far more smoothly when firms approach collections from the client’s point of view. Organizations must make careful considerations when selecting who should reach out for collections. They must factor in whether the relationship is new, if it’s long term, and/or if it extends across multiple practices in the firm. Firms must also use straightforward and deliberate language when establishing terms for payment. Maybe a specific client has the money to pay yet they were confused because the terms were set in ambiguous or jargony language. Personalization goes a long way when dealing with a diverse group of clientele. The difference in fiscal year cadence, a newness to the firm’s invoicing system, distractions in a client’s personal life—all these unique factors require an equally bespoke approach.

Striking the Right Balance

While setting bold revenue goals goes hand in hand with overhauling collections, firms need to remain realistic about expectations. Change can be incremental and nonlinear, and that’s okay. This is where KPIs come in: advanced analytics can make sure that firms don’t get too carried away cutting corners in an attempt to iron out their collections inefficiencies. There is a happy medium between cleaning the slate and stagnating, and advanced analytics can determine precisely how much needs to be overhauled to reach sensible revenue targets. Just to put in perspective how archaic the current state of collections metrics are, some firms don’t even track their percent collected at the year’s end. Modern metrics should go above and beyond percentage collected—they should measure the percent of revenue collected versus written off, the percent of clients with outstanding invoices, the number of clients past 30, 60, or 90 days outstanding, and the margin impact on the firm from improved collections.

The future of collections analytics involves data that is not only reactive, but predictive. In the not-so-distant future, collections departments will be able to build a profile of a prospective client, and from there determine if they are more or less likely to pay on time—even going as far as to determine by how many cycles their bills would be late. These advancements in predictive analytics will not only help firms to make more lucrative client selections, but also more accurate revenue projections.

While creating an effective collections department may be the first step to sustained profitability, these changes must be part of a larger, overarching culture shift. Overhauling collections will impact the bottom line, but it won’t impact sales, associate development, and delivery. Companies can make a roadmap from the remodeling of their collections practice—a first step in leading an organization toward profitability, sustainability, and increased satisfaction for clients and associates alike.

By Mark Masson, Jay Russell, and Ed Estrada

Originally published in AmLaw, January 26, 2023