My last post talked about revenues.  This time let’s look at expenses.  People costs represented 77% of total in 2002 and now run closer to 79%.  This includes all compensation costs (fully loaded) as well as partners.  Nearly half the law firms recently surveyed indicated they have terminated associates and staff while a quarter have reduced their partnership ranks.  And they may not be through as three-quarters are considering partner reductions and over half more associate and staff cuts.  We are way beyond the critical mass necessary for it to be acceptable to reduce headcount.  Now even law firms in good condition are taking a critical look both the number and quality of personnel.  This is when organizations return to a lean and flat operating philosophy.  The result is that personnel who do not directly deliver a necessary service are most likely to be made redundant.

Partner reductions are a bit more complex.  If key partners abandon ship, it will likely accelerate the firm’s decline.  And too many partners leaving for whatever reasons may trigger default provisions in debt and lease covenants.  But a careful review with strategically focuesed reductions are going to be necessary at many firms.  Reducing draws may also be required.  Smaller draws eases working capital needs and the firm can always make spot distributions if economic conditions/performance warrant.

Personnel turnover is expensive and disruptive.  An alternative to layoffs is to reduce cash compensation.  Working for less pay while retaining benefits might very well be preferable for both employer and employee then not working at all.  This is not a common approach in law firms, other than for partner draws and distributions.  Hourly staff will probably not be asked to reduce pay.  Exempt staff may, but it is still likely to be a minority of these folks. 

However, law firms are universally giving this a very careful study for associates.  While law firm leaders are carefully considering their year-end associate bonuses (no one is anxious to be out in front this year and only a few have gone public so far) and their own year-end partner distributions; it may be wise to take heed of the reaction to the Big Three auto executives riding to Washington on private jets and the bonus announcements at some endangered investment banks.  Justified or not, one needs to pay attention to optics.  Your clients are already seething over high outside counsel costs and struggling mightily with budget cuts of their own.  Another round of big associate bonuses and year-end partner distributions will not help your cause, particularly with pricing in 2009.

There is a need for balance in this situation.  No bonuses or adjustments might not yield the proper result any more then throwing money at everyone would.  High performers should be recognized and earn more, but this should happen within the context of the firm’s culture.  A true firm mentality where the individual rises and falls based on how well the organization does is different from an organization where it is all about the individual.  I am not advocating for or against either style, only that your pay decisions be consistent with the operating philosophy.

Benefit costs are likely to rise again this year for employers and employees.  The most significant cost is health care coverage and employers are shifting even more of those costs to employees.  Most notable are the higher deductibles in PPO plans where half now require a deductible of $1,000 or more as reported by Mercer.

Occupancy is the next most prominent expense line item.  These costs averaging around 7% of revenue in 2002 and in better more recent years closer to 6%, are long term fixed costs, likely with escalators built in.  In a robust economy that is an advantage as growing revenues allow you to leverage the fixed investment.  However, in a down economy those fixed costs consume an even greater share of diminishing revenues.

Marketing, technology and personnel training/development costs are prime areas for reduction in difficult times.  Projects will be reduced in scope and/or scale, some will be deferred and others will be cancelled outright.  Certainly there are savings to be had, but a more prudent action would be to prioritize and invest across all of these areas for the most critical needs in each.