Technology Investment – Any Happy Returns?
by Ed Poll
The upfront costs associated with technology may seem great at first glance, but a more comprehensive analysis may reveal that the ROI is worth the initial expenditure.
New computers, software and database research services are significant overhead costs for any law firm, and after nearly three years of recession firms are looking hard at whether they can afford the high up-front expense. However, information technology is so essential for most firms and firm activities that IT spending cannot be avoided entirely. The fundamental issue is for the firm to understand what it actually seeks to accomplish with technology purchases, and to accordingly make appropriate decisions about those purchases.
To a fair number of observers within and without the legal profession, technology is a force that reduces the practice of law to a commodity service. This ultimately will mean (to use the provocative title of a 2008 book by British technology consultant Richard Susskind) The End of Lawyers?. Susskind’s point was that new information technology creates an inevitable market pull toward the commoditization of, and thus price deflation for, legal services. Yet that is not the real bottom line. The Industrial Revolution and all subsequent uses of “automation” show that the more equipment is used to make a product, the labor needed and the price charged do decline but volume expands. Use of electronic technology in the law follows the same principles known to the industrial world: increased machine power reduces labor, which tends to reduce cost, which tends to reduce price, which should increase volume – and, ultimately, profits.
The fundamental issue determining profit in this equation is not the use of technology itself – it’s how much that technology costs, and how quickly the organization that purchases the technology can realize a return on its investment. It is always necessary to remember the ways in which the price – or rather, the cost – of technology can in part offset its value. Awareness of what technology can consume from a firm’s cash flow, as well as from lawyers’ billable time, gives a true picture of the return the firm gets on its technology spending.
Return on Investment
The benefit from a technology purchase can be measured by its financial results. The most common financial measure is called return on investment (ROI). Here is a typical way to calculate ROI. Say the slated expenditure is $1,000, and the expected savings or the expected increase in net revenues is anticipated to be $100 annually. Taking the savings as the numerator and the expenditure as the denominator, the percentage is 10 percent per year, which is the return on investment of the purchase. Another way to look at this is to figure that the $100, if it occurs each year, will result in a "recovery" of the entire investment after ten years, or, said another way, that the "payback period" is ten years.
There is no one right or correct rate of return. The return selected or expected is a function of personal choice, available alternatives, and available resources for investment. The ultimate payoff is in new services that technology allows the firm to offer or greater efficiency that it provides. Because there are invariably a number of technology expenditures competing for priority, using ROI is a great way to rank them in the order of financial preference. Then, depending on the budget and resources available, the most productive or profitable investment can be made first.
It should be said that not making a technology purchase can also impact ROI, but in a negative sense. Too many small firms and solo practices are behind the technology curve, even to the point of not using email or not keeping electronic files of client records. Others have technology but may go as long as six years between upgrades. They cite cost, time to learn and implement the new technologies, and lack of certainty that new technology will increase efficiency and work quality. And this is before the Great Recession that led to more widespread deferral of purchases. None of these reasons will likely protect a firm against a client who alleges that outdated technology contributed to incompetent representation, which could lead to malpractice litigation that threatens the firm’s existence. At the very least, if these lawyers eventually want to sell their practices, the value is going to be diminished if a new lawyer has to invest in the IT to get the practice up to the level of competing firms.
Given that making a technology investment is more supportive of a firm’s profitability than not making it, and assuming that the firm has properly assessed the ROI of its purchases, there are two additional factors determining how profitable the investment will be: how it is financed, and whether it will be used properly.
To pay for an upgrade, firms typically pursue one of several options.
Bank financing for technology purchases may be through a line of credit, equipment loan or term loan. The cost of such loans varies (factors include the firm’s bank balance, other services purchased, and credit rating). And with the reluctance of banks today to loan money for any reason, loans for a technology purchase are even less attractive because the purchase so quickly becomes obsolete. It’s fair to say that bankers are nervous when it comes to financing IT purchases. Thus, the prospective borrower must provide as much safety to the bank as is possible, especially by contributing both capital and collateral to the overall financing package. The size of such a contribution obviously impacts both ROI and profitability.
Even with a necessary and accepted purchase, the firm still must ensure that the level of usage and type of application justifies the expenditure. Many technology applications that are increasingly common in law firms have definite ROI pitfalls. For example, client relationship management (CRM) databases, when shared on computer desktops, can make available to all firm members the personal data and contact history of any client. The goal is to make marketing easier and more effective. The catch is that many lawyers balk at the time needed to get CRM systems running. They must go through their Rolodexes and PDAs and figure out which contacts to contribute to a central repository, and what information to input – like the sort of work the firm does for the clients and what email alerts they might want to receive. Add the fact that some lawyers don’t want to share any information about “their” clients, and the result is a big IT expenditure with a small ROI. No matter how sophisticated the database, CRM only works when all knowledge is shared and all lawyers take the time to build and use it.
Knowledge Management (KM) systems, which combine the work product of all lawyers into a single unified database that can be accessed to the benefit of all clients, pose similar challenges. Best practices require every firm, whether one lawyer or one thousand, to create a classification system all work so that it is accessible for use in future matters. This is only feasible by using shared document and email management systems. Without systematic technology integration, the result will be haphazard, after-the-fact efforts that doom KM efforts to failure. Moreover, the KM process only works when the information is classified and categorized consistently and continuously. Many lawyers believe that this is not billable time, particularly after a transaction or case is completed, and so they either do not do it or do it incompletely. No matter how sophisticated the database, KM only works when all knowledge is shared in a way that all lawyers can access it. Failure to invest the time need to update the knowledge management database weakens it; and holdouts diminish the return for colleagues and clients alike.
We began this analysis with the premise that effective law firm technology use should lead to a higher volume of work for the firm. The key to higher volume is understanding what the firm wants, what clients need and choosing the technology that bridges the gap. Or, said another way, the difference between want and need is value. Law firms that partner with their clients can show those clients how they can reduce their legal costs (without reducing the lawyers' per unit fees) and can develop strategic plans for meeting legal challenges.
Undeniably there is somewhat of a trend among corporate clients to view certain legal services as a commodity, and to apply standardized rates or flat fees where appropriate. However, most clients recognize the importance of and are willing to pay a fair fee for value. What they do not want is to pay too much – to pay for inefficiencies, duplications, or unnecessary services. And this is what the right technology should eliminate. Providing greater value in legal services produces more effective representation at a lower cost to the client without discounting either the value or the per hour fee of the lawyer. That is, or should be, the true bottom line ROI on a technology investment.
Ed Poll principal of LawBiz Management Company, is a nationally recognized coach, law firm management consultant, and author who has coached and consulted with lawyers and law firms in strategic planning, profitability analysis, and practice development. Mr. Poll has practiced law on all sides of the table for 25 years-- as a corporate general counsel, government prosecutor, sole practitioner, partner, and law firm chief operating officer and been a consultant to small and large law firms for 20 years.
The opinions expressed in this article do not necessarily reflect the opinion of ILW.COM.