Yesterday, we talked about the guy with $750,000 in revenue and only a paltry $110,000 in personal income.
How did he get to the point where he had decent revenue but so little of it left to put in his pocket?
He was the frog boiling in the pot. It happened slowly, day by day, over time.
The Warning Signs of Problems to Come
Clients started coming, and he took on their cases. The fees weren’t great, but they weren’t terrible. The growth felt good, and he kept saying “yes” without carefully examining his finances.
He became more popular and kept taking on more clients. He was earning a decent income, and he didn’t worry about finding a path to a higher income. He figured that the phone was ringing, so he should accept the cases. Profitability wasn’t something he considered. He was too busy enjoying the revenue.
The clients came because they got good service at a low price. The work piled up, and he added employees each time he found someone he thought would be a good addition. Add clients, add employees, and stir. The work kept coming, and he kept hiring.
His neighbors and peers watched him grow and gave him lots of positive feedback. Life was good.
Unfortunately, doing lots of work and having lots of employees doesn’t always translate into profits. A crowded office doesn’t necessarily mean a profitable office.
The next thing he knew, he had grown to three quarters of a million in revenue and a mere $110,000 in income. This wasn’t the plan. He was making just as much a couple of years earlier with revenue that was less than half of what he’s bringing in now. Oops.
He managed to grow the top line without growing the bottom line. He added responsibilities, burdens, and stresses to his life without figuring out whether he would be compensated for the additional work.
Is This a Fixable Problem?
Can he get his income back on track?
He has three options:
- He can grow himself out of the problem. He’s making some small amount per employee. Adding employees (while adding clients) lets him earn more. It’s a high volume approach. My experience tells me that it won’t work for him. Why? Because he’ll end up spending more supervising these additional employees. He’ll have to add some level of management, and that expense will chew up his share. His revenue per employee will stagnate. It may even decline.
- He can get more efficient. He can figure out how to deliver the same service at a lower cost. Again, this isn’t likely to work. Most of the service delivery for lawyers involves personal interaction. It’s tough to delegate that work to low-level people or technology, and he’s already paying fairly low wages. I think he can gain efficiencies, but he’s not likely to dig his way out that way.
- He can cut employees. That’s what he needs to do. That’s how he can improve his profitability. He’s smart though. He pushes back when I push for cuts. He knows cutting people will create a new problem.
In pushing back, he explains that his team is barely getting the $750,000 worth of work done now. Cutting the team will result in unhappy clients due to delays and shortcuts being taken. He’s right. This situation is difficult to fix. That’s why I hope you avoid the problem before it happens to you.
It’s Not Just a Headcount Dilemma
Cutting employees alone won’t solve the problem because he has more than a bad-revenue-per-employee-number problem. He has a pricing problem. He’s not charging enough for the work he’s producing. He has grown revenue by pricing the work below the cost of profitably producing the work.
Now, if he raises prices, he’s going to lose some future clients. He’s going to get the “you’re too expensive” story from prospects.
When those prospects walk away, his revenue will decline. That’s exactly what he needs to let happen. He tried being the low cost leader, and it led to being the low profit loser. Now he needs to slowly reverse course and get back on track.
He needs to increase prices as he wraps up the least profitable clients’ cases. He needs to avoid taking those highly cost-conscious customers going forward as he solves his pricing problem. He needs to drive up his revenue per employee by charging more for the same work. He’s likely to find himself charging fees comparable to his competition. Price setting, at least among experienced practitioners, is rarely accidental.
He’s going to have to delicately juggle a number of issues as he transitions from low revenue per employee to high revenue per employee. He’s going to have to make the change slowly to avoid delivering substandard service to existing clients. He’ll need to avoid dramatic change within the employee ranks by making the changes over time and allowing for natural attrition. He’ll want to increase prices slowly to keep the revenue flowing as he transitions.
Getting into the low-revenue-per-employee situation takes time. Correcting it takes more time as well as careful attention to the metrics. Use the lessons this guy had to learn the hard way to your benefit. It’s easy to slip into this situation. Open your eyes and make sure it doesn’t happen to you.