K&L Gates' Full Frontal Financial Disclosure

Parsley Sage Rosemary & Ginsburg LLP

“Always a reasonable result for a reasonable fee, always”

MEMORANDUM

To:	Partners
From:	Mike Marget
Date:	March 4, 2013
Re:	K&L Gates’ Full Frontal Financial Disclosure

        A week ago, a major law firm – K&LGates (1,700+ lawyers) – chose to disclose its key financial information to thepublic via its website.  Since law firms are not required to publish financial statements, this move was surprising on at least two levels:

1.   The firm chose to disclose significantly more financial information than is typically published in connection with The American Lawyer magazine’s annual survey of the top 200 Legal Industrial Complex firms.[i]  K&L Gates provided 2 pages of financial data – the typical revenue, PPP[ii] and RPL[iii] numbers, plus other statistics like cash, debt and capital balances as of year-end, high/low debt balances during the year, and a good deal of narrative akin to the management discussion section found in a corporate annual report.

2.   What could be the firm’s motivation for taking this step at this time?

K&L Gates Motivation

        Chairman Peter Kalis said the firm wasmotivated to improve the public image of the profession in light of the “Dewey debacle” – where management at Dewy & LeBoeuf misled partners, bankers and clients (via the AmLaw rankings)[iv] about the firm’s financial stability before filing for bankruptcy.

        Notwithstanding this noble and altruistic motive, K&L Gates has also positioned themselves very nicely vis-à-vis other firms in the never-ending quest to always pick up the best and brightest laterals to continually improve their franchise.  In one bold step, K&L Gates sent the following message:

• Our internal financial disclosures and external communications (e.g., to The American Lawyer) are the same; we don’t manipulate our revenue figure or our equity partner headcount.  
• Not only do we have no debt at year-end, we didn't borrow as much as a penny against the line of credit during 2012 and 2011.  
• We’re "transparent" with our partners and our clients about the firm's financial stability.
• Can your current firm or other potential lateral firm say the same thing?

Reality Check/Lateral Partners

        Can every firm be trusted to refrain from manipulating the numbers in the press release the same way they did for the AmLaw rankings?  There will undoubtedly be temptations, but the more statistics disclosed the less likely it becomes to alter the important numbers without leaving an obvious audit trail.  Moreover, if other firms do not reconcile their internal and external reporting, they can count on their rank-and-file partners to call them out about it.

        Nevertheless, laterals must always be weary of whatever financial data is provided by prospective new firms.  As a financial person, I would like K&L Gates’ disclosure to be expanded to include, among other things, information like the quality of the firm’s inventory (i.e., accounts receivable and unbilled fees) and the number of highly compensated partners with long-term guaranteed contracts (another problem at Dewey). 

        If you are a major rainmaker contemplating a move, use your clout to examine more financial data before taking the plunge to join a new firm.  For the sake of the capital you will invest in the new firm, for the sake of continuity of service to your clients, and for your own mental health, perform significant due diligence before committing to a new firm.  There are other financial reports you should request and review:

• Citibank and Wells Fargo[v] provide participating law firms with detailed financial analysis – comparing the firm with peer firms – as part of their quarterly industry financial reviews.  Request copies going back 2 years, read them and have a sit-down with the firm’s CFO to discuss.
 
• PricewaterhouseCoopers publishes a similar report which compares firms by geographic area, size and other demographics.

These reports provide significantly more data than that disclosed by K&L Gates last week.  Should any prospective new firm not wish to share this data with you, I would be afraid -- very afraid.

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[i] Don’t get me started about the financial fallacy which is the AmLaw rankings.  Simply put – firms lie.  Not all of them, but enough to call into question the entire process.  Exhibit 1is Dewey & LeBoeuf who overstated their revenue by more than $150 millionfor each of calendar year 2010 and 2011.  The magazine took a credibility hit on that one, but has never adequately addressed the systemic problem illustrated by Howrey, Thacher Proffitt, Thelen, Heller Ehrman and others who kept posting good numbers right up until the time they ceased to exist. 

[ii] PPP is profits per equity partner.

[iii] RPL is revenue per lawyer.

[iv] See Endnote i.

[v] Buy a banker from the Legal Industry Groups at either Citibank or Wells Fargo a cocktail and he/she will tell you the numbers they receive in connection with their “privately published” surveys differ significantly from the very public numbers appearing in the AmLaw rankings.

Financial Data with Destiny

Parsley Sage Rosemary & Ginsburg LLP

“Always a reasonable result for a reasonable fee, always”

MEMORANDUM

To:	Managing Partners and Administrators
From:	Mike Marget
Date:	February 22, 2013
Re:	Financial Data with Destiny

        Managing a law practice has never been tougher.  Everybody is looking for that silver bullet to restore profitability despite waning demand for legal services.  Whatever measures your firm adopts to improve the bottom line, continuous access to actionable financial data has never been more important.

Since the onset of the Great Recession, large law firms have been relying upon their internal accounting systems as a strategic resource to make better daily business decisions.  Real-time access to firm financial data has become de rigueur, enabling both leadership and individual lawyers to identify trends at a macro level, and then drill down through the data to understand cause and effect by client, matter, fee-earner, practice group, area of law and other relevant metrics. 

        The sophisticated accounting software utilized by the largest firms is designed with a single purpose in mind – to make every lawyer a smarter financial manager.  Data is easily accessible online and provides a clear and accurate view into every important financial driver of profit and cash flow.  Depending upon the “access rights” granted specific individuals:

1.   Billing attorneys query the status of individual clients and matters – e.g., last invoice date and amount; total AR currently outstanding; date of last payment; and balance held as unapplied retainer or in trust accounts.

2.   Timekeepers may consult a calendar representation of hours reported with the ability to edit and spell-check the narrative language.

3.   Billing attorneys review aged accounts receivable and unbilled work-in-process reports on demand.

4.   Firm leaders analyze a myriad of information regarding clients, individual lawyers, practice groups and the firm as a whole.

5.   Key performance indicators – billable hours; billable hour value; fee billing; fee collections; effective hourly rates by timekeeper and group classification; utilization and realization; new clients and new maters opened – as compared to budget or targets – may be “sliced-and-diced” in various was to both to analyze current performance and project future results.

Financially-savvy firms use their accounting systems to recognize problems and monitor progress toward improvement.  For example, assume a “commodity” practice area where billing realization is below firm average or budgeted amount.  The low realization might be the result of staffing errors – too many hours worked by timekeepers with higher billing rates necessitating fee reductions in the billing process.  A possible solution might be to reallocate workloads so timekeepers with lower rates work on these commodity matters, while higher-rate individuals are assigned to other client work where they can realize their full rates.  Every law firm requires an accounting system capable of providing this type of insight into their financial operations.  

Unfortunately, not all law firm accounting software is created equal.  Many smaller firms are constrained by systems incapable of transcending rudimentary time-and-billing transaction processing.   

Fortunately, there are options for small and midsize firms to obtain sophisticated law firm accounting systems which need not involve an expensive capital outlay for the software and associated hardware purchases and maintenance costs.  One possibility is Software-as-a-Service (SaaS) where the software resides in a hosted, Cloud-based environment and “rented” by the law firm rather than purchasing it outright.  Another route involves outsourcing some, or all, of the firm’s bookkeeping and billing procedures to a competent third-party provider who will supply the sophisticated software as part of an overall services package.

Whether it is acquired by purchase/installation in-house, via SaaS, or through outsourcing, sophisticated accounting software can be transformative for the firm by providing greater awareness of the financial drivers of profitability and enabling better financial decision making. 

CLIFF NOTES -- 2012 Year-end Tax Planning for the Firm

Parsley Sage Rosemary & Ginsburg llp

“always a reasonable result for a reasonable fee, always”

MEMORANDUM

To:	Partners
From:	Mike Marget
Date:	December 11, 2012
Re:	Cliff Notes – 2012 Year-end Tax Planning for the Firm

           Year-end tax planning is a mindboggling concept in the best of times.  As the end of 2012 approaches, “uncertainty” is the operative word due to a combination of upcoming events, including the likely expiration of the 2001-era tax rates and a new Medicare tax levied on the high income earners.    

          I recently conducted a brief, informal and very unscientific survey of tax accountant friends who advise high income individuals, including a number of partners (shareholders) in law firms.  Their advice:  law firms should accelerate revenue and defer expenses this year in anticipation of higher tax rates in 2013.

1.  Why Accelerate Income and/or Defer Expenses?

          In most years, taxpayers prefer to defer revenue and accelerate expenses in order to minimize taxable income.  This year is different.  Absent agreement in Washington to the contrary, the highest marginal tax bracket automatically increases to 39.6% from the current 35% on January 1, 2013.  In addition, a new 0.9% Medicare contribution tax on earned income takes effect for 2013 for married taxpayers with modified adjusted gross income over $250,000 and over $200,000 for taxpayers filing single.  Taken together, the tax rate applicable to most law firm partners will increase by 5.5% on their law firm income earned next year.[i]

          With these likely 2013 rates, partners will owe 5.5% more in federal income tax on every dollar earned next year at the highest marginal rate as compared to the 2012 rates.  Accordingly, the partners will save $5,500 on every $100,000 of taxable income which can be “shifted” into 2012 from 2013. 

          Generally speaking, the idea of deferring income/accelerating expenses is a good idea when tax rates remain the same or are likely to decline year-to-year.  Conversely, if rates are likely to increase in the succeeding year (i.e., the likely 2012/2013 scenario), the opposite is true.  However, there are some caveats:

A.   Law firm compensation percentages are not static.  Partner A may be entitled to 30% of the profits for 2012.  Shifting $100,000 of income from 2013 to 2012 to take advantage of lower rates could result in a $5,000 windfall if Partner A’s profit percentage in 2013 falls from 30% to 25%. 

B.   For every action there is an opposite and equal income or not-income reaction for someone else.  Assume you pay your tax accountant every December for the advice and service provided during the year – including the suggestion this year to defer expenses in 2013 to maximize taxable 2012 taxable income.  If you decide to defer the accountant’s payment to January 2013, your law firm wins, and your CPA loses.  Because of your decision to defer the regular December payment to January, you have shifted taxable income from the lower rates of 2012 to the higher 2013 rates for your CPA.  Talk about being hoisted on your own petard!

C.   It is often difficult to “go back” in time.  Should your firm decide to defer associate and staff bonuses from December 2012 to January 2013, later reverting to a December bonus payday becomes problematic.  Switching back will mean 2 bonus payments in a single calendar year – one in January for the prior work year and a second in December for the concurrent work year.  Such moves should not be taken lightly since they impact issues raised in both A and B above.

D.   Not all partners are created equal from a tax perspective.  Whatever your firm decides to do – take your CPA’s advice and accelerate income/defer expenses for 2012 or simply maintain business as usual – discuss it with all the partners.  Don’t assume every partner has the same individual tax goals and will benefit from the same strategies.  Moreover, a dramatic income shift may subject certain partners to penalties and interest for underpayment of quarterly federal and state income tax estimates for 2012.

2.  Deferring 2012 Expenses to 2013

          The following is a partial list of things to consider if your firm wants to defer 2012 expenses into 2013:

A.   Vendor Payments.  Most law firms pay their vendors on a 30-day (possibly longer) payment schedule.  In prior years, your firm likely accelerated items scheduled for payment in early January in order to take the tax deduction in the current year.  If your firm decides to maximize 2012 taxable income, you will want to defer as many expense payments as possible.

B.   Year-end Bonuses.  If your firm typically pays bonuses to associates, staff and non-equity partners in December, you may want to consider postponing those payments to January 2013.  Be mindful, however, that the deferral of bonus payments may subject the receipients to higher tax liabilities at 2013 rates.

C.   Delay 4^th Quarter Nonresident State Composite Filing.  If your firm processes 4^th quarter composite filings in December (so partners can deduct the state income tax payments on their personal returns), deferring those filings and payments to January will shift the personal deduction from 2012 to 2013.

D.   Depreciation Elections.  Consider electing out of 50% bonus depreciation for qualifying assets placed in service in 2012 tax year. 

E.    Qualified Retirement Plan Contributions.  Generally, contributions to a qualified retirement plan for 2012 are deductible in 2012 if contributed in 2013 before the extended due date of the law firm’s tax return for 2012.  Firms wishing to maximize partner income for 2012 may want to consider taking a 2013 tax deduction for the 2012 plan year contributions, rather than electing to take the deduction for tax year 2012.

3.  Accelerating Income into 2012

          Law firms seeking to accelerate revenue can consider the following:

A.   Accelerate billable hours and progress bill clients for December time and soft costs and collect before December 31, 2012.

B.   Collect non-refundable retainer payments in December for work to be performed next year.

C.   Collect on outstanding accounts receivable, giving discounts were appropriate in order to save on the tax differential.

D.   Advise partners that they may want to consider converting their 401(k) account balances to Roth 401(k) balances before year-end – and pay the taxes this year at current rates as opposed to the then-prevailing rate applicable to future withdrawals.  (One nice feature of the Roth IRA conversion is it comes with a “reversal feature.”  If a taxpayer converts a regular IRA to a Roth IRA before year-end and it turns out to be a bad idea, the conversion carries with it a “re-characterization” feature.  Up until the due date of your tax return in 2013, you can reverse a Roth conversion.)

Conclusion

          Regardless of whether the President and Congress reach a compromise on “the fiscal cliff,” it is a safe bet that tax rates – for married taxpayers who earn over $250,000 ($200,000 if single) are going to be higher in 2013.  As a result, law firm managers should work with their outside accountants to make a plan and then involve the partners (and other stakeholders) in the 2012 year-end tax planning effort.  Doing nothing is a perfectly viable option – but only after all other alternatives are thoroughly explored and discussed.  Effectively, it may come down to something this simple – as to each thing which can be accelerated or deferred – should the partners pay the tax now or later?

OBLIGATORY DISCLAIMER:  This presentation was prepared for general guidance and discussion purposes and does not constitute professional advice.  Readers should not act upon the information contained herein without obtaining specific professional advice.  No representation or warranty (express or implied) is made as to completeness or accuracy of the matters discussed herein.

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[i] For purposes of this memo, I’m assuming all partners are in the highest marginal tax rate – currently 35%.

Outsourcing -- How it Works in Practice

Parsley Sage Rosemary & Ginsburg llp

“always a reasonable result for a reasonable fee, always”

MEMORANDUM

To:	All Partners and Senior Admin Staff
From:	Mike Marget
Date:	October 31, 2012
Re:	Outsourcing – How it Works in Practice

“Who wants to manage the accounts payable clerks, and the billings?”  Thus spoke practice management consultant Peter Zeughauser as he predicted that large law firms eventually will outsource most of their back office functions.  The quote appeared in a Wall Street Journal article discussing the many ways large firms are trying to reduce their back office costs.  I think Peter is correct.[i]  Outsourcing makes business sense – it reduces costs, increases efficiency and frees up management time for more important things.  Not just for large firms, it makes sense for small and midsize firms, too.  Let me explain.

The purpose of this memo is to make the business case for small/midsize firms outsourcing their accounting and billing functions to an experienced, qualified outsourcing service provider (“OSP”) – someone like 4L Law Firm Services LLC (“4L”).

This is the third of three memos inspired an article appearing in the  Wall Street Journal article on October 7.  The others:  WSJ—Big Firms Wring Costs from Back Office Tasks and Outsourcing—How it Works in Theory.

Is it even Possible to Outsource a Law Firm’s Accounting & Billing?

Before making the business case, let’s first discuss whether outsourcing is even possible?  The answer is “yes.”  Advances in Internet connectivity and desktop virtualization make outsourcing not only possible, but practical for small and midsize firms.

With today’s technology, a law firm’s back office no longer needs to be located in the same building or even same city as the firm’s lawyers.  Big firms discovered this long ago and resisted duplicating accounting staff in every office. 

The same technology which permits big firms to centralize their accounting enables small and midsize firms to outsource.  Regardless of where the software resides, back office and front office personnel in different locations can utilize the same applications.  This allows billing and general ledger accounting tasks to be assigned to individuals in one city and for lawyers in another to enter time, initiate disbursements (with the checks printing to any designated printer in the lawyers’ office) and have real-time online access to a myriad of actionable financial data to manage their practice, their client work and the firm.

Outsourcing Lowers Costs for the Law Firm

The primary promise of outsourcing is quality back office services at a lower cost than the law firm can provide with internal resources.

Quality service and lower cost are made possible through a combination of economies of scale and process improvement.  Because it services multiple firms, 4L handles a higher volume of accounting and billing transactions each month.  With this greater volume, 4L is able to leverage its accounting workforce more efficiently than any single law firm with lower volume could hope to accomplish on its own.

In addition, because the accounting and billing operations constitute 4L’s front office, 4L has invested in superior accounting software – from OrionLaw Management Systems, Inc. – and assembled an experienced law firm accounting staff capable of handling the workflow more efficiently and productively than any single firm could duplicate with internal resources.

Through a combination of higher volume, improved technology, experienced talent and process improvement, 4L provides the accounting and billing services to law firms at lower cost and passes along significant savings to its client law firms.

The following chart illustrates the potential cost difference to law firms using internal resources versus outsourcing its accounting and billing tasks:

Law firms with 11-to-20 lawyers spend on average $7,005 per lawyer annually on accounting and billing staff salaries and benefits.  This data is from the 2011 Small Law Firm Economic Survey.[ii] 

Using the Survey census data, I applied 4L’s service fee pricing model to the participating firms.  The outsourcing option would cost those firms an average of $4,614 per lawyer annually[iii] – as compared to $7,005.  The savings is $2,391 per-lawyer or 34% annually.

The Collateral Benefits of Outsourcing

If lowering accounting and billing support costs by 30%-to-40% is not enough, outsourcing provides other collateral benefits.  Outsourcing:

·         eliminates future capital expenditures;

·         fosters greater efficiency and productivity for the front office;

·         introduces best practices and stronger internal controls; and

·         frees up firm leadership time to focus on other practice management challenges.

Law firms who work with 4L never have to worry about capital expenditures for software upgrades or hardware purchases or maintenance.  4L provides the Orion accounting software via the Cloud where each firm’s data resides on a separate private virtual server.  The software and hardware is provided and maintained by 4L without cost to the law firm.    

Use of the Orion accounting software also makes the law firm’s front office more efficient.  There are numerous ways to enter billable time, to lookup client-matter numbers and task codes, and make online inquiries of key financial data such as bank balances, aging of accounts receivable and client status as to last billing, last payment and other information required to manage the firm.

Working with 4L provides a higher degree of internal accounting controls than smaller firms generally implement.  The 4L staff performs monthly bank reconciliations on all firm and trust accounts and balances the detailed monthly accounting summaries to the general ledger accounts to ensure accuracy of the numbers.

Outsourcing also improves existing internal procedures.  4L works with its law firm clients to implement the best practices to streamline billing and collection processing.  We recommended changes to billing procedures at one firm which increased their cash flow by nearly $140,000 this year.  With another firm, we identified and corrected flaws in produces used to collect documentation needed to bill client advances which increased billing and reduced expenses by more than $150,000.

But perhaps the most significant collateral benefit of outsourcing is it makes firm management more effective.  The Peter Zeughauser quote at the top of this memo sums it up nicely.  Is the law firm best served when senior management is spending time on accounting and billing processes?  I think not.  Freed from the day-to-day oversight of these back office tasks, firm management can devote increased attention to the things which matter most:

·         Representing current clients;

·         Supervising, training and developing junior lawyers;

·         Seeking ways to become more profitable by reducing the direct costs of providing client service; and

·         Engaging in activities needed to attract future clients to the firm.

Outsourcing Makes Business Sense

A central precept of business management is to purchase goods and services from responsible suppliers who can provide the requisite quality at the lowest reasonable price.  A make-versus-buy decision should be a “no-brainer” when purchasing produces equal or better quality and is less expensive than doing it yourself.  In this way, outsourcing has become a $500 billion-a-year business.  Big business has embraced it in a big way and big law firms are turning to outsourcing with greater frequency – even though they already enjoy significant economies of scale 

Outsourcing makes sense because it reduces costs, improves efficiency and lets management focus on core business issues.  It just makes good business sense to outsource – regardless of the size of your law firm.

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[i] I decided to go with the first name reference here because it lets me tell the following story.  I’ve met Peter on a couple occasions.  The first time was about 10 years ago in Chicago.  We were both presenting at the same conference and all the speakers had dinner together the night before.  All I recall about that dinner is there was good wine (French, naturally) and good conversation with Peter regaling stories about his service as a hockey goal judge for Anaheim Ducks’ home games.

[ii] Small Firm Economic Survey, 2011 edition, published by ALM and The National Law Journal.

[iii] It is important to note the projected annual fee per-lawyer includes the cost of the Orion accounting software which 4L provides, without fee to its client law firms.

Outsourcing -- How it Works in Theory

Parsley Sage Rosemary & Ginsburg llp

“always a reasonable result for a reasonable fee, always”

MEMORANDUM

To:	All Partners and Senior Admin Staff
From:	Mike Marget
Date:	October 28, 2012
Re:	Outsourcing – How it Works in Theory

Outsourcing is a $500 billion-a-year business.  Big business embraces outsourcing in a big way to reduce cost, foster greater efficiency and free management time to focus on core competencies. 

Outsourcing initiatives tend to target back office tasks – HR, payroll, call centers, help desk and accounting/billing activities.  Xerox – who in recent years has become a big outsourcing service provider (“OSP”) – runs a number of TV commercials[i] touting how they perform accounting tasks for Michelin and Marriott and call center management for Virgin Airline. 

The purpose of this memo is to discuss how outsourcing works from the perspective of the OSP and the benefits to the OSP’s business customer.

How Outsourcing Works for the OSP

The OSP’s goal is simple.  Deliver quality services better, cheaper and faster than the business customer can accomplish with internal resources, and do so profitably over the course of an enduring relationship.  In order to grow its business, an OSP works hard to provide excellent service to each business customer in order to secure quality references essential to attracting additional customers.

The outsourcing business model is significantly more complex than simply moving jobs from high cost metropolitan areas to places where salaries are lower.  While wage differentials may be part of the equation, an OSP’s success is primarily dependent upon two other factors: 

       1.       Economies of scale; and
       2.      Technology, talent and process improvement.

Economies of Scale/Leverage

Volume matters.  An OSP with multiple business customers enjoys a higher volume of work.  Higher volume results in more consistent capacity utilization with fewer peaks and valleys in the workflow.  Fewer peaks and valleys permit the OSP to leverage its workforce for higher productivity – and consequently lower operating costs – as compared to a single organization with lower volume. 

In Microeconomics 101, we learned that higher volume generally results in greater productivity.  The higher volume/greater productivity thesis is confirmed in the context of a law firm’s back office with data from a national survey of law firm economies focusing on firms with 20 or fewer lawyers.  According to the survey, firms with 11-to-15 lawyers average 0.12 FTE accounting personnel per lawyer versus a 0.11 FTE per-lawyer ratio among firms with 16-to-20 lawyers. [ii]  So, what does this mean?  Take for example a firm with 13.33 FTE lawyers and 1.6 FTE accounting personnel; then assume the firm increases 50% in size to 20 FTE lawyers.  Will this now-bigger law firm require a corresponding 50% increase in support staff to 2.4 FTE to handle the increased number of accounting and billing transactions?  Not according to the survey.  The now-bigger law firm should require just a 37.5% staff increase (not 50%) – to 2.2 FTE – since the typical 20-lawyer firm is able to manage its accounting and billing operations with 2.2 FTE, rather than 2.4.  The 0.2 FTE difference illustrates the workforce economies of scale available in a higher volume environment.  A high volume OSP is able to further maximize the economies of scale when leveraging the work effort supporting dozens or even hundreds of lawyers.

Investment in Technology, Talent and Supervision

Whether you work in a law firm or a Fortune 500 company, it is infinitely easier to justify capital spending on front office activities – the things which attract clients, generate higher revenue or reduce direct costs – than on measures aimed at improving back office functions or reducing indirect costs.  Granted, if a particular back office system is broken or on its last legs, you have a shot; short of that, back office capital spending is a tough sell.  An OSP views capital investment on matters related to the business customers’ back office activities through a different lens.

With outsourcing, the business customer’s back office is the OSP’s front office.  As such, OSPs invest heavily in technology, talent and process improvement in order to bring down the OSP’s operating costs.  The OSP requires lower operating costs in order to (a) pass a portion of those savings on to the business customer, (b) recoup marketing and capital investments and (c) make a reasonable profit.  It is standard practice for OSPs to upgrade the business customer’s (former) back office technology and implement “best practices” in order to streamline and standardize operations. 

From a staffing perspective, OSPs generally engage better talent than the business customer is able to attract and retain in a on its own.  Recruiting and retention is easier for a larger, focused OSP who can provide a career path and greater responsibilities and opportunities than can the business customer on its own.  This is particularly true when the OSP’s business customer operates in an environment where mobility from the back office to the front office is limited, if not impossible, due to training, experience or licensure, as it is with law firms.

Finally, a high volume OSP has greater flexibility and management depth to utilize part-time workers and provide 24/7 services than a single organization trying to operate hard-to-supervise second and graveyard shifts. 

How Outsourcing Works for the Customer Firm

From the business customer’s perspective, the primary motivation to outsource is to save money.  Outsourcing permits businesses to reduce their indirect costs and either realize higher profit or pass the savings on to their customers in the form of lower prices.  However, cost is only one of three motivating factors when businesses evaluate outsourcing.

Cost Savings

Obviously, each situation is different, but proponents of outsourcing trumpet 30%-to-40% cost savings when businesses outsource.

In addition, outsourcing generally relieves business customers from ever again having to make capital expenditures to support the outsourced tasks.  From the business customer’s perspective this conserves capital for expanding front office activities and converts back office fixed costs into variable costs.

Improved Internal Services

As a result of its ongoing investments in technology, talent and supervision, OSPs support business customers as change agents.  They tend to document and clarify back office procedures leading to continuous process improvement and error reduction associated with back office activities.  Time-saving technologies are introduced and the OSP staff brings new ideas and perspective to back office tasks. 

The back office procedural improvements collaterally enhance front office operations as well.  For example, reducing the back office time needed to process invoices can lead to saving time and resources in the front office.  Similarly, the new technology implemented to reduce the billing process may provide more meaningful financial data to improve management supervision over sales, billing and collection efforts.

Reduced Management Distraction on Non-Core Activities

Perhaps the most important collateral benefit derived from outsourcing involves liberating management time to focus on core competencies.  Outsourcing avoids management headaches such as finding, recruiting and evaluating back office staff, supervisory oversight and problem-solving.  It permits management personnel to focus on their “highest and best use” – those things directly associated with revenue generation – customers, delivery of goods and services, attracting new customers and increasing profit margins by reducing direct costs.

Conclusion

A $500 billion-a-year industry isn’t going away anytime soon.  I believe it is here to stay because a big part of management involves managing the costs of running the business.  Goods and services are generally purchased from the supplier who offers the requisite quality for the lowest reasonable price.  If an OSP can provide back office services of comparable (if not better) quality for a lower price, shouldn’t such offers be entertained?  If not, isn’t management letting down the business’ shareholder owners?  Moreover, what happens when the business’ direct competitors make the move to outsourcing and thereby obtain a competitive advantage? 

Today most OSPs focus on big business – where there are bigger contracts and bigger profits to be made.  Eventually, outsourcing will expand further among middle market companies and make inroads into small business as well.  It’s inevitable.  It just makes business sense.

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[i] Xerox has a really coolwebsite devoted to their outsourcing prowess.  The TV commercials tend to run during Notre Dame football games on NBC.  GO IRISH!

[ii] Small Law Firm Economic Survey, 2011 Edition, p. 179.  This survey is published annually by ALM and The National Law Journal.