The front page article in the Financial Times on 5 June told the whole story. In a type size that would do justice to the tabloids was the headline "Law firms' profits are fuelled by M&A boom". The article went on to outline how the boom in cross-border M&A, with strong growth in regulatory and compliance work, has increased profits at magic circle firms by up to 25% in the last year. However, this has been balanced by another round in the seemingly endless 'war for talent' that has driven the leading firms to raise pay sharply for associates as they battle to retain the best brains.

The competition with the banking and finance sectors, coupled with increasing disillusion of young lawyers with the profession's work/life balance, presents an ever increasing challenge.

While the FT concentrated on the very largest international law firms, the issues are similar in commercial firms of all sizes. Improved financial performance, even in the largest firms, has been achieved in an environment that is even more competitive in the wake of dramatic developments in globalisation, the communications revolution and sweeping regulatory change. Managing these strategic issues successfully requires greater focus, by firms of all sizes, on financial management.

It is an axiom of corporate life that getting financial management right defines a successful business, while it is generally poor financial management that leads to corporate failures. To a limited extent, non-lawyer financial managers have been part of the law firm senior management teams since the late 1980s, but recently the long-discussed move to a more corporate structure has rapidly accelerated the finance team to the centre of the management structure.

However, law firms may have under-estimated the cultural shift required to turn a professional partnership into a successful business operation. While the headline revenue numbers tell one story, margins are under considerable pressure with costs and particularly support costs rising quickly.

In 2005, PricewaterhouseCoopers' (PwC's) Financial Management in Law Firms survey stated that the principal driver of increased profits per equity partner in many firms had been the constraints on the numbers of equity partners in the firm with reductions in more than 50% of the top 25 firms. On the other side of the equation, the PwC survey sees many firms effectively controlling costs, and particularly staff costs at 40% or less of fee income.

The challenge, as outlined in the FT article, will be to maintain this level in a market that combines rising staff costs to obtain and retain the best in order to service a boom in work.

Tony Williams, principal of Jomati Consultants, confirms that "in order for law firms to maintain and grow their profitability in the face of mounting cost inflation they will need to rigorously review all aspects of their operations and ensure that they are in an area of the market where they can genuinely differentiate their service offering from that of their major competition. Efficient and cost-effective administration functions are essential to the delivery of high quality client service".

As the focus on overheads and costs continues to bite and firms face increased costs to service areas such as risk management, compliance and performance measurement, the implications in many support functions such as HR, marketing, administration, procurement and IT may be to decide that some or all of these functions should not be carried out in-house at all and that a more efficient and effective service provision can be provided by an external company.

The concept of outsourcing certain clearly-defined business processes is rapidly gaining ground in UK law firms of all sizes. More than ever, businesses are looking at outsourcing a wide range of core functions as part of their strategic approach to both growth and success. As law firms embrace senior managers from outside the profession, they bring with them best practice from the commercial world and outsourcing a range of business operations is rapidly moving up the management agenda.

As an example of this trend, it is expected that over the next five years in the UK, where it is estimated that 10%-15% of a firm's annual revenue is spent on office administration and document management, outsourcing will be adopted to an extent similar to the US as competition drives firms to increase service levels in every aspect of their relationship with clients. US firms have consistently found that by outsourcing office services they have more time to devote to fee earning and client management.

A 2005 survey of the US legal profession found that 85% of all firms out-source some or all of their business processes. Of the top 20 firms by size, when asked about the event that trig-gered the outsource arrangement, more than 61% said it was part of an overall internal cost/benefit analysis. In addition, 54% identified the real difficulty and cost of recruiting skilled professionals as one of the key rationales.

While considering this type of structure, much is often made of the potential financial savings. However, in the legal sector, while cost savings are a factor, the most beneficial gains are achieved in the saving of senior management, fee earner and secretarial time when they are removed from dealing with apparently run-of-the-mill yet critical administrative functions which are effectively handled by an expert outsourcer.

How does this form of business process outsourcing work operationally?

Typically, when outsourcing administrative services, staff currently performing the agreed functions will transfer under TUPE to the new service provider, and remain on the firm's premises. The outsourcer applies their own management style, best practice processes and procedures and introduces a service culture where the users of office services within the firm become 'customers' of the new managed service.

"Traditionally, outsourcing has been used as a tool to drive down costs and to free management to focus on their core business. While costs and management time were factors we considered, our decision to outsource was driven by a desire to reduce the number of non-legal functions handled by fee earners," says Neil Munn, finance director at Clarke Willmott.

Engaging an outsource provider offers not only access to the staff onsite providing the day-to-day services, but also a team of highly skilled and experienced managers working behind the scenes whose aim is to increase the return on investment in the services provided. This is achieved by implementing process improvements, many of which are driven by more effective utilisation of resources. These improvements and tangible changes will be monitored by the service provider and reported on a monthly basis ensuring that agreed deliverables are achieved and continuous improvements to service level and delivery are made.

To sum up, the pressures of competition, rising costs and a more proactive approach by the buyers of high-level professional services, has exerted significant pressure on headline profits. As firms develop a range of corporate-style business models to manage their businesses more effectively and react to competitive and regulatory pressure, they will increasingly look at measures to maintain the ratio of costs and profits at acceptable levels.

In an era when we may see external investors becoming shareholders in law firms, effective financial management techniques and the teams to implement them will be at a premium. Corporate clients of all sizes have experience of outsourcing large parts of their own business processes and support services, including legal services, and recognise the value it can provide.

Indeed, they look favourably at those firms that can demonstrate that they approach the management of their business in the most effective manner that will provide benefits to them as clients. |

Margaret Lang is chief executive of Intelligent Office UK.