In an interview with the Financial Times1, legendary short-seller, Jim Chanos, revealed signs that he looked for in selecting a target. His targets are, of course, businesses that are over-valued: companies that, for example, might have a long history of success but which have structural deficiencies. The short-seller does not look to resuscitate such a business, but rather how to exploit that disjunction.
What is particularly of interest was what were those tell-tale signs for Chanos. They were: ‘technological obsolescence, consumer fads, single-product companies, growth via acquisitions and accounting games.’
Now there are of course differences between (most) law firms and listed companies but the master short-seller’s list should give some law firms pause for thought.
Let’s just take two elements from the list: technological obsolescence and single-product enterprise.
As to technological obsolescence, technology is moving so fast that anything less than constant attention to it will, if not put a business at risk, certainly put it at a competitive disadvantage. It doesn’t matter if the law firm’s client base is made up of corporates or individuals. Attention to the rapidly changing world of technology is vital.
Take for example a firm with a corporate base. It has presumably long since eschewed reliance on paper. It doubtless has a practice management system which allows for real-time analysis of its data and which enables business processes to be speeded up. These are two obvious and essential aspects of being in such a market but they are inward-focussed. Does the firm know what its clients are doing on the technological front with their own customers and suppliers? If the firm isn’t keeping pace with its clients’ technological advances then how long will it be before clients will find themselves questioning whether the firm is sufficiently aligned with them? Does the firm offer clients a platform to monitor progress of work the firm is doing for them? Is there a platform which allows for communication between the firm and a client so that there is a central resource, open to all with appropriate security clearance, which records and allows for the review of the entire history of dealings in each file?
Well, says the firm with an individual base, ‘There’s no need for us to invest in all that stuff because our clients are not that sophisticated. We just do one-off matters for them.’ So what is that firm doing as far as social media is concerned? How are potential clients going to find out about it? Word of mouth? Good luck. Word of mouth has taken on a whole new meaning in this time of Facebook and Twitter. Does the firm have a website? How often are new and relevant articles published to it? We are living in an age where consumers are conditioned to look to the internet for information and guidance. And these are just questions arising from the client-facing aspect of the business. If a firm has not invested in a practice management system appropriate to its size and aspiration it leaves itself vulnerable to being overtaken by more technologically advanced competitors. (Just one example will demonstrate the truth of that last point: an efficient and effective lump-sum costing strategy can only arise if costing is based on reliable data and that requires a good practice management system. And no one needs to be reminded of the increasing demand for fixed fee pricing for the provision of legal services.)
As to a single-product business, it is obvious that therein lies a risk. Remember all those firms whose focus was workers compensation law? Remember all those firms whose bread and butter was conveyancing? Think also of a single-client business (an even riskier proposition). Now think of those businesses who have a range of clients but a substantial imbalance of contribution to total revenue from among its clients. In each of these scenarios you see an example of putting your eggs in one basket. But it happens and is still happening. Some large, long standing and well-respected law firms have disappeared in recent years largely because of an imbalance in their sources of revenue and the resultant fragility in their underlying structure.
Every law firm should have as part of its strategy a review of its sources of revenue. Not just to see who’s up and who’s down and by how much on last year. Long term thinking must also figure. Is there an imbalance among those sources with some clients dominating all others? If so, the firm should develop a plan which recognises that fact. It may be that the firm is comfortable with that imbalance and is comfortable with the risk that it presents. If however the firm wishes to avoid risk, its plan should be to address the imbalance – without diluting the intrinsic value of the dominant clients. Any such plan would have a number of facets dependent upon the particular circumstances confronting the firm. The key however is first identifying and acknowledging the risk arising from an imbalance of sources of revenue.
Developing a business strategy first calls for an honest appraisal of the existing business. That business may be successful now and may have enjoyed success for many years but a baseline analysis might reveal cracks that will threaten that success continuing if they are not addressed. If we need reminding of what happens in other parts of the commercial world, let’s not forget that short-sellers do very, very well.
- Financial Times, 24 July 2020, article by Harriet Agnew