All businesses must balance debts and investments in change

Law firms have debts to pay before investing in innovation

Software engineers use the term “technical debt” to describe the sum total of shortcut and trade-off decisions made when coding a software product. This debt starts small and feels manageable. “I realize this [shortcut is a hack] but I don’t have time to worry about it now. I’ll go back and clean it up later.” they say to themselves, and less frequently to others (quite often, management has no clue or interest in these “sausage making” decisions).

Not all of this debt is bad, as sometimes trade-offs must be made in order to meet deadlines and “ship it”. Not paying down this debt, however, can be disastrous in the long run.

In reality, these developers rarely have the luxury of refactoring, or “going back to clean it up”, to reduce the debt. So it accrues over time. And for some, adds up to the point that product becomes “insolvent” as the company can no longer safely enhance or even fix the software should something go wrong. I’ve observed tech debt in many businesses I’ve advised, and hell, I’ve incurred my own tech debt during my time as an engineer. But sadly I’ve also seen this debt cripple businesses to the point of catastrophic failure.

Credit Martin Fowler and Jae S Um

Catastrophic tech debt is a result of two separate management failures: near-sighted decision making and lack of continuous improvement. In the first instance, we often make decisions that make today better — by moving faster or cheaper — even when we know that these choices can come back and bite us in the long run. In the second instance, we often feel the cumulative effects of those decisions in sometimes vague ways, but we rarely take steps to properly diagnose or treat the root cause. And the management debt piles on.

Spend or save?

Investing in innovation is like retirement investment. It’s a hedge against a future where your income will likely change. In order to maintain your lifestyle, you’d better think ahead and plan accordingly. But as any financial adviser would tell you, it’s probably wise to pay off debt before saving for retirement or adding to your rainy day fund. Especially that high interest credit card debt you racked up in Reno.

So why would a law firm (or any business) invest time, energy and capital into innovation if they are already in debt elsewhere? Perhaps they don’t realize just how much they owe.

Additionally, again using software engineering terms, most firms have some refactoring to do before adding net new features. Particularly if they are unsure how to operationalize or support those features, or what the demand for those features really are. And we all know there is nothing more frustrating from a user (client) perspective then observing a steady stream of bells, whistles and innovations when the core product isn’t delivering as expected.

Total amount due

Let’s stretch the analogy further and look at the forms of debt that many law firms have accrued:

Technical debt: over the past 2–3 decades law firm have acquired and installed layers upon layers of operational systems. And then added more layers to make them work together, as they are all from different providers on different platforms. And then added more layers to extract value from them with BI and analytics tools. And for some firms, this is on top of custom-coded software that undoubtedly contains some technical debt of it’s own. This is a very complex and expensive challenge, which creates drag and friction in operations. 💰

Data debt: within these systems lies a vast amount of business and practice information. In many law firms I’ve advised, we’ve encountered tens of millions of documents in DMS or RMS systems and hundreds of millions of time entries in billing systems going back many years. Unfortunately, over the years this data was not always curated, categorized or otherwise captured in ways that support new needs around business and practice analytics. It is a very expensive proposition to go retroactively update all of this data, and we can’t wind back the clock. 💰

Procedural debt: for decades, lawyers have “sold law” by the hour while non-lawyers did their best to support them. For reasons that have been well covered in the legal market, this is no longer tenable. But changing the way lawyers have always worked and how legal services are delivered to clients is a monumental challenge. Almost every professional, cultural and economic incentive in a law firm fights against this change, which makes it a very expensive and risky undertaking.💰

Structural debt: the law firm itself, usually a partnership operating on a cash-based model in which equity partners withdraw all profits each year, is also being challenged. How can a firm properly invest in its future, or pay down the debts I describe, in this model? Furthermore firms cannot accept outside investment thanks to ABA and state bar regulation, so their only recourse is to incur bank debt to cover the other debts, or to ask the partners to pay in themselves. This is a big ask. 💰

So let’s do the math. (💰 x 4) x (compounding interest) x (current market pressures) = (crippling debt).

A payment plan to balance debt & investment

I’m not suggesting that law firms freeze in their tracks to focus on infrastructure and operational investments alone. But I am saying that many firms may be investing in the wrong things, but for the right reasons. The need to improve service delivery and go-to-market is clear, but you can’t innovate a whole firm at once. You need to target your investments, practice by practice, team by team, client by client.

But targeted investment requires focus and fact-based decision making to select the right targets. And much of the “innovation investments” we are seeing in the market today do not, in my opinion, follow this approach.

If I were looking for the best investment opportunities as a law firm leader, I would begin by better understanding the debt we’ve accrued before experimenting with broad innovation plays. I would also want to better understand where true innovation investments can and should be made based on the right criteria — which in my experience is always P&L impact, and nothing else.

No going concern plays with house money, but law firms have unique challenges in planning for reinvestment into the business: law firm partners must shell out their own cash to pave new pathways to growth and longevity. When evaluating investment decisions, remember to take a holistic look at the business and its current operating performance — because, inevitably, all debts are due in full sooner or later.