This is the third installment in this series of blog posts, in which we will use Peer Monitor data to examine the characteristics of firms with consistent topline growth over the past few years. In this installment, we continue with our discussion of law firms with consistent revenue per lawyer (RPL) growth and how it impacts law firm financial performance. For the sake of our analysis, those law firms that had RPL growth outpacing inflation in both years will be referred to as “Both” firms. Firms who’s RPL growth did not outpace inflation in either year will be referred to as “Neither” firms. (You can read the previous installment here.)
Do the ends justify the means? Is it possible that the firms that are consistently growing their revenue per lawyer are doing so at too high of an expense? No pun intended, but the point still stands. There exists a theory that there are an infinite number of alternate universes where an infinite number of scenarios are playing out simultaneously, and in one of those universes it would be the case that firms too aggressively pursuing RPL growth did so at the cost of profitability. In this alternate universe, our Both firms are increasing their RPL perhaps through outlandish investments which does provide the growth, but as far as the partners are concerned, the juice is no longer worth the squeeze. In the universe we currently reside, however, this is not the case.
In a galaxy far, far away, Both firms achieve profitability increases not through strides made in demand and rate growth, but rather through cost-cutting measures akin to millennials and cord-cutting. In reality, this new-found revenue growth has only emboldened continued investment. Both firm’s direct expenses have been growing at or above 3% YoY since Q3 of 2016. Over the same period, they have increased their overhead expenses between 2% and 3% for the majority of that time frame, with one quarter where investment spiked to roughly 4.5%.
In previous installments of this series we mentioned how Both firms were able to drive revenue increases by consistently growing their worked rates at or above the level of inflation. However, one counter-intuitive revelation did surprise us: The Neither firms were much more successful than the Both firms at fully realizing these rate increases. Throughout the entire period of time observed, Neither firms had higher billed & collected realizations against their standard rates. In the end, Both firms’ rate growth — while exceeding inflation — was effectively nullified by the average realization advantage present among our Neither firms.
However, one way in which Both firms overcame the gap in expense growth as well as in realization was through average utilization on a per lawyer basis.
Indeed, productivity levels varied wildly between our two firm groups. Interestingly enough, in Q4 of 2014, the average lawyer in the Neither group worked slightly more (0.6 hours) per quarter than the average lawyer at a Both firm. Since that time, however, Both firm lawyers have been more productive in each subsequent quarter, culminating in an average of about 9 additional hours worked per lawyer per quarter by 2017. Practitioners in the Equity Partner, Non-Equity Partner, Associate, Staff, and Other Lawyer categories all are more heavily utilized in Both firms. Doing more work with the same amount of lawyers is one surefire way to increase profitability, and Both firms clearly excel in this category.
These factors culminated in Both firms increasing their profits per equity partner (PPEP), as well as profit per partner (to account for any income partner shenanigans), on average at a significantly higher pace than our Neither firms, in both YoY time periods covered in the study. Specifically, Both firms increased their PPEP by 7.2% in 2016, and followed that with growth of 7.8% in 2017. On the opposite end of the spectrum, Neither firms are actively contracting in both categories, in both years. Neither firms’ PPEP decreased by 5.5% in 2016, and fell a further 4% in 2017.
While the assumption going into our analysis was that the Both firms would outperform the rest, the gap that exists is quite staggering in both years. Through all of the hypothetical scenarios as to what the path to success looks like in the law firm universe we are currently occupying, one thing we know is those firms that are able to consistently grow their top-line in regard to RPL are also better able to effectively funnel those earnings all the way down to the partner’s pockets.