NEW YORK — The heady question of what’s happened in the legal industry over the past 10 years since the Financial Crisis and ensuing Great Recession was discussed at some length during the opening sessions of the 16th Annual Law Firm COO & CFO Forum, held Oct. 25-27 and presented by Thomson Reuters Legal Executive Institute.
The amount of displacement and disruption during the past decade has brought deep changes to how law firms successfully navigate the business of law, says Forum Co-Chair Dan DiPietro, Managing Director & Chairman of Citi Private Bank Law Firm Group. “So, the question then becomes, what are law firms doing going forward to cope? Because some firms are coping quite well.”
However, even those firms doing relatively well in a marketplace that has seen flat demand and flat to declining profit margins have had to adjust their thinking to reflect an environment that has become much more client-centric. “Before the Financial Crisis, virtually all the major decisions involved in the delivery of legal services — from pricing and staffing to the strategy of the delivery itself — were made by the law firms,” says Forum Co-Chair Jim Jones, a Senior Fellow at the Center for the Study of the Legal Profession at Georgetown University Law Center. “That changed with a big shift to a buyers’ market where all those decisions are now being made by the client.”
As clients began to push for more value in their legal spend, law firms were pressured to increase their efficiency, their predictability and the cost-effectiveness of their delivery, Jones explains, adding that quality of work was taken as table-stakes which every firm had to meet. “All of this required a drastic shift in the mindset of the legal industry.”
Unfortunately for law firms, Jones continues, they also were getting pressure from other forces in the market as well. “In this past decade, we began to see an overall stagnation in demand for law firm services,” he says. “However, we also saw an overall increase in the legal spend by clients.” So, where were these extra dollars in legal spend going? For one, legal departments began to bolster their own in-house capabilities and keep more work inside; and two, alternative legal service providers started to take a bite out of the large pie that had traditionally gone exclusively to law firms.
Looking at the Numbers
When you look at the numbers that the legal industry has tossed up over the past decade, you can draw some stark conclusions about where the industry has been and possibly about where it’s going. Demand for legal services that grew 4% to 6% each year before the start of the Financial Crisis in 2007 has remained virtually flat ever since; profit margins too, have remained flat to slightly declining throughout the past decade. Add into this another grim statistic for the legal industry — the sharp decline in the realization rate (the rate that clients are willing to pay) to its lowest level ever of 83% of standard rates — and you come to one inescapable conclusion, Jones notes.
“Taking all of this together, you can see that law firm financial performance over the past decade has been driven by a single factor, and that’s the firms’ ability to raising billing rates.”
And if raising rates is the only path to profitability for many firms, Jones contends that law firms are going have to start asking themselves some hard questions. “Primarily, does this represent a sustainable business model?”
Gretta Rusanow, Head of Advisory Services for the Law Firm Group at Citi Private Bank, says that based on her firm’s gathering of law firms’ financial results from several surveys, you can see a great dispersion over the relatively modest averages in demand, revenue and profit. And this clearly shows that some law firms have figured out a way to keep the (tepid) good times going.
“You can see that not everyone has had the same terrible experiences over the past decade,” Rusanow says, adding that while some firms in the AmLaw 25 reported good years, and others in the AmLaw Second 100 experienced continued declining demand, success wasn’t necessarily tied to how big the firm was.
“It isn’t all about PPEP (profit per equity partner) or about size,” she says, adding that success stories ranged from the largest, most profitable firms to smaller, Second 100 firms. “The success was spread across the industry.”
In fact, as Rusanow reviewed what she called the “most successful” firms, she saw that many had a clear “investment strategy” and had actually seen increases in expenses and lawyer headcount. Still, these most successful firms were able to notch continued year-over-year revenue growth, and PPEP that was 1.2% higher than the average for the legal industry.