Forum Magazine: Dead Weight and “Disappeared Revenue” – The Legal Industry’s Overcapacity Problem

Topics: Data Analytics, Forum Magazine, Law Firm Profitability, Law Firms, Midsize Law Firms Blog Posts, Small Law Firms Blog Posts, Talent Development, Thomson Reuters

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It’s a problem that many law firms, especially larger ones, don’t seem to want to talk about, even though the problem is relatively simple to understand.

Overcapacity.

Too many lawyers chasing a shrinking amount of legal work that is going to traditional law firms. The data demonstrates this dilemma currently and has since the Great Recession; in fact, the numbers seem to just get worse.

During last year, the number of lawyers in US firms grew by a relatively modest 1.3%; however, even that small increase in head count took its toll on productivity, given how flat demand growth has been in the legal industry for a number of years. The decline in productivity – defined as the number of billable hours worked by lawyers divided by the total number of lawyers – across the legal market has resulted in a negative growth trend that has been difficult for the industry to shake off.

As Thomson Reuters’ recent “2018 State of the Legal Market Report” points out:

Since 2011, there has been an overall downward trend in the productivity of all categories of timekeepers except associates, and the downward trend has been particularly serious in the of-counsel ranks. For all lawyers, the current level of billable worked hours per month is some 13 total hours below the level at the beginning of 2007 (just before the onset of the Great Recession). That represents a total of 156 billable worked hours per year which, if multiplied by the average hourly worked rate for all lawyers in 2017 ($475), indicates that the decline in productivity over the past decade is costing firms about $74,100 per lawyer per year.

Now, multiply that by a large law firm’s 150 lawyers or so, and you have around $11 million a year in what some call “disappeared revenue.” That is the cost of overcapacity – and why some legal industry observers are quite nervous for what may be down the road.

“You have all these data points which reinforce each other – there are fewer hours-per-lawyer billed than years ago, the growth in lawyer head count is outpacing growth in demand – and you start to see this overcapacity problem for what it is,” says Bruce MacEwen, publisher of Adam Smith, Esq. and a highly regarded legal industry consultant. “And with 110,000 lawyers populating the Am Law 200 firms, that’s about $8.2 billion in essentially disappeared revenue each year.”

How We Got Here

If you look at the chart that shows the balance between lawyer growth, demand growth and productivity over the past several years, you can see the path that the legal industry has been on. Since 2012, as the chart shows, demand growth, though often fluctuating moderately and dipping often into negative territory, stayed pretty reliably in the range between -1% and +1% growth per quarter.

Lawyer growth, on the other hand, remained steady, though moving down from 2% quarterly growth to the 1% range in recent quarters. Still, that means even at the slower pace, the hiring continues even if the client business isn’t there to meet it – which is why productivity, the end result of the interplay of these two factors, has been on a general downward trend over the last several years and in fact, hit historic lows in Q4 2017.

But what does that mean for a single law firm? Or, more to the point, why are these firms continuing to hire if – as the numbers demonstrate – they don’t have enough work for the lawyers already employed?

MacEwen suggests a rather simple answer: fear of falling behind.

“It’s pretty hard for a managing partner to swim against the tide from what other firms are doing, and most firms are continuing to grow,” he explains. “I think people get nervous if they’re in a firm that’s not growing, not hiring new lawyers out of law school and increasing head count.”

But lawyers are not great businesspeople, MacEwen adds, and law firms’ problem with overcapacity clearly demonstrates the trouble they have implementing real operational discipline. If your firm really doesn’t have enough work for the lawyers you employ, that could become a bad situation very quickly. “There’s nothing more dangerous than a lawyer with too much time on his hands.”

What Can Be Done?

This question also has a relatively simple answer. Since there are only two factors at play in this equation – the amount of business and the number of lawyers – law firms find they must either increase business or cut head count to change the overcapacity equation.

There are several paths to the same outcome, MacEwen says, and if a firm hired him to advise on this, the first thing he would do is dive deep into the data to find the firm’s real exposure to the overcapacity problem. “That $74,000-per-lawyer-per-year figure is an average,” he explains. “And that’s fine for looking at the whole industry, but not for examining the problems of a single firm.” MacEwen says he would then focus on the people or even the practice areas at the firm that were really underperforming and urge the firm to counsel those people to improve or leave. “If the firm just plain doesn’t have enough work to keep everyone busy across the board, that’s one problem – you focus on the seriously unproductive individuals. But if the overcapacity is concentrated in one or two practice areas that are very slack, that’s a different problem,” he adds. “But still at the end of the day, you’d be seeking a solution that would reduce lawyer head count one way or another.”

And while this may be a bitter pill for some firms to follow, purging overcapacity can offer some secondary benefits beyond improved productivity and cost-saving. First, for the lawyers that remain, their day may become busier, but often the busier someone is, the more productive and efficient they become.

Second, looking inward at your firm’s overcapacity problem can give management a chance to take a hard look at which of its practice areas are strong and which are weak, and to reallocate resources accordingly.

“It could really lead to a greatly improved culture within the firm,” MacEwen says. “Busy people are happy people – especially lawyers.”

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