The billable hour rate is the lifeblood of a large or medium law firm. And in recent years, the flow of this necessary component has been turbulent. According to the Peer Monitor Economic Index (PMI) for Q4 2015, recently release by the Legal Executive Institute and Thomson Reuters Peer Monitor, worked rates — the rates negotiated between clients and their counsel — grew at a troubling 2.4% in Q4 2015. This represents the slowest rate of growth since Q1 2011.
While growth of 2.4% in worked rates may not seem troubling at first blush, there are a few important considerations to keep in mind. First, this is the rate the client agrees to at the outset of the engagement, but it does not necessarily represent the value at which each hour worked will actually be billed to the client. Partners may apply additional discounts when preparing the final bill to the client. And it is common practice among law firms to reduce the number of hours on a bill through write-downs. In fact, according to Peer Monitor, law firms realize only 89% of their agreed worked rates.
In many ways, the entire year of 2015 was a lackluster one for rate growth. Standard rates rose only 2.3% in Q4 after having risen by 2.6% in Q3. Standard rates continued to be quite a bit removed from the rates actually billed to clients. The average difference between standard rates and worked rates represented an effective discount of 7% off the standard rate in Q4 2015.
These challenges in rate growth must also be coupled with the fact that overall realizations have held steady at 89.2% of standard rates.
…Law firms may be running out of room to pull their traditional levers of profitability. Clients are pushing back on rate hikes, demand has continued to be a challenge, and expenses can only be cut so far before firms start trimming muscle and not fat.
It is important to remember as well, that growth in rates must also offset growth in expenses. Law firms have done a fairly effective job of managing expense growth in recent years, with direct expenses growing only 1.8% in Q4 2015, the slowest rate of growth in this metric in two years. Overhead expenses for law firms saw slightly more rapid growth in Q4, rising 2.7% for the quarter, but this can still be considered quite modest growth, especially when looked at in a historical context where expense growth routinely topped 10% year-over-year a little more than six years ago.
As the PMI report argues, law firms may be running out of room to pull their traditional levers of profitability. Clients are pushing back on rate hikes, demand has continued to be a challenge, and expenses can only be cut so far before firms start trimming muscle and not fat.
As discussed in the 2016 Georgetown Law-Peer Monitor Report on the State of the Legal Market earlier this year, those firms that are currently experiencing better financial performance are also the ones most likely to have undertaken steps to implement better systems for knowledge management and project and process management. Firms wishing to stay competitive in today’s market and uncover additional profits may need to consider similar steps.