Who would have guessed in March of last year that midsize law firms, indeed law firms of all sizes, would see growth in their profits per equity partner (PPEP) in excess of 10% on average? Yet, according to the recently released 2021 Report on the State of the Legal Market, that is exactly what happened.
Midsize law firms saw their average PPEP grow by nearly 13% at the time the report was prepared in November 2020. This seems an unlikely result, given that demand for law firm services was down, key practices had suffered throughout the year, and individual lawyer productivity had greatly softened. So how were law firms able to be so much more profitable?
Simply put, they were able to cut their way to profitability in 2020. Massive shifts in expenses, investments, and headcount, coupled with resilient rates, created short-term cash that shored up law firm profits.
Indeed, the cuts happened abruptly, favorably impacting in-year financials, especially as the V-shaped recovery saw a slight return in legal demand, also in-year. As we move deeper into 2021, however, we have to be mindful of the fact that the tactics that led to strong profit growth in 2020 are not long-term strategies. In fact, we’re likely to see another mirage in 2021 from the pent-up legal demand that has carried over from 2020 and which will eventually level out.
So how can midsize law firms position themselves for long-term stability, growth, and success, rather than relying on these short-term solutions? A few suggestions include:
Focus on key practice areas that are poised for recovery
Nearly every key practice area for law firms suffered from a lack of demand last year. However, many of those practices appear poised for a recovery in the coming year.
Prepare for the return of litigation — Litigation work slowed through most of 2020 due to a lack of ability to move cases through the courts. While some of this work may be gone for good, much of it has just been stuck in an expanding logjam. As matters start to flow again, that logjam will clear, bringing more work for litigators.
Moreover, economic slowdowns historically signal an impending boom in litigation. Looking back to the financial crisis of the late 2000s, nearly every type of litigation matter tracked by Thomson Reuters Monitor Suite saw growth in matter volume for two to three years after the economy began to recover.
Midsize law firms need to position themselves now for what litigation might look like in the near future. While it’s impossible to know when litigation practices will begin to pick up, it is certain that if law firms wait until the resurgence starts, it will be too late.
Spotlight midsize agility and client responsiveness — Many observers thought that corporate practices would see sluggish demand for the foreseeable future, and that may still be true. But a surprising upswing at the end of 2020 serves as further reinforcement that midsize law firms need to capitalize on their advantages in terms of agility and responsiveness.
Be ready for the bankruptcy wave — While many law firms saw their bankruptcy practices grow in 2020, that was not the case for all midsize firms, many of whom saw their bankruptcy practices continue to lag. This, however, may well be a temporary condition. Many of the bankruptcies in 2020 were large enterprises for whom government assistance and protection was either unavailable, or was given too little, too late. There is a growing sense that a wave of bankruptcies may be on the horizon as many of the government’s protective measures expire.
As with any practice area, in-depth knowledge of the current trends impacting clients will be critical, as will foresight and early planning. It seems likely that there will be increasing amounts of work available for those firms that have positioned themselves to capture it.
Monitor rates closely
For several years, midsize firms have lagged market averages for rate growth. There may be good reason to be more conservative in pushing rate growth, especially because midsize firms often want to position themselves as budget-friendly alternatives to larger firms and help clients find cost savings without sacrificing quality.
Yet, when considering rates, don’t go with your gut — go with the data, or you risk undervaluing your services.
If the data shows a firm’s rates are well above those charged by its competitors, that could be a good argument for freezing rates. At the same time, the perceptions that a firm’s rates are competitive can be overcome by data showing that the firm’s rates are actually below average, thus opening the door to pursue a rate increase with data supporting the request. In either scenario, the key factor is the data. Some of the answers are in your own time and billing solutions, and contextual data about peer pricing is available from third parties.
For any law firm that has not yet sought to solidify its own internal data and seriously explore sources for competitive intelligence, there’s no better time to start than now.
Find alternative paths to profit
There are essentially three factors that go into determining profit:
- price — how much the customer or client pays;
- volume — how many units or hours are sold; and
- cost — what the enterprise pays to produce its output.
Law firms have a few basic options to improve profits: i) sell the same number of hours at a higher rate, which may get more difficult if clients push back on rates; ii) sell more hours, which will be a challenge, given that average attorney productivity has steadily declined for most of the past decade; and iii) improve efficiency and lower costs.
The third option is the proverbial road less travelled, but it may provide the greatest foundation to building future profitability.
Every hour an employee works has a cost associated with it. For the average partner at a law firm, more than 300 hours of potentially billable time are lost to write downs every single year, resulting in massive costs with no chance of return. This necessarily hurts profitability.
A midsize law firm partner told me that their associates, who have been working from home the better part of 2020, are actually billing more hours because they are no longer spending time commuting. An extra hour per day per associate, across the entire firm, is significant. As more firms consider extending flexible work arrangements, it would be wise to keep this upside in mind.
Law firms looking for where to focus in 2021 would be well served to carefully explore exactly how much of their timekeepers’ time is lost to inefficiencies every year. For the most part, these hours are something a law firm can make efforts to measure, manage, and ultimately reduce.
A year of possibilities
The last few years have been especially challenging for many midsize law firms. Despite some positive results in 2020, finding growth for profits in the coming year and beyond will not be easy. Firms are advised to capitalize on the positives coming out of the pandemic — return of litigation, pent up demand, the impending wave of bankruptcies — and the healthier margins that resulted from the expense-cutting spree of 2020. But these “sugar highs” will wear off, and firms without a data-driven growth strategy will be disadvantaged.
I hope these suggestions, and other ideas that I will be addressing as the year progresses, can put midsize law firms on the path to greater growth, efficiency, and ultimately, profitability.