The 2020 Report on the State of the Legal Market — produced by Thomson Reuters Legal Executive Institute and the Georgetown Law Center on Ethics and the Legal Profession — focuses on not only the scale, but also the pace of change in today’s legal environment.
The report quotes Prof. Willie Pietersen, of Columbia Business School, stating that “long-term success in business depends on the ability to do two seemingly contradictory things at the same time: improve existing processes and products and invent totally new, better processes and products.”
Today, midsize law firms are caught in a rather precarious position during this period of change. On one hand, they are generally more nimble and able to better react to market changes than their larger counterparts, many of which face greater institutional inertia. On the other hand, they often lack some of the leadership infrastructure that can serve as a change-driver within larger law firms. The smaller management staff increases the pressure on partners and committees to manage both sides of the business paradox that Prof. Pietersen outlines.
To dig deeper into this question, Thomson Reuters Legal Executive Institute has published the 2020 Report on the State of the Midsize Legal Market, as a special look into this segment of the law firm market, how it’s adapting to needed change, and the challenges it is facing.
Of course, to drive any sort of change, a law firm must first be in a sustainable and stable financial position. And fortunately for many midsize law firms, 2019 represented a return to positive territory on many key metrics, and greater positivity in others. For example, midsize law firms finished the year with positive demand growth (as measured by total billable hours) for the second year in a row, ending 2019 up 0.4% on average, after posting 0.2% growth in 2018. The growth in worked rates (the rates a firm agrees to with clients) for midsize firms, finished the year at 3.0%, capping off seven consecutive years of steadily improving worked rate growth.
Changing Firm Structure
Midsize firms grew their headcount last year by a relatively modest 1.3% on average, which was 0.6 percentage points slower than the next closest market segment. However, this meant that midsize firms were able to keep their productivity loss in check at only 1.1%, far better than Am Law Top 50 firms, which saw productivity decline by an average of 2.4% in 2019. Midsize firms, by and large, are top heavy, and 2019 saw an attempted balancing: replenishing equity partners at less than 50% and associates at 150%. These moves also create a side benefit of increasing profits per equity partner.
To tackle the business paradox, midsize firms are following their larger competitors in building out teams of professional staff, expanding the “C-suite” and adding legal project managers, pricing specialists, and heads of strategy or innovation. Last year saw an increase in staff compensation expense to accommodate these growing teams. These new roles are more aligned with client expectations, and not coincidently, more aligned with client structure.
Changing Business Models
Firms are also changing their underlying business models to coincide with the change in law firm structure. Likely stemming from client demands, the need to compete, and the rapid pace of technology innovation, investment in technology grew 6.7% year-over-year. Technology is helping firms to deliver more value to the clients they serve, both in outcome and experience. Firms are increasingly turning to alternative legal service providers (ALSPs) to help manage work the firm would have traditionally handled in house, but can now be performed more efficiently, cost effectively, and with higher quality through outside vendors. Marketing and business development saw a noticeable reversal in investment, climbing from a 1.6% contraction in 2018 to a 1.7% investment growth in 2019. An increased focus on marketing and business development should help firms improve the perception of their individual brands in the market, which in turn will help them capture an increased share of the mature market. A few of the larger firms are even creating “captive” subsidiaries for legal related services, a form of internal ALSP.
As Prof. Pietersen advises, it is critically important to recognize when a disruptive change is occurring and take action, and there is strong evidence that a significant disruption in the market is occurring. Many firms are continuing to improve existing processes, a few are inventing totally new, better processes, and some are sitting idle.
As we watch the market change, the risk to any individual law firm is not complete obsolescence, rather it is being marginalized as others shift to meet market demands. The firms that shift with it will be the ones that come out on top.