The latest Peer Monitor Quarterly Index report showed a second straight quarter of average contracting demand. Though not unprecedented, we haven’t seen two consecutive quarters of contracting demand since the middle of 2012.
At a recent gathering of law firm leaders, some of the attendees expressed a bit of surprise that demand had contracted in the second quarter. I’m not quite sure why, since demand has been notoriously flat for the last several years. The first quarter of this year showed encouraging signs of positive demand, increasing 1.2%. If this year was to stay consistent with recent years, a negative quarter would be likely somewhere this year in order to keep demand relatively flat.
At this same gathering, in fact — and prior to results of the third quarter being computed — I predicted that 3Q would end up showing negative demand as well. Why? A couple reasons, actually.
First, BTI Consulting reported not long ago that corporate clients had shifted $4 billion of their legal spend back in-house. Last year when we scoped the size of the legal market, we found that large and medium firms accounted for just shy of $200 billion in value. So just accounting for the $4 billion shift, that would imply a nearly 2% contraction in the market. So far through the first three quarters of this year, however, the average firm in the Peer Monitor sample has not seen such a dramatic reduction. But that does not mean the full impact has yet been felt, either.
The reason I say this is also the second reason I predicted contracting demand in 3Q. In the early part of this summer, many large law firms decided to provide their associates with a fairly substantial compensation boost. While some firms are better positioned to absorb the additional comp expense than others, it’s a safe bet that most firms were expecting that the additional costs would ultimately be borne by clients. Clients, however, were less than enthusiastic about this.
Several GCs were fairly outspoken that they did not want to be left on the hook for additional comp, and that law firms better not seek to pass those costs along. Many firms, it seems, interpreted this warning as a caution not to raise rates. However, that did not stop them from trying to alter billable hour expectations. A few examples that were discussed rather publicly in other publications showed firms expecting an additional 100 or 150 billable hours to be booked (on an annualized basis) in order to realize full compensation potential.
It is questionable where those firms expected those hours to come from, given that overcapacity of talent coupled with soft demand has led to productivity contractions for most of the last decade. On top of that, many GCs are likely to be watching their bills like hawks for the remainder of the year to try and head off any padding of hours.
Given the confluence of these factors, it wasn’t altogether surprising that 3Q showed negative demand, and if the situation remains unchanged, we may well see that 2016 will be our first negative average demand year since 2013.