With sky-high demand and expenses beginning to rise, the conventional wisdom on rate increases in Big Law firms last year was straightforward: Get it while the getting is good.
Standard rates grew about 5.7% across the industry in 2021, according to Wells Fargo. More than 80% of the Am Law 100 increased billing rates by over 3%, according to this year’s report, and a similar proportion intend to do the same for 2022. Meanwhile, worked rates—the rates that firms actually agree to with particular clients for work on given matters—grew 3.9% across the industry and 5.6% in the Am Law 100 specifically, according to Thomson Reuters.
Industry analysts describe those increases as fairly aggressive. But at the same time, firms weren’t only charging those prices, they were collecting on them—posting their highest realization rates since the Great Recession. The average realization figure among Am Law 100 firms that responded to this year’s survey with data was 83%.
The Wells Fargo report found firm leaders expect to raise rates again this year by an average of 6% to 7%, “modestly” more than last year.
“They know from past experience that if and when we run into a brick wall, their ability to raise rates is going to be severely limited,” says Jeff Lowe, global practice leader of Major, Lindsey & Africa’s law firm group. “So there’s some sense of, ‘Let’s do it while we can, because when the situation changes, we won’t be able to. At least we’ve locked in the higher rate while we can.’”
The brick wall may be around the corner. Deal lawyers have said demand has already begun to slow this year. Regular expenses such as travel, entertainment and overhead are expected to return to something more like the pre-pandemic norm. And associate compensation has already increased since last year, when firms saw that expense rocket up by roughly 11.2%.
Meanwhile, inflation likely isn’t going anywhere, and further aftershocks from world events such as the war in Ukraine aren’t out of the question. Analysts say while the largest and most successful firms can absorb that convergence, others will be in a bind. The looming crunch could alienate clients, cut into law firms’ profits and force talent out the door.
Jim Jones, director of the Georgetown University Law Center on Ethics and the Legal Profession, says it’s not going to force firms out of business. But the compensation increases on their own are “really unsustainable” for a lot of firms.
“That increase in expenses alone is going to put enormous profitability pressure on a lot of firms, and that was before all the more recent raises in compensation came in,” Jones says. “So I think firms may even have to look at a midyear rate increase, which isn’t something they often do. They often raise rates at the beginning of the year. But, especially if inflation continues, I think an awful lot of firms are going to be in an economic bind.”
He says it’s unclear how clients would react to such increases. But if recent history is an indicator, and especially if demand is down, they could turn elsewhere for their legal work. Jones notes that while firms could be intentionally shifting their focus to transactional matters, a decline in litigation over the years at big firms could also be a result of that work moving down market.
Andrew Sachs, CEO of recently merged midsize firm Robbins DiMonte in Chicago, said earlier this year that multiple factors have given smaller firms such as his—which counts litigation as one of its core practice areas—more opportunities in the COVID-19 era. But rate pressure is definitely one of the changes leading work away from large firms.
“Especially among in-house counsel, there has been a lot more rate pressure in our industry since COVID started, and with rate pressure, firms like mine get more at-bats,” Sachs said. “I definitely think it is a factor. There’s a time when an in-house lawyer who is handling these types of decisions sometimes goes with name recognition. And that’s not an insult, just a reality. You go with some of the bigger names. But we’ve gotten more at-bats in the last 12 to 18 months than we were getting before COVID hit with those types of clients.”
Rate increases don’t just affect clients and firms. They also affect individual lawyers and groups of talent.
When his 10-person trademark team moved in February from Perkins Coie to Holland & Hart in Salt Lake City, Craig Beaker cited clients’ response to rate pressure as one of the reasons. He said he needed to find a platform where he could better optimize value.
“We certainly started to see clients wanting a better value proposition as rates continued to go up,” Beaker, now a partner at Holland & Hart and co-leader of its outdoor recreation industry practice, said at the time. “As Am Law 50 firms continue to increase rates, that becomes harder and harder to do. So, I think Holland & Hart provided an excellent platform for us to deliver excellent legal services, but at a better value proposition.”
Smarter and Smoother
Not every client-firm relationship is in peril, even if the demand environment shifts. And it’s not as if firm leaders haven’t been considering their best course of action if and when the good times come to a halt.
The Wells Fargo survey showed most firm leaders expected a drop-off in demand growth this year anyway. The more than 130 firms surveyed by the group projected an average demand increase of 3.5% in 2022. Last year, both Wells and the Citi Private Bank Law Firm Group pegged demand growth at 6.5%.
Firm leaders have also gotten much smarter about billing matters, analysts say—not simply applying rate increases across the board, but negotiating with clients and pricing based on demand, exclusivity and quality.
Lisa Smith, a principal at Fairfax Associates, notes that the last two years have put the industry in great shape. If anything, firms have gotten more efficient with their expenses, better at emphasizing collections, and more flexible and creative in responding to unforeseen events.
“Even if that improvement doesn’t continue at the same rate, they’re coming into whatever headwinds we might be seeing in a strong position,” she says. “I think firms, particularly back in 2020, showed that they could really pivot pretty quickly, and that’ll be key if they do see demand start to drop off. Can they respond and pivot quickly enough? So I think firms are better positioned now for those headwinds than they were a couple years ago.”