Welcome to the Law.com Pro Executive Briefing. In part two of our two-part briefing looking at the financial health of the nation’s largest firms, we examine what comes next. If you have topics or data you’d like to hear more about, let us know at [email protected] and [email protected].
Am Law 100′s Blockbuster Performance: Where Do We Go From Here?
Any firm leader we spoke with in the early months of 2022 noted that the frenetic demand for legal services in 2021 was carrying over into the new year, with little signs of slowing down any time soon. How quickly things could change?
Last week in this briefing, we talked about just how phenomenal a year the Am Law 100 had in 2021. This week, we are looking at what may lie ahead.
Listen, we’ve been down this road before. The pandemic hit and demand was supposed to plummet and here we are two years later with the best financial performance the industry has ever seen. So we aren’t going to spend this briefing telling you why the war in Ukraine or rising inflation is about to put an end to your joy ride. We will spend a bit of time discussing some of the headwinds, along with what we are hearing in the market about whether firms are feeling their effects yet. But we also want to discuss the market factors that took root during the pandemic and the challenges they may cause when a slowdown does come.
Whatever rate increases firms were able to push through at the start of the year may prove very important in counteracting at least some of the possible dip in demand. We have heard that firm leaders are already noticing a softening in overall hours.
Here are a few of the headwinds we are increasingly hearing firms discuss as real worries:
- Inflation: The impacts of inflation are tied into everything else mentioned below. Firms are feeling it in what they have to pay talent and the cost of running events and other T&E. It’s also going to impact deal valuation and quantity. It’s tied into continued supply-chain disruption, which is further impacted by events in Ukraine.
- Ukraine/Russia: The conflict has undoubtedly caused significant disruption to the legal industry, some good and some bad for firms financially. Advice on sanctions and other tricky legal issues are a boon to outside counsel, while many firms have had to uproot their operations and distance themselves from clients with ties to Russia. But the financial impact there is frankly limited. The bigger impact from the war would come from an impact on deal volume and a general retraction of corporate spend.
- Deal Flow: We have heard some reports of a general softening in hours, particularly as it relates to deal work, including private equity.
- Q1, while still huge given the highs of the deal market, saw a 23% decline in deal value and a 19% decline in deal volume.
- SPACs are falling out of favor to some degree, due to increased regulation, redemption rate growth and a general dropoff in M&A.
- Talent Wars/Talent Shortage: Keeping talent in place and happy is a major challenge. And firms are eating away at profits with a race to pay more. Right now they can afford it. This could all subside, of course, if the market turns.
- Flight From Quality: This is purely meant to be a play on words of the commonly heard “flight to quality” rationale for the elite firms’ growth during the pandemic, not a suggestion that firms outside those ranks are less than quality. The question remains whether we will see buyers of legal services rationalizing their spend in 2022. It certainly will be harder for them to build out their own teams given how general counsel are all bemoaning the talent war and how difficult it is for them to compete for talent given what firms are paying. Will GCs finally say enough is enough on rates (assuming the cost of increased law firm talent is being passed on to them). If the deal work slows, will there be even less bet-the-company work available to justify going to the top firms?
- As one general counsel explained to us recently, a firm in the bottom quartile of the 100 Am Law 100 was pitching rates between say $1,000 and $1,500 an hour, with the argument that it was a lot less than the nearly $2,000 or more they might pay for the top quartile. But the GC said that savings wasn’t meaningful enough, so they’d rather go to a firm that’s charging out at $700-$800 an hour if they were going to move away from the Am Law 25.
- Another in-house counsel of a household-name company said they were looking for midsize firms that could handle those matters in the $500k-$1.5million range because they had so many of them but had to justify the cost of outside counsel.
Lessons from 2008, in Perspective, Part I: When the pandemic first hit, many in firm leadership positions immediately thought back to the 2008/2009, and the impact “the great reset” had on the legal profession, especially the Big Law segment. In fiscal 2007, Am Law 200 hit year-over-year gross revenue growth of 12% while year-over-year GDP growth dropped to 1.9%. Am Law 200 revenue growth dropped to 3.5% in 2008 before falling to a century low -2.9% in 2009. We’re not predicting a similar drop for law firms this time, for a variety of reasons. However, since the legal profession is largely based on past precedent, we’d be remiss if we didn’t mention it.
Lessons from 2008, in Perspective, Part II: Among the reasons we don’t anticipate the large law sector is heading for similar precipitous drops as in the past revolve around the lessons learned from 2008 & 2009. As the chart above shows, law firms have done a great job reducing revenue & revenue per lawyer volatility over the past decade, while the chart below illustrates the consistent profitability growth for firms coming out of the great reset. Collectively, firms simply are much improved at running their practices as a business, reducing the impact of market fluctuations on their bottom lines.
Lessons from 2008, in Perspective, Part III: Often lost in the narrative surrounding 2008 is that two unrelated, yet significant, events also happened that year. First, it was the first year that several e-billing providers began providing aggregated legal spend benchmark data back to their legal department clients. This created a more informed, data-driven buyer who, if they chose to use it, now possessed benchmark data on rates, matter duration, staffing ratios, total matter costs, and more. This data was often segmented by firm size, geographic location, timekeeper years of experience, role, and more. Second, 2008 marked the launch of ACC’s Value Challenge. Just as 2020 and 2021 were the perfect storms for unprecedented revenue and profitability growth for law firms, 2008 was the perfect storm for legal departments looking to increase their ability to manage matter spend and the law department/law firm relationship.
The number of data and analytics vendors specializing in spend management continues to grow. AI-powered bill review, along with human-analyzed bill review, is now a standard offering. Post-mortem analysis of matters that exceed budget limits can be quickly performed and granularly examined by legal departments as the clients seek to minimize spend bloat. Legal spend dashboards, many featuring a variety of metrics often not measured by firms, are increasingly common in legal departments. Firms can expect an increase in proactive fiscal oversight as clients seek to rein in costs, including rates, staffing, budget scoping, and more.
Finally, while US GDP rebounded sharply in 2021, the Am Law 100 largely kept pace with the GDP growth, which is a good sign for law firms as the U.S. heads into uncertain headwinds.
Pandemic Changes in a Post-Pandemic World
When the market does come back down to earth, and we know it will, it won’t be in the same structure it was prior to the pandemic. Some changes to the business model and the way business gets done will have to be reckoned with.
Uniform Comp: A significant but perhaps under-noticed shift out of the pandemic is the push more Am Law 200 firms made to pay all of their associates the same regardless of location. Of course rates may have matched as well (which leads to questions about the value of secondary markets–a topic we will address another time). While there is a very valid argument that work isn’t tied to any one market and teams work across offices on the same matters, the shift is still a new cost for firms that they will now have to face even when demand is lower–or associates will have to face it if the work dries up.
Unchecked Hiring: It may not take a slowdown in work for this phenomenon to rear its ugly head, but as we discussed in this week’s Law.com Pro Fellows webinar, many firms are making hires without checking references or books, and with a blind acceptance that the purported books of business (which grew a reported 95% in the last survey period, according to Decipher data) are legitimate. Are firms still doing multi-year reviews of books to ensure they are factoring in a pandemic spike? Sight-unseen hires, literally or figuratively, happened more during the pandemic and could be felt a lot more when demand dips.
Comp and Hiring Balanced Out?: Aside from just uniform comp, comp also rose significantly over the past few years. That hit to profits will be tougher to absorb in a downturn. But one potential bright spot is that, for all of the talk of a frenzied hiring market, overall head count growth didn’t soar nearly as much as the revenue growth might suggest it would. It was more of a deck shuffle than adding new talent, meaning the need for layoffs could be abated. It should be noted, however, that associate growth was more significant than in other categories. We will discuss more on that when the Am Law 100 releases April 26. One plus is that firms put most of their comp increases in added bonuses rather than just salary. That gives them some wiggle room when profits aren’t as flush.
Hybrid Work and Partner Promotions: As was recently noted in our March Law.com Pro webinar, hybrid work is still a work in progress for law firms. They know it makes sense, but a lot can make sense when times are good. We have talked before about the risk remote hires may face during a downturn, when they aren’t top of mind or worked into the fabric of the firm. There is also the promotion discussion. As a firm leader said in the webinar, if someone is up for partner, it probably makes sense to be in the office. It’s one thing to work remotely when times are good, the leader said, but after a year or two of revenue dips, the people who stay are the ones management can remember. Many may argue that is an antiquated philosophy, and firms need to figure out a way to equalize opportunities for hybrid and in-person employees alike. But we may only be months away from a downturn, and while the pandemic did a lot to change firms, some things have yet to be ingrained into the culture. So for all of our talk of how hybrid is never going away, is the path to success still paved with brick and mortar?
As we’ve said before, annual financial success isn’t always the best barometer of health–particularly when it depends on demand for elite legal services, a finite pie that fluctuates in its caloric value. Firms should ride this wave while being mindful of investment and innovation opportunities and continuing to focus on client development, even if you are currently turning some clients away.
In the Know
The Am Law 100 is Almost Here: The Am Law 100 results and related analysis will go live on The American Lawyer at 10 a.m. ET on April 26. We will have a discussion about the high-level findings at 11 a.m. ET that day, and a behind-the-scenes look at the unpublished data for Law.com Pro members only on April 28 at 11 a.m. ET. Register for that webinar here.
Am Law 100/200 Early Reports: Discussions with firm leaders about what drove their financial results can all be found in our early reports page here. This page is updated regularly.
Law Firm Strategy: Here are links to some of our latest pieces across Law.com on law firm strategy. All of our Pro content, including past briefings and webinars, can be accessed here.
Mental Health Survey Results Will Be Out Soon: Be on the lookout for the results of our global mental health survey, releasing the second week of May. This important research comes at a crucial time for the industry and will be broken out in many ways that will allow firms to assess areas of focus, program needs and areas of risk.