Adjusting to the New Normal
The takeaway from a review of the financial news on law firm economics for 2012 is, as the aptly titled "The Boom Years Are Not Coming Back" proclaims: Firms "can no longer rely on a rising tide that lifts all boats. In fact, the tide is out."
- Demand for legal services dropped an average of 0.4% between 2008 and 2012 compared to an average 3.7% increase between 2004 and 2008.
- Average revenue growth of 9.8% in that earlier time frame dropped to just 0.8% growth in the more recent years.
- Rates are rising at a slower pace now than before the downturn.
- Average hours per lawyer fell to 1,641 in 2011, versus an average of 1,742 from 2001 to 2007, with partners being responsible for most of that drop.
According to the Wells Fargo report on law firms, based on the first 9 months or 2012, equity partners are projected to have worked an average of 1,602 hours in 2012, down1.7% from 2011; nonequity partners an average of 1,530 hours, a 1.6 % decline (while at the same time their numbers have increased 4%); and associates are projected to average 1,768 hours, a 0.5% drop from 2011.
Citi Private Bank’s full-year 2012 forecast shows law firm profits increased by 4.3% in 2012, much higher than third quarter 2012 results anticipated, but due to factors in the fourth quarter that may not be sustainable--strong collections that raised revenues, a small spike in demand, and more moderate growth in expenses.
The collection cycle shortened by 2.1% largely because of the focus on 2013 tax changes. The full year demand growth rate averaged out to just 0.2%. Expense growth slowed to 3.1%, less than revenue growth, due to a slowdown in head count growth, the lack of spring bonuses in 2012 and firms possibly having caught up on delayed infrastructure projects. Equity partner head count was up just 0.1% and productivity declined 0.6%.
Still, the Am Law 1-50 results for 2012 are flat compared to the prior year, and smaller firms saw a decline. What Citibank calls "survivorship bias," in which failed firm Dewey & LeBoeuf's revenue was taken out of 2011 results and essentially transferred via laterals to other firms in 2012, resulted, in their opinion, in higher 2012 revenue than would otherwise have been registered. According to them, if Dewey's figures were included in the 2011 data, revenue growth for 2012 of 3.6% would be reduced to about 2.6%, demand would have been a negative 0.5% and equity partner head count would have been a negative1%.
Smock Law Firm Consultants’ annual survey in early January 2013 of 24 law firms came to much the same conclusions as Wells Fargo and Citibank. "Overall firm results were considered to be quite positive for 2012, not as strong as 2010, but certainly stronger than 2011....most firms we interviewed are looking at a flat or close to flat 2012 budget."
Similarly, the recently released Georgetown--Peer Monitor report describes 2012 as "another year of only modest growth," showing an average increase in profits per partner of 3.58%, while Am Law 100 firms saw profits rise 2.45%, compared to the 4% gain for non-Am Law 100 firms. [Note that all these reports differ in their assessment of the financial condition of the largest firms, a fact interesting in itself.] While this report agrees that law firms will not regain pre-recession growth, it contends that even the profitability in the decade prior to 2008 was not a harbinger of good times to come but mostly the result of high annual billing rate increases of 6-8% "that bore little relationship to what was going on in the broader economy...The cumulative impact of these increases over time created a trajectory that was simply unsustainable."
Citibank's maintains a so-called watch list, first mentioned publicly in October, based on an assessment of primarily four factors: heavy lateral churn, high bank debt, weak leadership, and cracks in firm culture.
While Citibank is not releasing any names, they note that lateral movement remains generally high while bank debt—which served as huge factors in the demise of Thelen, Heller Ehrman, Howrey, Dewey, and others—seems to have moderated. According to Wells Fargo, as of September 30, firms were carrying balances on their lines of credit that were, on average, a third higher than they were the year before. But the trend is for firms to reduce their reliance on debt and increase capital contributions. From 2006 to 2011, for example, average debt per equity partner among half of The Am Law 100 that Wells has been tracking fell from $64,338 to $55,491, having peaked at $85,716 in 2008. During the same period, debt as a percentage of net firm income fell from 5.8 percent to 4.2 percent. As a counterpoint, the Citibank advisory says partners contributed capital averaging $317,000 in 2011 versus $190,000 in 2004.
That leaves leadership effectiveness and culture, not measured by any of these reports, for firms to take a hard look at.
Continued overcapacity remains a bottom-line conclusion from all this data. The legal sector lost 2,400 jobs in January, according to seasonally adjusted preliminary employment data released by the U.S. Bureau of Labor Statistics. According to an analysis by The AmLaw Daily, losses effectively wiped out all the jobs the industry gained in December—a figure that was revised upward to 1,900 from an original estimate of 1,000, although the legal sector now employs 6,500 more people than it did at the same point last year. "Although the 1.125 million people currently working in legal services jobs make the sector's workforce the biggest it's been since May 2009, the industry has still shed about 50,000 positions since its precession peak." Further, the legal sector grew at a slower pace in 2012 than the broader economy: law saw a net gain of 7,800 jobs—a 0.7% increase over 2011, which was only half the growth rate of the overall workforce (1.4%).
The recent spate of layoffs and office closings at several large UK firms--including Allen & Overy, DLA Piper and Eversheds--has raised the question as to whether there will be another round of job losses in the US. Certainly the hard numbers make that look like a reasonable possibility.
So for 2013? While 2013 results will depend in large part on how firms handle expenses and headcount, the clear concensus is that the prosperity realized between 2001 and 2007 can't be considered the norm. "We think it is time to let go of any lingering notion that the industry will revert to the boom years before the Great Recession any time soon," according to Citibank's DiPietro. "[P]rofits per equity partner growth in 2013 will likely be again in the low single-digits—the new definition of a good year for the legal industry."
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