Report to Law Firms: 2017 Ain’t Looking Great

Sometimes, the market for legal services appears to move in slow-motion: Each month brings a new report highlighting the same trends – corporate legal departments are expanding, client loyalty is disappearing, law firm profits are under pressure but an elite pack is pulling ahead.

Against this backdrop, on Tuesday, Citi Bank Private Law Firm Group and Hildebrandt Consulting released their analysis of the first nine months of 2016 with an unlikely quote from Winston Churchill:

“To improve is to change, so to be perfect is to have changed often.”

It’s an odd choice given that the market didn’t really change a whole lot for most law firms in 2016: growth remained sluggish. And as the report’s executive summary predicts in its opening shot, 2017 “will likely be another year of modest industry growth.”

“We expect to see continued dispersion and volatility in the performance of individual firms, in line with what we have observed during the post-recession years,” the authors continue.

Still, the report is worth paying attention to because it’s the product of a critical mass of roughly 200 U.S. law firms, which come together, open their books, and allow outside analysts to perform an industrywide check-up.

Here’s what the report found, in summary fashion:

  • If the overall market for legal services is growing, law firms are being left behind.
    • Demand for law firms’ services grew by just 0.3 percent through the first three quarters of 2016.
    • The pre-recession go-go days when law firm growth consistently exceeded 4 percent are gone.
    • See the chart below:

chart1-citi

 

  • Optimistically, overall law firm revenue was up 3.7 percent at the nine-month point.
    • But rate increases, which averaged out to about 3.2 percent, primarily drove this and it’s not sustainable.
  • Why can’t rate increases keep happening? Because overall realization rates, meaning what was collected versus what was billed, declined 1.1 percent at the nine-month point of 2016.
  • These days, law firms are asking partners to contribute more capital.
    • See the chart below which shows the average equity partner contributed $402,000:

chart2-citi

“What we’ve been seeing over a prolonged period of time is that law firms have been turning more to their partners to invest more in the firm,” said Gretta Rusanow, head of advisory services, law firm group at Citi Private Bank.

In some cases, the capital increase is linked to long term investments the firm wants to make, such as refurbishing an office, Rusanow said. In other cases, it’s so that the lawyers have more “skin in the game” and are literally more invested in the firm.

The report presupposes that modest growth is the new reality for law firms and suggests that it isn’t entirely accurate to suggest only an elite cadre of firms is going to grow. Rusanow was emphatic that any firm that takes the right approach can attain higher growth.

She said the strongest performers will manage expenses, be disciplined about rate increases, evaluate the equity partners and reward the best. The report listed other ideas such as brand differentiation, look for lower-cost alternatives to associates and manage leverage in response to the client needs.

“There will be firms that manage to grow at a healthy clip,” she said.

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