Biglaw's Pulse Beats Steadily, Doom and Gloom Notwithstanding

Jan 5, 2015 by 0

The stories about Biglaw over the past five years have been grim, but a closer inspection shows that despite a cacophony of daily doomsday stories from The New Republic, the Wisconsin Law Review, The Atlantic and other publications of varying quality, the future of Biglaw looks promising.

The size of modern-day, Am Law 100 firms allows them to downsize or expand as the market conditions dictate, but as a profession of perception, firms have to handle RIFs with care. Partners and clients might go next door if they doubt the capabilities of the firm. I have worked with partners before who moved simply because the perception of their firm’s stability was questioned by their clients….

 

One concern about Biglaw is whether firms are approaching critical mass. As many firms expand, they expect to keep rates constant while adding additional business to maintain bill rates. The data from the Am Law 100 paints a clear picture between firm size and efficiency. It shows that size alone is a poor indicator of law firm efficiency—if we accept that profit margin is a reasonable measure of efficiency:

Instead, leverage is a much better indicator of firm efficiency. Profit margins fall as the leverage ratio increases:

Why? Well, as the average Am Law 100 firm composition approaches 900 attorneys, what these firms are finding is that clients are regarding firms less as partners and more as service providers. Clients are balking at paying full freight for first-year associates and are trying to negotiate discounts for bulk work. Small and mid-sized law firms are seeing a rise in demand as they undercut Biglaw’s potentially four-figure rates.

Pressure from clients could eventually lead to a rise in alternative fee agreements or even more high-end temporary staffing models that utilize associates only when there is enough work to support their hours. One such company is Cadence Counsel, which seeks to make law firms more competitive to clients without compromising quality.

In ALM’s AFA report, they noted that 95% of law firms use alternative fee arrangements. 66% of firms reported that the number of AFAs increased from 2011 to 2012. Clients are increasingly trying to negotiate rate discounts, sometimes in excess of 15%, for bulk work. Some firms don’t have the profit margins to accommodate these rate discounts and could consequently cannibalize their clients (and service partners) to other firms.

The pressure from clients on firms to reduce hourly rates is hardly new, and in times of financial distress, firms sometimes relent. However, these concessions usually recede as financial normalcy returns. The question for Biglaw firms is, what will be financial normalcy?

In general, around 80% of associate hours worked are billed. That’s around two hours a day that are not being billed. As law firms push to increase their profit margins, we should see firms adopt better workflow practices and integrate cutting-edge technology.

A major drag on law firm productivity is the MS-DOS-era equipment that many firms still use. In light of the recent celebrity leak scandal, it is easy to see why law firms are hesitant to adopt cutting-edge or cloud based technology, but the tradeoff is efficiency for firms, clients, and PPP, and potentially less hours or higher compensation for associates. Either way, reducing costs and overhead is a good thing, leading to generating more money to invest elsewhere (in people or otherwise) to achieve higher ROIs.

Gross income is at its highest peak ever for the Am Law 100 (adjusted for inflation) and real growth has occurred tepidly but steadily for the last four years. From 2012 to 2013, real gross income grew by 2.57% in the Am Law 100. This was well under the mean of 6.02% but just a little over half a standard deviation from the mean (Z = -.64). Nonetheless, the growth was much improved from the 4.9% drop in the 2008/2009 fiscal year.

As the economy settles, so will Biglaw. The days of double-digit growth are likely long gone (and have been since 2002). In the future, firms will have to address the attacks against the billable hour from undercutting boutiques and irate clients, inefficiency from technological lag, and diseconomies of scale. Nonetheless, the reports of Biglaw’s death have been greatly exaggerated.