Hildebrandt/ Citi Client Advisory: Slow Growth For Law Firms in 2010

Considering the contraction in 2009, this isn’t as newsworthy as it might appear. In fact, there is little evidence 2010 will be much better than 2009 according to the Advisory:

“However, while the profession is no longer in crisis mode, we recognize that firms will remain under intense pressure to create new models for pricing and delivery of legal services,” DiPietro said in a news release. “The report addresses these issues as well as the industry’s response to the current market environment.”

I suppose this will lead to another in depth discussion of alternative fee arrangements.  How novel.

Some highlights:

• Realization continues to drop in spite of efforts to raise rates to offset drops in demand;
• Pressure for discounting, fee caps, multi-year rate schedules and alternative pricing increases;
• Increases in “negotiated” rates are being offset by drops in “collected rates”, leading to the lower realization;
• Firms chose to cut expenses, especially compensation costs, to offset losses (a typical reaction);
• Biglaw firms fared better than smaller firms, mostly due to dramatic purging of staff and cost controls;
• Significant improvements seen in 2009 in demand for Mergers and Acquisitions, general corporate, tax, capital markets, and real estate practices;
• Expect further cost cutting measures in 2010 (ie, not likely to be a boom year for technology vendors seeking to encourage firm investment in technology).

A look at the effects on key profit drivers:

• Productivity still in negative growth “driven to some extent by associate pushback on the unsustainable billable hour requirements in many firms”;
• Leverage is increasing to make up for declining productivity (which makes no sense as this drives up costs without adding value);
• Realization, as earlier stated, is in steady decline;
• Expenses had been a source of continual growth until 2009;
• Growth prior to 2009 was consistently driven by rate increases between 6 to 8 per cent annually;
• Expectations for future rate increases are low due to increased client resistance.

The Advisory mentions something that I have touted for years:  the need for improved efficiency to maximize profitability.  During the boom years, it enhanced an already profitable model.  Now, it will be a necessity to offset rate stagnation.

Legal Current has more on the advisory.  To read their take and download a copy of the Advisory, click here.

Are Law Firms Ready For Rate Deflation?

After hitting 5% in July of 2008, inflation has dropped rapidly and is now in negative territory (annualized) for the first time in 54 years.  This creates tremendous spending opportunities but there are many risks.  One of the risks to law firms is a deflating billable rate.  With deflation hitting most aspects of the economy (food and energy being notable exceptions that at least in the latter case isn’t expected to deflate for a while and in fact may be the next credit “bubble” if, err, I mean when cap and trade is passed), it is only a matter of time when clients will either request more discounts or a reduced rate – and if clients don’t ask, other attorneys will offer lower rates to lure new clientele.  Many businesses will be working from much tighter margins while the cost of doing business, including defending lawsuits, won’t lower with their margins.  Something will have to give – either longer A/R outstanding or reduced rates.

It may not come.  But there is reason to believe it will.  Attorneys from large law firms who have been laid off are finding themselves entering the mid-firm market and some enterprising ones will start their own firms, determine a model that maximizes profit, and “Wal-Mart” some out of business while still raking in incredible profits.  All it takes is better efficiency in serving clients (and, in my view, an unprofessional but very business-like approach to targeting and accepting clients).  The relationship you have with your clients puts you at an advantage right now.  However, in forecasting models you should prepare for a fight for your business based on  rate.    

If you are faced with reducing rates to keep clients, efficiency is key to making up the lost revenue.    Don’t rely on volume alone as it can fool you into thinking you are in a better financial position than you are.  You may end up hiring excessive numbers of attorneys, especially as the costs of attorneys goes down (another inevitability that is already happening – salary reduction for new associates).  If you are still making minimal margins because you are too busy to implement efficient processes and you get undercut by someone willing to lower their rates, your firm will be in for a rather intense correction.

Even assuming rates don’t increase, there is a high probability that any planned rate increases will be difficult to implement.  Firms have been contracting for several months and most have already cut costs as low as they can.  A reduction in rate is an unplanned occurrence that can place even more pressure on firms to reduce costs.

From the firms I have consulted, most are still unwilling to invest in efficiency – rather, they are placing more emphasis on productivity and staff reductions.  There are a few firms who are changing their model to streamline processes – those who invest in better procedures will not only be in a better position to absorb rate stagnation (or deflation) but will be in a better position to increase profitability later this year when the economic numbers start to improve.  The test will be whether they retain earnings, a concept that is anathema to many firms.

Please note that due to the activism of the Federal Government to re-inflate the credit markets, there are arguably two possible results:  massive inflation or another asset bubble (which will lead to a result similar to what we are experiencing now).  Either way, the pattern of erratic markets is not likely to end anytime soon and with trillions being poured into the economy, money may get loose for a while – smart firms will invest in their firms (take advantage of the deflation) and set aside sufficient amounts to take short hits on revenue rather than make distributions (in case of a rapid spike in inflation or another asset bubble).  We are in for a long period of uncertainty.  Universal health care, carbon emission taxes, and of course the obvious tax increases to pay for the action taken already and to sustain the new entitlements.

Law firms will not be needed less (and in fact in some areas they will be needed more) but they are not immune to shifts to the economy.  There will be areas of rate inflation but your firm may not be one of the beneficiaries.  Some areas of law that have flourished for decades will suffer greatly and some boutique firms will cease to exist entirely.

Prepare for it.  If your firm flourishes and all the doom and gloom above doesn’t come to fruition, great.  Your bottom line thanks me for helping you have such a strong equitable position during your time of saving – go buy a new touch screen whiteboard or make a distribution so you can pay for all those projects at home.  If the firm struggles, however, you may avoid having to make decisions that are not only uncomfortable but can lead to a fracturing of the firm.