Demand Down; Rates Up; Review Season

Demand Down
Midsize firms experienced demand growth (measured in hours worked) in Q3 of this year, relative to Q3 2021, according to Thomson Reuter’s Law Firm Financial Index (LFFI), aggregating data from over 160 law firms (LFFI Q3 2022 Executive Report, Thomson Reuters, 11/7/22).  The AmLaw 100 registered a decline of over 2.0%, while the Second Hundred experienced a smaller decline.  Monthly hours billed by equity partner, non-equity partner, and associate groups respectively registered the lowest Q3 marks in recent years.  And demand contracted in all practice areas except L&E.

Demand decline coincided with expense growth, as firms welcomed new first year classes at higher salaries and incurred increased overhead due to returns to office.  With less revenue and higher expenses, profits per lawyer declined to $315K, down 2.9% from Q2 2022, but still significantly higher than at any point in 2020 (LFFI).

Rate Hikes
Despite the decrease in demand in Q3, AmLaw 100 and Second Hundred firms were able to increase worked rates 6.7% and 4.7%, respectively, over Q3 2021; and Midsize firms grew worked rates 4% (Across-the-Board Declines Mean an 'Inflection Point' for Law Firms, Andrew Maloney, 11/7/22, American Lawyer, citing Bill Josten, strategic content manager for Thomson Reuters).  And law firm leaders appear to have further rate increases planned for 2023.  In response to a survey of law firm leaders by Thomson Reuters, 98% respondents reported that their firms “definitely will” (56%) or “probably will” (42%) raise rates in 2023 as a mechanism to improve firm performance (2022 Law Firm Business Leaders Report, Thomson Reuters Institute).

Similarly, Wells Fargo’s Legal Specialty Group reported that firm leaders plan to raise rates 7% - 8% on average in 2023 (Raising Billing Rates in 2023 Becomes a 'Singular Focus' for Law Firms, Andrew Maloney, 11/22/22, The American Lawyer, “Raising Rates”, citing Wells Fargo Legal Specialty Group’s 3rd Quarter report, based on a survey of 65 AmLaw 100 & 31 Second Hundred firms).  Senior Consultant Owen Burman noted these were the highest planned rate increases in their 15 years of tracking (Raising Rates).

This news has generated considerable consternation among some in-house lawyers, as well as consultants who advise in-house lawyers on pricing (‘Surprised, Angry, Dismayed': Legal Departments Vow to Fight Law Firms' Rate-Hike Plan, Hugo Guzman et al., 11/29/22, Corporate Counsel).  Such consultants continue to advocate for moving rate negotiations to legal operations professionals and away from in-house counsel who “lack the skills, gumption, desire and/or temperament to take an arm’s-length tone in rate negotiations” (Surprised, Angry, Dismayed, quoting Wolters Kluwers ELM Solutions Nathan Cemenska). 

With many legal departments facing budget decreases in 2023, in-house counsel may be forced to seek rate concessions or to move work to firms with lower rates.  Some commentators predict that leverage lies more with in-house counsel now than over the past couple years when firms were so busy that they could afford to lose multi-million dollar clients.

Review Season
Q3 headcount numbers do not support rumors of widespread stealth layoffs.  In fact, headcount was up 3% compared to Q3 2021 (Law Firms Are Letting Productivity Slide, Remembering the 'Lost Generation' of Lawyers, Andrew Maloney, 11/12/22, The American Lawyer).  Relatedly, productivity (hours billed per lawyer) has declined for three consecutive quarters (1.1% in Q1, 3.5% in Q2, and 3.8% in Q3), with AmLaw 100 firms experiencing the largest Q3 decline at 5.6% (Productivity Slide, citing LFFI).  This year’s review season may provide firms the opportunity to right-size declines in productivity.

Right-sizing through review season carries reputational risk, however.  As ALM Editor-in-Chief Gina Passarella Cipriani notes, midlevel associates gave firms the worst marks of all survey measures on transparency around partner promotion criteria (The Performance Review Season Talent May Dread, Gina Passarella Cipriani, Law.com Barometer, 10/6/22, citing AmLaw’s 2022 Midlevel Associates Survey).  And it can be a challenge to explain internally how associates who were fully utilized and appreciated during the busy times are now failing based on their own merit.  Significant layoffs carry reputational risk as well, and firms will be wary to cut too deeply for fear of facing another talent shortage if demand improves in 2023 (Performance Review Season and Productivity Slide).