The profitability of global law firms has continued to decline against a background of “falling demand and surging expenses”, research has found.
Thomson Reuters Institute predicted that law firm leaders would have to cut staff if the trend continued, with equity partners facing the prospect of reduced payouts as well.
Even though lawyers remained more profitable than their pre-pandemic levels, “those gains are rapidly dissipating as time runs out in 2022”, according to Thomson Reuters’ law firm financial index.
Profits per lawyer fell by 2.9% in the third quarter of this year, bringing them down to the lowest level since the start of 2021, but still 17% ahead of the figure for the start of 2020.
Direct expenses, which include salaries, grew by almost 11%, and overheads rose by almost 13% in the third quarter of 2022, “due in part to the return to the office”.
Demand fell slightly in the quarter compared to the same time last year, by 0.7%, following a fall of 0.5% in the previous quarter. However, in some practice areas it fell by much larger margins, such 13.6% for mergers and acquisitions, and 2.9% in real estate.
Thomson Reuters said this was a fourth consecutive fall in profitability “from the prosperous peaks seen in Q2 of 2021 and gives a strong indication of where law firm profitability is headed”.
It continued: “As we rush towards the end of 2022, this quarter’s number may point to the many difficult decisions facing law firm leaders going into the next year and beyond.”
For the time being, law firms were trying to “wait it out”. Thomson Reuters said: “With fresh memories of the difficulty of rehiring talent, law firms seem willing to accept some productivity contraction in the short term; however, the large productivity contraction in Q3 weighs heavily.”
As a result, leaders were “likely to face increasing pressure to make cuts wherever they can find them”, and equity partners “could be receiving annual pay-outs which are on pace to be considerably less, on average, than in the previous year”.
This would “potentially place firms under immense pressure to bring expenses under control by cutting headcount, much the same as in 2008-09”.
But since that time, law firms had evolved, with the increasing presence of non-partner leadership making firms “more adept at strategic decision-making”, as shown during the pandemic.
“Those law firms that are able to retain and develop their talent, rather than jettison them, could come out of a short period of economic uncertainty stronger than their rivals,” Thomson Reuters said.
“This, however, assumes that any further economic turmoil is relatively light and bearable. If it is not, these same firms will find themselves making deeper cuts than they may have originally.”
The only sector to show positive growth was employment, where demand increased by 0.3%. It fell in litigation by 0.4%, intellectual property by 0.8%, corporate by 1.9%, tax by 3%, and bankruptcy by 11%.
Hours billed per lawyer per month were down on the previous three quarters, at all levels. For equity partners the total fell from 122 to 119 compared to the same period last year, and for associates from 133 to 128.
Despite the “bleak portrait” for the quarter, researchers said mid-size law firms “saw demand and revenue grow at the fastest rate in the market, a historical rarity”, capitalising on the “more robust areas” of employment and litigation, while transactional work declined.
Mike Abbott, head of the Thomson Reuters Institute, said: “Law firms are finding themselves squeezed by both slowing demand and rising expenses. While firm profits have slid recently, they still remain well above pre-pandemic levels.
“The lessons from the Great Recession are still on the minds of law firm leaders, and they recognise the importance of taking a long-term view on how to best position their firms for ongoing success. But doing so may present some near-term challenges.”