Since 2000, law firm PEPP (profits per equity partner) have increased on average 11% for Amlaw 100 firms and 8% for Amlaw 200 firms.  Some observers fear that, like other markets that have sustained growth periods at or near double digits in the past 10 years, the law firm partner profit "bubble" may soon burst as well.

Looking at Amlaw 200 data, PEPP increased by 2% in 2001.  In 2002, the increase was 7%.  2003 saw an increase of 11%, 8% in 2004 and 2005, and 10% in 2006.

This increase doesn't only apply to Amlaw 200 firms.  Looking at the differences from 2005 and 2006 for the top respondent firms in the Law Firm Economic Survey  by Juris Inc. and LexisNexis, respectively (the only two years available), firm PEPP increased 11%.  It is likely that most firms in the mid-market and small market increased incomes by respectable if not similar percentages over the same period.

What can you do to prepare for a stunt in the growth (or decline) of PEPP?  Bruce MacEwen posted an article May 5th  on his blog Adam Smith Esq., titled A "Bubble" in PPP? that looks at some short term ideas to help "mitigate the downward trend" and predicts a change in the las firm business model over the long term:

Short term ideas:

• Redeploy lawyers in troubled practice areas to healthier ones;
• Use the opportunity of "shared pain" with your key clients to get closer to them;
• Adroitly stand by while the normal waves of attrition take their toll;
• Build or at least safeguard capacity in selected practice areas that you anticipate will emerge strongly from the downturn;
• And always, always, keep a sharp eye on costs–although, truth be told, you don't have much material flexibility here. You're not moving your offices to Brooklyn and you're not paying less than market for partners and associates.

Long term predictions:

• the billable hour, lamented by many but eliminated by few, will eventually replaced with a more "value-based" model, though MacEwen stresses that he is not "holding [his] breath" on this;
• the traditional associate/partner model changes to include more non-equity partners and more contract attorneys;
• at least fundamentally, "the core processes by which law firms manage cases and deals must and will change" (ie, more project management, more team philosophy centered around practice groups to become more efficient).

Ultimately, MacEwen believes that due to increased demand (at least for Amlaw 100 firms), finding work won't be the problem.  However, he sees the traditional model as being unsustainable based on the limits placed on things such as productivity (>2,400 hours?), rates (>$1,000 per hour?)and realization (>100%?).  Because of this, if PEPP does suffer a downturn for an extended period of time, the long predicted changes to law firm dynamics may happen.

If this occurs in large law firms, it is incumbent on smaller firms to adapt quickly.  The predictions above are all point towards efficiency that allow firm profits to increase through efficiency rather than increased rates and worked hours.  Much has bee written about the "unmanageability of law firms".  Despite this, firms have continued to make exceptional profits - due in no small part to their enviable margins.  With good management, law firms can see profits that far exceed anything that firms receive currently.   And if partner profits start decreasing, your firm will be in crisis -  just as it is not a good idea to go to the grocery store on an empty stomach, it isn't a good time to contemplate an overhaul in processes during a crisis.

Much of the allure of smaller firms is quality service at a lower price.  Some large firm partners charge rates in excess of $1,000 per hour.  If large firms realize they can offer similar services at lower prices and still increase profits, smaller firms can be squeezed out of the marketplace.

Think Walmart.  As Walmart entered the scene, small businesses were unable to compete based on their lack of purchase power.  Walmart could offer more product selection at a lower price.  Home Depot and Lowes did the same to small hardware stores.  The small shops that survived did so by using their secret weapon - customer service and personal engagement.  Still, you won't find many of these shops who don't struggle on a monthly basis and have to watch as their clients often come to them for advice, then go to Home Depot to buy the big-ticket items.

For small and mid-size firms to compete in this changed environment, they will have to embrace workflow efficiencies that meet or exceed that of the larger firms - and use their "secret weapons" of personal engagement with clients and responsiveness.  However, without the fundamentals of an efficient business in place, your firm will suffer under the weight of your processes.  

There will always be individual clients available, but more dependable sources of income often come from business clients and their leaders.  These clients are already demanding more cost certainty.  If larger firms are able to provide this value to business clients first at a price that isn't so different than yours, your firm may be in trouble.

The time to act is now.

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• Reflections on the 2007 ALM Billing Rates & Practices Survey
• Law Firms with Non-Lawyer Management Achieve Higher Per-Partner Incomes
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• Law Firm Business Model: Margin

There are differences in opinion on regulation of financial markets.  On the one hand, Alan Greenspan takes a mostly hands-off approach to financial markets, except when risks to the economy appear.  Martin Wolf, among others, have criticised Mr. Greenspan for his policies that they believe contributed, even caused, the current credit crisis.

They both seem to enjoy sparring via the Financial Times.  For a little background, read what Mr. Wolf wrote of Mr. Greenspan after he retired as Federal Reserve Chairman (requires registration to read).  It was written about in the New Economist blog with a summary. 

In March, Mr. Greenspan opined in the Financial Times that regulation won't create a "perfect model of risk".   He concludes:

"Thus it is important, indeed crucial, that any reforms in, and adjustments to, the structure of markets and regulation not inhibit our most reliable and effective safeguards against cumulative economic failure: market flexibility and open competition."

Mr. Wolf responded in his forum with nine points in opposition to Mr. Greenspan (read through the comments to see Mr. Wolf's response).   He and others criticised the former Chairman for keeping interest rates too low for too long after the brief recession of 2001.  This, they maintain, led to the massive asset bubble fueled by great liquidity.  Mr. Wolf also aludes in one of his points that far too little attention is still being given the "excessive savings outside of the United States".  Some fear global inflation in excess of 5% will be the result.

Mr. Greenspan answered in the Economist's Form section of the Financial Times that was published in print April 7th in an Op/Ed piece.  Again, Mr. Greenspan set the rules of the game as black and white: 

"My view of the range of dispersion of outcomes has been shaken, but not my judgment that free competitive markets are by far the unrivaled way to organize economies. We have tried regulation ranging from heavy to central planning. None meaningfully worked. Do we wish to retest the evidence?"

Mr. Wolf responded on April 8th in an editorial titled, "Why Greenspan does not bear most of the blame".  He grants many of Mr. Greenspan's arguments, but finishes:

"Regulation cannot be perfect.  But the worse the outcomes now become, the more difficult it will be to defend free financial markets at all.  Without a credible design for regulatory improvement, it will prove impossible."

The arguments on both sides are well worth the time spent reading and provide a better understanding of the likely debates to be held later this year contemplating additional regulation of the financial markets.  The breadth of reach that resulting legislation will have affects just about every area of the legal market in some shape or form.  The thought leaders are debating it right now.  Take some time and read the opposing views.  On whose side do you favor?

We have begun taking submissions for the 2008 Law Firm Economic Survey.  If your firm is interested in participating, please contact Brian by clicking here.

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An article in the Tampa Tribune (hat tip:  Estrin Report) reports that foreclosures are so high in some areas that firms are hiring as many as 200 additional staff to handle the workload.  Foreclosures in Hillsborough County, Florida in February more than doubled the amount from February 2007 and is more than 5 times the foreclosures from February 2006.  This reportedly is putting a strain on the "assembly line" approach firms here use to push these cases through the system. 

This is an extremely worrying sign.  Granted, the investment houses purchased in Florida may not be the primary residences of the owners.  However, their investments were lost and many lost their savings in the process. 

This is more evidence that the 2008 Client Advisory published by Hildebrandt and CitiBank is off the mark.  There does appear to be offsetting legal work to be found.  This is reassuring news to law firms, especially those who have expanded practice areas, that they may not suffer what the Client Advisory termed "the perfect storm" where all areas of practice trend downward with no offsetting surge of work.

However, it is likely that Congress will act to slow foreclosure activity on primary homes sometime this year.  Though good news on the surface, Congress isn't very effective in softening the effect of a market correction.  

Our economy is volatile.  Opportunities for work will be everywhere but not necessarily in areas traditionally served by your firm.  Firms need to prepare to be innovative in their business development approaches this year to take advantage of the continued fall out from the several market corrections that have happened and will happen in the coming months.

We have begun taking submissions for the 2008 Law Firm Economic Survey.  If your firm is interested in participating, please contact Brian by clicking here.

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This morning I am off to Chicago to attend the ABA Techshow.  I am speaking on benchmarking and the results of the 2007 Law Firm Economic Survey Friday at 2:30pm central.  If you are attending the conference I encourage you to drop by.  I plan to do some blogging at the event as well, including recording some interviews.

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I had a chance to catch up with John Remsen, Jr. last week and asked him about the economic outlook for law firms in 2008.  Like many, he believes we are in the midst of an economic down cycle that will affect how law firms perform in 2008.

•  Partners need to push work down to associates so they free up time for marketing and business development.  Most compensation systems tend to reward the opposite behavior.
• With this time, they should go visit top clients to thank them for their business, and learn about their issues and concerns.
• Invite clients into the firm to discuss industry trends and opportunities.
• Resist the temptation to cut marketing expenses.  Most of your competitors are cutting back so you have a chance to stand out and solidify your position as the economy improves.
• Make sure that marketing and business development activities sustain themselves consistently, in both good times and bad. 

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Rob Millard's blog Adventure of Strategy takes a second look at recessionary pressures against law firms in 2008. He links to a new Client Advisory from Hildebrandt and CitiBank that is a depressing read.

 

According to the Advisory, 2007 started out with high expectations and ended in uncertainty. Litigation doesn't look as good since some companies appear to be settling out of potentially protracted litigation. Merck was used as the example with their recent announcement that they were settling their Vioxx claims. (Of course, news yesterday that Merck is back on the defensive may dampen that bleakness and provide hope for trial attorneys on both ends of the aisle.)

 

The Advisory warned of the "perfect storm" in which finance, transactional, and litigation work have all trended downward at the same time, with no offsetting surge in work related to the economic downturn itself.(p 2)

 

Breaking down the reasons for their bearish outlook:

 

• The cost of leverage. The Advisory compares the economic downturn of today and 2001 and notes that the relatively high level of equity partners in 2001 in firms allowed for the use of leverage to increase profits. De-equitizing partners and increasing the barriers to equity partnership have left firms with little wiggle room to work in this economic downturn. This may be true for large firms, but it certainly isn't the case for mid-size firms who are still very much top-heavy according to the 2007 Law Firm Economic Survey from LexisNexis. If leverage was a method of bailout for large firms in the economic trough in 2001, then mid-size firms stand to profit from utilizing it in 2008. This pre-supposes firms have the will to make the admittedly difficult decisions in the more personal environment of the mid-size firm. It stands to reason that a struggling business that wants to survive will make the hard decisions to prevail in hard times. Interestingly, the Advisory argues the negative impact of increasing leverage in the firm that may necessitate a revisit to this subject. In our surveys, increased leverage has been correlative to increased income. Is the Advisory making the argument that you can be over leveraged? Is utilization of associates not the only factor?
• Realization Rates. Realization rates are lower now than in 2001, placing additional pressure on increasing rate. Which leads to the next point -
• Client push back. Clients, in spite of firm predictions of increasing rates, are placing price pressures on firms that place a premium on firms who are efficient at providing legal services. That, combined with lower realization rates, hurts profits.
• The Challenge of Laterals. There are more lateral hires now than in 2001. According to the Advisory, laterals are the first to leave the firm when hard times hit. Perhaps for similar reasons, perhaps not, respondents to the LexisNexis 2007 Survey confirmed that they have more success with new hires than with laterals.

• Lack of Offsetting Practices. It's the "perfect storm" of no transactional, litigation or finance work (although I personally think that may be a bit overstated).

Is this a pre-warning? Click here to read the Advisory in its entirety.

 

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877/377-3740, e-mail info@juris.com or go to www.Juris.com.

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