Practice Management

Where Will Profits Come From in 2011?

By Ronda Muir

After literally years of bad news, recent reports have sparked a flurry of hope for an uptick in demand for legal services in 2011.  Let's look at the data for some indication of whether that optimism is justified. 

According to the Citi Private Bank report issued for the first 3 quarters of 2010, while demand in 2009 was down an average of 4%, for the 1st 3 quarters of 2010 demand was down only 1%.  But Citi predicted that the demand picture showed "no signs of improving any time soon," with average demand in the next few years continuing to stay flat.

So when the 2010 4th quarter results were recently announced, showing that demand went up 1% for the quarter, the news was greeted with whoops of prospects "bouncing back."

The fourth quarter improvement does sound significant, given the turnaround from the prior years' rates of lowered demand.  But a look at the 3rd quarter of 2010 results makes for a more nuanced comparison.  That quarter showed an overall increase of 0.5% in demand, ranging from the AmLaw 51-100's most significant decline to those firms smaller than the AmLaw 200 showing demand up by 1.5%--an indication of the middle firms' risk of being squeezed by changing fees and the redistribution by clients of their work.  [More on the positioning of large and small firms in whatever recovery occurs in the next few blog entries.] 

Further, in the 3rd quarter, expense reduction, including a reduction in lawyer head count, is starting to slow, with average productivity increasing, while remaining at historic lows (@1650 average hours per lawyer compared to 1700-1800 in prior years) and average equity partner hours higher than that of their associates.

The fourth quarter results do indeed included a half-percent rise in demand from the prior quarter and a full1% rise from the prior year. Direct expenses fell another 4.5% and productivity also rose 0.7%.

We will leave to another day the discussion of why firms are still committed to calculating "productivity" on the basis of hours billed per lawyer--AFAs are making the lie of that metric.  But using the data as we have it, the future picture still looks troubling.

Much of the increase in profits continues to be due to cutting costs, although those opportunities are getting fewer, and lowering leverage.  And even when work is performed and the bills out the door, realization rates, both billing and collection, went down throughout 2010, continuing a troubling trend.

The proof of this analysis is in the spate of recently announced firm results, with the exception of outstanding results from Quinn Emmanuel and Wachtell.  Clifford Chance cut costs by $65million last year, including a head count cut of 12%, yet saw revenue go down 5% and profits down 3%.  Shook, Hardy reported a slight rise in PPP but flat revenues, making it clear where the profits came from. Patton Boggs reported a slight rise in PPP and Wilmer Cutler showed negligible revenue growth but PPP up 17%--all by reason of lower head count and fewer equity partners.

The writing on the wall is pretty clear.  Profits are unlikely to come from general demand in the market.  And there is only so much of your expenses and partners that you can cut and still survive as a thriving firm. 

So where will profits come from?  Profits will come from solidifying the relationships you have with existing clients, determining ways to provide greater value in more areas for those clients and aligning your internal people and processes so that you do in fact deliver that value, and growing your client base--into related industries, new industries and new service areas.

We and the team at The Value Advisory are expert at helping you do just that.

Full post as published by Law People on February 02, 2011 (boomark / email).