This decade has been bumpy from the onset. First covid, then skyrocketing inflation upsetting the global economy. Not to mention the effects of extreme weather around the globe. It doesn’t look like things will change for the better anytime soon, unfortunately.
While these events have induced a lot of misery for many, the legal industry has remained largely unaffected. Both 2020 and 2021 have been the best years on record. Lawyers that feared the sky would fall down when covid struck, could not have been more wrong.
I, myself, was not on the side of doom back in 2020. On the contrary, I was convinced the legal industry could weather the storm and the economy would be buoyant once the covid wave was over. I still believe that would have happened if not for the Russian invasion in Ukraine that sent energy prices soaring and disrupted supply chains.
Invariably when we move from one year to the next there is a tsunami of articles by reputable and non-reputable authors analyzing and predicting the future. I have read the analyses from the Economist, Bloomberg, the Financial Times and many others with great interest, but I don’t think reality will unfold as predicted. Who could ever have foreseen that China would abandon their extremely strict zero-covid policy from one day to the other?
Legal Industry getting nervous
Law firms are looking back at 2020 and 2021 as the best years in their existence. At least from a financial perspective. Profits grew double digits as there was high demand and costs were down. Extremely high workload, causing stress and anxiety, were notable side effects.
When demand cooled down a bit in Q2 of 2022, initially this was widely welcomed. Providing a bit of relief and time to breathe. When interest rates rapidly started to rise and it became clear the economy would enter into a recession, relief turned into panic.
Once again law firms fear the sky will fall down on them and I see firms that translate their nervousness into cost cutting and lay-offs. We all know that if one firm starts with lay-offs, others will follow. In that aspect law firms are like lemmings. There is this sense that the other firm will somehow be smarter and your firm should follow in order not to fall behind. I beg to differ.
Looking at real world data, how bad is it?
Lets have a closer look at what is the actual situation for the legal industry. Expenses are up. Direct expenses (salaries) are up 15,4% over the past 12 months (industry average for larger law firms), while indirect expenses have grown by 3,8% over the same period. The growth in direct expenses is mainly the result of aggressive hiring and rising salaries and bonuses. We can expect indirect expenses to grow faster in 2023 as housing costs will be further adjusted.
Looking at the demand side the picture is not quite as dramatic. The most prominent characteristic of law firm financial performance in 2022 was the substantial slowing in demand growth that firms experienced throughout the year. On a year-to-date (YTD) basis through November 2022, overall demand contracted by 0.1%. Over that same period law firms increased their rates by an average of 4.8%. Which means there still has been growth in revenue.
Looking at clients’ expectations regarding their legal spend over the coming year, almost half of companies expect to increase legal spending as opposed to only 19% expecting a decrease.
Analyzing these real world data, it seems highly unlikely that the legal industry will be facing serious headwinds anytime soon. Sure, extreme growth has come to an end, but we all knew that wouldn’t last anyway. For 2023 I personally do not foresee serious demand issues for the market as a whole. (How the M&A market will develop is harder to predict, but I would expect a rebound towards Q3/Q4)
Should law firms shed staff?
For the legal industry, like many other industries, the pandemic fundamentally changed the employment dynamics. Faced with ‘insane’ workloads and working from home, more talent than ever took the decision to leave their firm. At the same time law firms increased recruitment to compensate for the leavers and to help meet demand. On balance this resulted in about 4% growth in lawyers (FTE).
Now faced with more lawyers, growing expenses and normalizing demand, what would be the smartest thing to do? Many law firms have learned the hard way during the 2008/2009 financial crisis, that it is a lot easier to fire lawyers than hiring them back once the market rebounds. Lack of well trained experienced lawyers will result in high cost of lost opportunity. In other words: the short term cost savings do not outweigh the lost revenue in the longer term.
Having said that, this is the time to more critically evaluate the quality and potential of your associates (and partners). Invariably there are hiring mistakes or lawyers that have not developed as expected. While law firms should always be critically assessing the quality and potential of each lawyer, this is the time to upgrade the average.
While structurally and objectively going thorough that process, please do not forget to offer development opportunities to all lawyers, associates and partners alike. The law firm that becomes the best talent development machine will be the one that will come out on top. In the end being a top-law firm is about human talent more than about revenue. Growing talent is growing reputation and profitability. It is the best investment you can ever make.