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Big Law Defies Economics as Firms Prepare Record Rate Increases

Nov. 17, 2022, 10:30 AM

Welcome back to the Big Law Business column on the changing legal marketplace written by me, Roy Strom. Today, we look at why Big Law firms are on pace for a record increase in billing rates—despite an economic landscape that suggests prices should be falling. Sign up to receive this column in your Inbox on Thursday mornings.

The world’s largest law firms are set to defy basic economics again, which is a reminder of an old lesson: Never underestimate Big Law’s ability to raise rates.

Big firms plan the largest rate hikes on record next year, even as the “law” of supply and demand suggest prices should be declining.

Let’s start with supply. Big Law has more lawyer time to sell than ever. Headcount is up nearly 5% through nine months this year, according to Wells Fargo’s Legal Specialty Group survey of more than 120 firms.

Next, demand. The top half of the AmLaw 100 has seen demand drop 1.1% through nine months, Wells Fargo said this week. Again, that’s the opposite direction of conditions that support a price increase.

Big Law is undaunted by these pesky economic concepts.

Next year, firms expect to raise rates by 8%, Wells Fargo Senior Vice President Owen Burman told me. That’s the highest on record for the survey. “The industry does defy basic economics in many ways,” he said.

Still, plenty see a method to what might seem like law firm madness.

Rate increases failed to keep up with inflation last year and this year, a phenomenon that’s never been seen before in Wells Fargo’s 15-year survey history, Burman said. Law firm leaders can argue they’re making up for lost time.

Also, raising rates has been firms’ single most effective strategy for boosting revenue over the past 15 years, according to Bruce Macewen and Janet Stanton, who run law firm advisory Adam Smith Esq.

For clients with highly sensitive legal matters—a crypto exchange, for instance,working with Sullivan & Cromwell on a bankruptcy—marginally higher rates are of little or no concern.

Law firm rates in some practices display characteristics of what economists call a “Veblen good,” Macewen said. That’s typically a category of luxury goods for which demand increases as prices rise.

What’s the point of buying a $100,000 sports car if your neighbors don’t know it’s expensive?

“There are a lot of goods and services where price at the high end is completely untethered from normal laws of supply and demand,” Macewen said.

Stanton added, “There is no pain threshold in Law Land.”

The higher rates could help ease what is turning into a difficult period for many firms.

They are struggling to right-size their associate ranks after a boom in hiring and salary over the past two years. It’s led to early rounds of associate layoffs at some firms. Cuts are expected to grow during the New Year’s associate review period.

Still, there’s a risk of raising prices at the wrong time. The biggest is that customers will switch to a cheaper firm.

Midsize firms could benefit. They are outperforming in the current market, seeing demand grow 1.7% this year through six months compared with a .2% drop for the AmLaw 100, Thomson Reuters data show.

“Lower rate growth may have heightened the appeal of midsize firms to increasingly cost-conscious clients,” Thomson Reuters said.

But it’s not that straightforward. It seems midsize firms benefited from a change in the types of services clients purchased from law firms rather than apples-to-apples price shopping.

Midsize firms topped Big Law demand growth in practices such as real estate, labor and employment and patent prosecution, Thomson Reuters said. Those practices are typically bargains compared with mergers and acquisitions and bankruptcy, where AmLaw 100 firms saw better demand growth than smaller rivals.

The data suggests that clients continue to choose law firms based on the type of work they need rather than sending it all to one place.

If that continues, the price gap between midsize firms and the top 50 firms will only grow. The highest-priced work will be clustered in the biggest firms while the rest will be handled elsewhere.

That would entrench the biggest firms’ grip on the “luxury” end of the market. It would give them more pricing power and potentially make 8% rate increases a more normal occurrence.

Unless clients finally hit that elusive pain threshold.

Is 2023 the year they start feeling the pain? We’ll see.

Worth Your Time

On a Podcast: Big Law layoffs are happening, but it’s nowhere near a Great Financial Crisis moment of panic, Meghan Tribe told Bloomberg Law’s On The Merits podcast. She was discussing reporting we did for a story last week on the state of associate layoffs.

On a Video: Talk of the billable hour’s demise has forever been greatly exaggerated. Bloomberg Law video journalist Macarena Carrizosa has a report on why Big Law sticks with the practice—and what that means for lawyers’ well-being.

On Lobbying: Law firm lobbying operations see a Republican-led House and Democratic-controlled Senate cooperating on enough legislation next year to keep corporate clients investing in Washington, Justin Wise and David Hood report.

That’s it for this week! Thanks for reading and please send me your thoughts, critiques, and tips.

To contact the reporter on this story: Roy Strom in Chicago at rstrom@bloomberglaw.com

To contact the editors responsible for this story: Chris Opfer at copfer@bloomberglaw.com; John Hughes at jhughes@bloombergindustry.com