Big Law’s Windfall Profits May Lead to Prolonged Rate Pressure

Welcome back to the Big Law Business column on the changing legal marketplace written by me, Roy Strom. This week, we look at the strange relationship between cost and price in the Big Law market. Sign up to receive this column in your inbox on Thursday mornings.

Big Law leaders were concerned at the start of the pandemic that 2020 would be disastrous for their firms’ financial health. It looks, instead, like the year had record profit growth for the AmLaw 100.

Celebrate for now, but market dynamics may imperil elite law firms’ prevailing growth strategy of consistently raising billing rates.

First, let’s talk about the profit growth.

Profits per equity partner grew more than 20% last year through November for the AmLaw 100, according to a report this week by Georgetown Law and Thomson Reuters Institute. That’s more than double the growth rate in 2019.

It’s even more striking in hard numbers. The average AmLaw 100 equity partner in 2019 earned just shy of $2 million in profit. So, a 22% increase represents $400,000 more per AmLaw 100 equity partner. That group last year included more than 21,000 lawyers.

How did firms achieve such stellar profit growth? It wasn’t a booming market for legal services. The report says AmLaw 100 firms saw demand drop 2.6% from a year ago through November.

Instead, the profit is largely a result of an industry-wide push to slash expenses.

Firms cut marketing and business development spending 44%, the Georgetown and Thomson Reuters report said. Recruiting expenses fell 40%. Office expenses dropped 22.5%.

In total, expenses for AmLaw 100 firms were down 6% from last November, according to the report.

This is vastly different from how Big Law has operated since the Great Recession. Cutting expenses has not been a prominent feature; raising billing rates has.

“The only thing that has sustained law firm profits has been the ability to raise rates,” James Jones, director of Georgetown Law’s program on Trends in Law Practice, said in an interview. “Law firms have been reluctant to do the other things required, which is to make their work processes more efficient.”

“One thing this pandemic has done,” Jones said, “is prove clients right: You can perform this work more efficiently. And after this pandemic, I don’t think there is any going back.”

In rational markets, cost and price are very different. The cost to produce an item has little to no bearing on the price a consumer is willing to pay for it. But in the legal market, there is precedent for prices falling after costs are slashed.

The last time law firm expenses were slashed, collected billable rate growth stalled dramatically. Expenses began to free-fall in early 2008, eventually bottoming out in mid-2010, data from Thomson Reuters Peer Monitor show.

The amount of money firms collected, as a billing rate, meanwhile, showed a similar pattern. The average collected bill was virtually flat from 2008 through 2012, despite fairly routine increases in standard rates, Peer Monitor data show.

Law firms said they were charging more, but they collected about the same.

“If law firms try a major increase of rates this year,” Jones said, “they are going to see enormous pushback.”

Law firms may not feel pressure to raise rates. For one, their partners’ pockets are flush. And they were able to raise rates just before the pandemic. In April, AmLaw 100 firms had pushed rates 6% higher than April 2019, Peer Monitor data show.

But even if firms hold off on pushing rate increases this year, there could be longer-term pressure.

After the last recession, the percentage of bills law firms collected (known as realization rate) plummeted from around 93% to just above 80%, where it stands now. I’ve written before about the distortions that this creates. These distortions will likely only increase if firms continue their rate-raising strategy.

Mitt Regan, director of the Center on the Legal Profession at Georgetown, said many firms raise rates knowing they will ultimately be discounted. It’s part of a marketing strategy to communicate the firm’s strength, he said.

“The underlying rationale for this is less a traditional economic one, and more the desire to signal the status of a firm,” he said.

But that message is harder for clients to accept when their own legal budgets are being cut. My colleague Ruiqi Chen has reported on how the pandemic has forced legal chiefs to do more with less. She also spoke with a number of general counsel who warned against rate increases this year.

“We expect and know that our trusted law firm partners will work with us to continue to deliver value without increased costs,” April Miller Boise, general counsel of power management company Eaton, told Chen. “As a general matter, we are not approving rate increases for 2021. The model where law firm rates increase every year, year after year, is broken.”

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