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Finding stability and growth for your law firm in a challenging economy

The year 2023 is proving to be a hard one to forecast. On the one hand, demand growth is slowing and the overall economic picture in the United States is unclear. On the other hand, law firms finished 2022 with reasonably good financial results, according to the “2023 state of the legal market” from the Thomson Reuters Institute.

Law firms are looking for ways to build on their financial health and find growth in an environment where they can’t count on more work coming their way.

In 2022, while financial results were strong, law firms saw a combination of falling demand and growing headcount. This dynamic resulted in a significant decline in productivity. In fact, hours worked per lawyer dropped to 119 hours per month, a low point for at least the past two decades. According to the “State of the legal market” report, the average lawyer in 2022 produced $98,000 less in total fees than a comparable lawyer in 2007.

As law firms grapple with declining demand, overall economic uncertainty, and talent and culture challenges, there is still reason to be optimistic about their financial futures. That is, there are many areas within your control that can help you build your financial health and find growth in 2023.

First, keep headcount in line with demand growth — this is a tricky balance to strike, as you want to be prepared to take on new work when it comes, but you also don’t want to carry more people than you can keep productive. While it can be tempting to cut headcount when demand dips, it’s risky in what is still a job hunter’s market.

Second, optimize profitability by maintaining strong financial hygiene practices. Make sure you are billing for the time you and your associates actually work. It’s tempting to preemptively write down your hours to keep a client happy, but data shows that lawyers often write down significantly more than their clients expect.

Third, grow your rates in line with the market. Prices have gone up for many professional services in the past few years. Are your rates keeping up? Market data and client feedback can help you charge appropriately for your time, offsetting some loss in demand growth.

Finally, keep an eye on which practice areas are seeing positive growth and which are sliding. You may offset softness in one practice area by extending into another, more active one.

Smartly combining these approaches can help you manage your firm's topline growth and bottom-line health.

Keep headcount in line with demand growth

Lawyer growth spiked in 2021 and 2022 as firms staffed up to meet shifting and growing demand after an initial pandemic-driven decline. Lawyer growth for both years was between 3% and 5%, year over year. This is higher than any year since 2008, the beginning of the Great Recession.

According to the “State of the legal market” report, this trend affects all categories of timekeepers, major practice areas, and firms of all sizes. Although, the report does note that the biggest spikes come from associate hiring, Am Law 100 firms, and transactional practices.

Notably, support staff levels shifted over the past two years. According to the report: “During 2020 and 2021, the total FTEs for support staff declined while, at the same time, the total compensation for support staff and the compensation per role increased. These general trends, if continued during 2022, would suggest that, while firms are decreasing the numbers of lower-level staff, they are increasing staff in higher functional areas while paying the compensation differentials necessary to do so.”

Staffing levels increased in recruiting and talent management, practice group operations, executive management, finance, and marketing and business development functions. Firms reduced staff in library and research, administrative, secretarial and word processing, and operations functions.

“Law firms have historically struggled to find the balance between headcount and demand,” says William Josten. Josten leads enterprise legal thought leadership for the Thomson Reuters Institute and works with law firms of all sizes to understand how market forces shape their business. “The softening demand is heightening this issue. Law firms don’t want to cut headcount now because it’s still a long, hard, and expensive process to hire when demand comes back.”

That dynamic leaves firms trying to keep the people they have and to keep them busy.

Retain your staff

A  2022 report from the Thomson Reuters Institute looked at the attributes of firms with lower attrition compared to those with higher attrition.

The firms with low attrition didn’t have the highest salaries; instead, they had a better work environment. “In general, when asked their favorite aspect of their current firm, standout lawyers at Stay firms were more likely to cite factors such as the people with whom they worked, the collegial nature of relationships within the firm, the supportive nature of the firm, and the quality of work they were offered,” according to the report. Further, “Standout lawyers at Stay firms were also more likely to strongly recommend their firm to a friend as a good place to work; and they were more likely to self-identify as either an innovator or an early adopter of technology.”

Firms that kept their employees longer could grow lawyer headcount more aggressively without damaging per-lawyer productivity. Corporate general counsel (GC) interviewed by the Thomson Reuters Institute rated Stay firms more favorably regarding their service and the strength of their relationships.

Keep your current team busy

The best source of new work is often the same work already in front of you. Many firms want to deliver more work to existing clients to offset softening demand and slower new client growth — which is a strong business development strategy, but what do you do if your resident experts don’t have the capacity to take on the extra work? It’s especially risky when certain practice areas or matters are in higher demand than others.

You can take this as an opportunity to develop attorneys in different areas of law. The cross training is valuable to them for career development and allows you to optimize their productivity without hiring additional attorneys. Legal know-how tools can help attorneys get up to speed quickly in new practice areas and new types of matters.

Attorney hiring will continue, likely at a slower pace in 2023 than the two years before. Hiring people into a healthy firm culture with opportunities to stretch into different practice areas will make it likely to have a more stable, resilient workforce for a shifting demand landscape. This strategy will help you take advantage of growth opportunities as they emerge and improve your bottom line in the near term.

Optimize your profitability

Your realization rate is another crucial factor in topline growth. Are you getting paid for all the hours worked or the value delivered? The “2023 state of the legal market” report showed that collected realization against worked rates declined last year after rising steadily for the past two years.

“Particularly noteworthy is the fact that we saw atypical declines during the third quarter of 2022,” the report says. “The all-firm average in collected realization normally increases from Q1 through Q4 of every year, but this year we saw a noticeable drop from 91.7% in Q2 to 91.2% in Q3, which continued into Q4.”  

Firms can redouble their focus on billing and collections to offset this leakage. Write-downs are a significant cause of fee erosion and the declining realization rate, as noted in the “State of the legal market” report.

The “Law firm billing practices white paper” addresses this challenge in depth. It notes that while every hour spent working on a matter contributes to the firm’s “cost of production,” firms erase many hours each year; this happens in two steps. First are the silent write-downs, where lawyers report less time than they actually work. Often, these write-downs happen when associates spend time getting up to speed on a new matter or feel they have spent more time than “allowed” on legal research, drafting, or e-discovery projects. It can also happen when partners spend time correcting or revising an associate’s work — they may feel the initial draft should have been better and don’t want to pass that cost on to the client. Silent write-downs like this account for $47,000 per partner per year.

Once the prebill goes to the partners reflecting these initial losses, we see even greater write-downs, often to the tune of $190,000 per partner. While these write-downs are sometimes the cause of client regulations, caps, or expectations, they are more often because the time spent on a task or matter exceeds the partner’s expectation of how long a task should take. The partner fears the client’s reaction and preemptively reduces the bill rather than having to defend the firm’s prices or practices.

Write-downs are an important area to address and law firm leaders know it. Of the billing practices survey respondents, 76% felt it was “extremely important” or “important” to reduce the number of hours that are worked but not billed. Two strategies can help reduce write-downs in law firms: help your associates work more efficiently and help partners feel comfortable defending the firm’s pricing.

Help associates present client-worthy work faster

Partners write down $19,000 in fees per associate per year because they think the associates take too long to complete their tasks. Look for ways to drive efficiency so associates can complete their tasks in less time with more confidence. More training and mentoring from senior associates and partners could help; it could also mean investing in technology and content that supports their learning process and speeds up their drafting time.

“This doesn’t mean your attorneys will bill less or work less,” said Josten. “It means that they’ll work the same amount of time but be able to bill for more of those hours. And as everyone gets more efficient, if they do have excess time, they can put it toward business development or projects that attorneys are passionate about or initiatives that improve profitability.” 

Help partners defend your pricing

Partners are putting more downward pressure on realization rates than clients are. Recognizing this is an important first step toward helping partners communicate about pricing and bills. Partners’ sensitivity toward billing for work that takes too much time or needs redoing is understandable. After all, most can remember the great reckoning around 2008 when corporate clients started pushing back harder on their bills. Many said they didn’t want to pay to train law firm associates.

We’re working in very different times now, with different tools and processes that can squeeze much of the excess out of the training process. “Law firms should set rates it can stand behind,” says Josten. Get your partners’ buy-in on these rates: help them understand how they were set and how to defend them. Then, support them as they communicate these rates to clients.

Raise your rates appropriately

Rate increases are an essential source of topline growth. There are signs that rate growth is not keeping pace with inflation or market tolerance; be sure you are raising your rates in line with the rest of the market and within your clients’ tolerance zone.

According to the “State of the legal market” report,

“Through November 2022, fees worked increased by 5.0%, much slower than 2021’s 8.1% pace, but on its face still reasonably strong from an historic perspective. The problem is that, during the same period, firms were being simultaneously hit with highly expensive talent costs and the effects of broader inflation.”

The report notes that firms may not be increasing their rates fast enough to keep up with expenses or inflation. Still, there is sensitivity to raising rates when corporate clients themselves are calculating their risks in a recession. How can you assess how much room you have to raise rates? Look at market rates and talk to your clients.

Research market rates

When did you last look at market rates for firms of your size and in your practice areas? It can be hard to look beyond client anecdotal feedback or a moment of generosity from a competing law firm at a networking event. Investigate sources of trusted intelligence to help you know if your rates are in line with the market. If they are wildly below, start planning to get them in line with the market. If they’re above market, congratulations! Continue with your current pricing strategy.

While rates will vary by location, firm size, or practice area, there are some useful benchmarks in the “2023 state of the legal market”: “All segments of the market grew their worked rates at a pace exceeding that of 2021 – indeed, mirroring the 12-year high-water marks set in 2020. Through November 2022, firms had increased their rates by an average of 4.8%. Am Law 100 firms led the way with a 6.3% jump, followed by Am Law Second Hundred firms at 4.8% and Midsize firms at 3.8%.”

Assess your clients’ price sensitivity

As you craft your rate growth roadmap, testing it with clients is worthwhile. While market-rate research can help you feel confident about your decisions, road testing with clients can help you make the process smoother.

  • Talk to partners about the pushback or feedback they’ve gotten on their bills in the last year. This will help you assess clients’ attitudes toward your current rates — it can also help you and your partners identify opportunities to write down fewer hours, as discussed above.
  • Talk with trusted accounts about their reaction to a proposed rate increase. Be prepared to revise your plan if you get consistently negative reactions suggesting their price sensitivity is far greater than expected.
  • Ask what resources or rationale your clients need to explain or defend your rate increases internally. They may need to see market data that says they won’t get a lower rate at other firms. They may also appreciate seeing that they’ve been benefiting from below-market rates up until now.

Of course, no client will say, “Yes, please, raise your rate.” But your clients do understand price increases and market dynamics — their businesses have likely implemented price increases too. With some level of client feedback early in your process, you can calibrate the rate increase and help them prepare for it.

Look for growth opportunities in new practice areas

The demand growth picture was nearly universally bleak in 2022, with Am Law firms seeing significant declines in all practice areas. Still, midsize firms were able to compete in certain practice areas. These included litigation, labor and employment, and intellectual property, according to the “2023 state of the legal market” report: “Indeed, Midsize firms were the only market segment showing positive demand growth (in their non-transactional practices) during the second half of 2022.”

Watch market trends throughout the year and be prepared to extend into new practice areas as opportunities arise. With the right know-how and training tools, your lawyers can take on new matters rather than refer them out. “It’s a time for leaders to remind their partners: ‘We’re all in this together,’” according to the 2023 report. “Contrary to the natural tendency to hunker down until the danger passes, firm leaders need to engage their practice and industry team leaders to actively work through the challenges that firms face. This should involve a careful monitoring of practice areas and key clients to identify new or expanding opportunities that might emerge from a rapidly changing market. Indeed, periods of turmoil often lead to such opportunities, if firms are capable of identifying and addressing them.”

Watch the market and equip your attorneys to master new practice areas to meet market needs. This practice will help you grow your topline while keeping your team engaged and ready to learn.

While no one can predict how economic forces will play out this year, some basic practices can help you protect your firm’s financial health:

  • Ensure you’re getting paid for all the hours worked if you are billing by the hour
  • Hire when you know you can keep that new attorney or staff member productive
  • Keep your rates in line with the market and with client expectations — you may be undercharging
  • Stay open to new practice areas that can help you respond to your clients’ current needs

This set of practices will help your firm manage topline growth and bottom-line health.

Getting lawyers up to speed quickly and being able to work in new practice areas present significant opportunities to improve your firm’s overall financial health. The legal technology of Thomson Reuters can help your lawyers extend their capabilities and work faster and more efficiently.

More resources for law firm growth:

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