The grass isn’t quite this green in the ‘new normal.’

In a piece from last month, New York Times columnist Paul Krugman wondered: Is Growth Over? One could very easily take this question, posed with respect to the broader economy, and apply it to the world of large law firms.

And what would the answer be? According to a client advisory just issued by Citi Private Bank and Hildebrandt Consulting, “Probably.”

Their analysis is gloomy, although guardedly so; we’re not talking about “the sky is falling” pronouncements. Let’s take a look at the specifics….

Earlier today, we received a copy of the client advisory and an accompanying press release (reprinted in full on the next page):

The Law Firm Group at Citi Private Bank and Hildebrandt Consulting today released their 2013 Client Advisory which forecasts that 2013 will likely see a continuation of the trends that have emerged over the last four years, during which profit growth and other financial indices reached lower set points.

What are those trends? Slowing growth, or even decreases, in demand for legal services, hourly rates, law firm revenues, and profits per partner. This chart, comparing the four years before the recession and the four years after it, provides a handy summary:

(“CAGR” stands for “compound annual growth rate,” and “PPEP” stands for “profit per equity partner.”)

This might sound a bit depressing. But here’s a part of the report that I actually found oddly encouraging:

[D]ata suggests that, in fact, the boom years (roughly, 2001–2007) were the aberration, and what we are experiencing now is more characteristic of the legal market before the boom years. The 1.7 percent PPEP CAGR of the 2008–2012 period is far below the double-digit profit growth that typified the boom years — and is even lower than the PPEP CAGR of 3.9 percent during 1992–2001.

In other words, the post-recession “new normal” bears some similarities to the pre-boom period, making the boom the outlier. It’s an interesting perspective to consider, especially for those lawyers who entered the profession around the turn of the millennium and don’t really know what it was like before then.

At the same time, according to the client advisory, there are divergences:

[T]he “new normal” is different from the “old normal” in a number of important ways. For instance, the market is far more global today. Technology has changed the way law firms work, helped clients to better analyze their legal spend and enabled the entry of nontraditional legal service providers to the market. The traditional law firm leverage model is also changing, with income partners and counsel comprising a higher percentage of the total attorney pool and other variations — career lawyers, contract attorneys — entering the mix. We are currently witnessing a high point in lateral movement. Pricing pressure is more intense, exacerbated by clients who are not just demanding and getting discounts, but also scrutinizing and questioning invoices to an unprecedented degree.

So while the “old normal” was followed by a big boom, the “new normal” probably won’t be. Trends like technology and outsourcing are putting pressure on prices that is unlikely to abate, even if the larger economy improves (as some think it will in 2013).

What does this mean for Biglaw? The report identifies four tough lessons from the past four years:

  • Firms must earn demand growth: Alas, they’re often doing this through discounting, which hurts profit margins.
  • Excess capacity squeezes margins: Average attorney productivity after the Great Recession has been about 100 hours a year lower than it was before the recession. Associate productivity is edging up, but there are now fewer associates. And partner productivity is down (consistent with a different study that we discussed last week, stating that some partners are billing just 1500 to 1700 hours, and predicting partner layoffs).
  • Low single-digit profit growth is good!: Indeed. And it’s important for firm management to manage the expectations of rank-and-file partners. Citi and Hildebrandt predict that low single-digit profit growth is what we’ll see at most firms in 2013.
  • Volatility is a fact of life: And it has contributed to a rash of recent of law firm failures. Reading between the lines of this advisory, you can’t help seeing “Dewey & LeBoeuf” everywhere.

The second part of the report offers advice to firms on how to navigate the new environment:

  • Listen to your clients: This sounds obvious, but you’d be surprised at how often firms don’t listen to their clients. For example, before undertaking an expansion into a new geographical region or practice area, a firm should assure itself that there’s actually demand from its clients for the new services.
  • Rethink your business model: The advisory encourages firms to consider sending certain functions to outside providers or to less expensive parts of the country or the world; to provide transparent and responsible leadership; to pay attention to firm culture, using lateral hiring judiciously rather than indiscriminately; and to maintain a strong balance sheet. (Those last few items all sound like lessons learned from Dewey’s downfall.).
  • Differentiate yourself: I talked about this a bit in my recent Bloomberg TV appearance. Firms need to figure out which areas to prioritize and which areas they’re going to stake their reputations on. The days of “pretty good” regional firms that get business just because they’re there are numbered; firms need to figure out what their marquee practices are going to be. Why should clients go to your firm as opposed to the one down the street?

This is just a quick summary. The full client advisory is interesting reading, and you can and should read it here. You can also flip to the next page to read the press release about it, which summarizes the findings and explains the methodology.


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