Matthew Guarnaccia recently wrote an article for Law360 about how profit margins are changing at top- and mid-tier UK firms. Apparently the big firms’ profit margins are getting bigger and the mid-sized firms’ are getting smaller. He concludes it is because the big firms are getting higher-margin work.
Although I actually agree with Guarnaccia’s conclusion (see below), his article misses a major point about law firm profit margins, which is that it is possibly the most meaningless statistic out there or, even if not meaningless, easily manipulated.
Consider a 100-lawyer firm. Each lawyer generates $750,000 a year in revenues, so the total dollars are $75,000,000. Overhead (not counting lawyer compensation) is about $20,000,000, so there is $55,000,000 of gross profits.
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Now assume that there are 20 partners and 80 associates and the associates are each paid $300,000 each, or $24,000,000. That leaves the firm with $31,000,000 of profits. The profit margin is now $31,000,000 divided by $75,000,000, which is 41%.
But how about if you had 80 partners and 20 associates? Now the profits are $49,000,000, which is a profit margin of 65%.
The second firm’s leverage is looking a lot worse (with 80 partners and only 20 associates), but its profit margin is dramatically higher!
And what if you had 1 partner and 99 associates? Now the profit margin is only 34%, but that one partner is earning $25,300,000!
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My point is that a firm’s profit margin can be completely manipulated by two factors:
The titles that a firm gives to its lawyers; and
The leverage in the system.
I do think the concept of profit margin can be looked at usefully if you have a relatively static system, such as comparing a law firm that doesn’t change much between several years to see if it is getting more or less profitable – or maybe comparing two very similar law firms to see which is more profitable. But to make comparisons between big and mid-sized firms in the way Guarnaccia has done – and based on those comparisons, drawing conclusions about the profitability of work — is not a good strategy.
Okay, now to come out the other way and say that Guarnaccia’s conclusions are probably correct, but maybe even more correct than he articulates. This is because it is likely that the major firms are artificially restricting the number of partners and using a lot of leverage, which will mean that their profit margins should be falling next to the mid-sized firms. Since the profit margins of the big firms are in fact rising as compared to the mid-sized firms, it is likely that the big firms are trouncing the mid-sized firms even more soundly on a profitability basis than it appears from just looking at the profit margins.
To conclude, I think profit margin is a dangerous statistic to use in comparing law firm profitability.
Profit Margin Gap Widens Between Top And Mid-Tier UK Firms [Law360]
Earlier: Reinventing The Law Business: A ‘Profits Per Partner’ Emancipation Plan
Bruce Stachenfeld is the managing partner of Duval & Stachenfeld LLP, an approximately 70-lawyer law firm based in midtown Manhattan. The firm is known as “The Pure Play in Real Estate Law” because all of its practice areas are focused around real estate. With more than 50 full-time real estate lawyers, the firm is one of the largest real estate law practices in New York City. You can contact Bruce by email at [email protected]. Bruce also writes The Real Estate Philosopher™, which contains applications of Bruce’s eclectic, insightful, and outside-the-box thinking to the real estate world. If you would like to read previous articles or subscribe, please click here.