Aggressive Billing Rate Increases Appear Likely, but Can Clients Stomach It?

Large law firms were broadly able to boost billing rates by an average of nearly 4% last year while posting their highest realization rates since the Great Recession.

And it wouldn’t be surprising if law firms try to raise billing rates just as much or more in 2022, especially as inflation surges, elite law firms install another associate salary bump and the overall cost for top talent increases. Still, analysts and law firm leaders say big firms will have to navigate significant rate pressures, including clients’ own anxieties about inflation.

Overall, law firms increased billing rates by about 3.9% last year, with Am Law 100 firms notching a 5.6% average increase, according to the most recent State of the Legal Market Report. Second Hundred and midsize firms increased rates by 3.4% and 3%, respectively. While the industry-wide average is down slightly from 2020, the authors still described the 2021 billing rate increases as “fairly aggressive.”

The average annual rate increase for firms since 2008 is around 3%. Jim Jones, a lead author on the report, said a year ago that he would be surprised if clients would “sit still” for a comparable hike relative to 2020—about 5%—given the continuing uncertainties of COVID-19 and corporate counsel demands to control costs.

But Jones, speaking in an interview this month, said he remains surprised, especially given that firms across segments had a 90.6% realization rate—the highest level since around the Great Recession in 2009. “I keep thinking we’re going to hit a limit, but we never seem to hit it,” said Jones, director of the Georgetown University Law Center on Ethics and the Legal Profession, about rising billing rates.

Law firms have reason to consider another round of aggressive rate increases in 2022, especially after prominent law firms in the last week raised, again, the salary scale for associates.

Speaking generally, “pushing through salary increases furthers the need for annual rate increases. It has to, in order to maintain adequate margin and profitability,” said Cara Rhodes, a law firm consultant at Hoffman Alvary.

Market and practice-specific differences also affect the rates, noted Jim Cotterman, a consultant with Altman Weil. But if the battle for talent continues at the current clip, it’s a good bet that rates will continue at pace, too.

“I have not seen much resistance to higher rates and law firms are keen to cover the cost of rising compensation costs from all of the activity last year,” Cotterman said in an email. “I expect the rate increases are going to center around that more than inflation.”

Firms surveyed by Georgetown and Thomson Reuters saw near-double-digit growth in their direct expenses last year, due significantly to associate compensation increases, while only increasing head count modestly, according to the State of the Legal Market Report.

“In response to the fierce competition for talent, firms are spending huge amounts of money and putting their profits at increasing risk for fairly modest returns—at least if you consider the real costs of high levels of lawyer turnover,” the report stated.

Rate Pressures

Inflation concerns could nudge firms to raise billing rates more. Inflation jumped at its fastest pace in nearly 40 years last month.

But analysts and law firm leaders say inflation could also motivate clients to talk with their lawyers about controlling rates. A report published last week by The Conference Board, a business research group, found that inflation was the second-biggest threat cited by hundreds of CEOs around the globe.

James Goodnow, CEO of Fennemore, said it would be “foolish” for any law firm leader to ignore the trajectory of inflation. He said in an email that the 7% increase in the consumer price index will not only affect things like deal financing terms, the cost of technology that law firms use as well as their health care expenses, but how they should think about interactions with their clients.

“With corporate expenses climbing, some clients may want to tighten their belts to maintain margins,” Goodnow said. “Relationship lawyers need to understand client needs better than ever and be ready to justify the value they’re bringing to the table.”

Josh Lorentz, a partner at Dinsmore & Shohl who chairs the firm’s finance committee, noted that rate increases aren’t just accepted unconditionally. They’re the result of a communication and negotiation process, he said, and one reason firms may be posting such high realization rates is they’re already doing a fairly good job of communicating their costs to clients.

Law firms that come up with alternative fee arrangements and that also successfully use analytics—such as in forecasting how to staff a matter so more high-priced timekeepers are only working segments where they’re really needed—will be better situated to make a case for their rates, he said.

“For those firms that are willing to do it, they’ll rise to the top,” Lorentz said. “And the firms that don’t want to be creative and don’t want to be innovative, their clients will find firms that will be.”

Jason Winmill, a consultant at Argopoint who advises corporate legal departments, said corporate America is currently “organizing its battle plans against inflation” and that includes managing costs of outside counsel. He said companies can use competitive pressures and shift to lower-cost firms, handle more legal work in-house and perhaps ultimately, selectively do without legal advice on certain matters if rates keep increasing.

“Inflation doesn’t mean they’re going to stop using Big Law firms. Outside counsel are critical to the in-house counsel business model,” Winmill said. “But they will employ a host of strategies to substitute, reduce, and limit cost increases, if possible.”