How Did Big Law Profits Surge? Demand and Big Rate Hikes Were Key

Profits growth of more than 5% would be a great year for any big law firm. But a look at the early reports of Am Law 200 financials shows many law firms with eye-popping profit per partner hikes of more than 20%, including at Sidley Austin, Dechert, McDermott Will & Emery, Hogan Lovells and Alston & Bird, among others.

Many firms’ profit gains were higher than their revenue growth. And unlike 2020, the profit surges up and down the Am Law 200 were not uniquely tied to expense cuts. 

A confluence of events led to these sky-high profits across the industry last year, including high demand; a practice mix that became more transactional; billing rate increases that were applied in the right areas; a change in leverage; and dips in head count at some firms—all events that firms could try to apply this year to replicate the financial success.

Revenue and profits both increased by double-digits across segments last year, according to several legal industry reports. The Thomson Reuters State of the Legal Market release pegged profit growth at 13.4% for Am Law 100 firms; 12.2% for Am Law 200 firms; and 22.4% for midsize firms.

Average revenue growth across segments was roughly 14%, according to the Wells Fargo Private Bank Legal Specialty Group and Citi Private Bank Law Firm GroupThe sheer amount of legal work in 2021—demand increased by 6.5% last year—dictated that most Big Law firms saw significant upticks in their revenue.

But aside from high demand, part of the profitability increase was due to holdover issues from 2020, said veteran legal consultant Tim Corcoran. “At the beginning of 2021, everyone was still remote and travel was low, so expenses were down,” he said. “And, of course, rates were raised in response to high demand.”

Indeed, Kristin Stark, a legal consultant and principal at Fairfax Associates, said the gain in profitability probably comes down to firms generally increasing both their rates and hours while not having to spend additional resources. Yes, firms spent much more on associate compensation in 2021, but demand and rate increases were high enough to surpass those costs.

Standard rates grew roughly 6% across the industry in 2021, according to Wells Fargo, while lawyer logged hours also grew 6.5%.

“The easiest way to think about it is if you’re able to increase revenue without increasing costs, it’s going to result in more profit,” Stark said. “A lot of these firms are raising rates pretty substantially. A lot of clients saw pretty solid rate jumps in 2020, but especially in 2021. And they [firms] were able to increase rates without adding a lot of additional costs.”

Corcoran also said the firms are becoming smarter about rate increases and where they are applied. 

For in-demand corporate and transactional work, for example, a firm might significantly raise rates due to high demand. For bankruptcy work, which saw much lower levels of demand, smaller increases or none at all might be the smart play.

“Firms are learning to price differently based on demand, exclusivity and quality,” he said. 

Firms have also increased their balance of profit-rich corporate work. Corporate and M&A practices—along with tax and real estate—accounted for 37% of the total hours tracked in 2021, “a proportional increase of 2.6 percentage points in just one year’s time and 5 points since 2015,” according to the latest Peer Monitor Index report.

Some firms may have also gotten a profit boost from slight dips in head count, coupled with an increase in hours billed.

Quarles & Brady’s revenue rose about 8%, but profits per equity partner skyrocketed more than 30% in 2021. The firm’s attorney head count shrunk about 4% while billable hours rose 3%. (The firm’s managing partner said the reduction in total lawyer count was due to normal attrition as well as the firm’s decision to defer the start of the fall 2021 associate class to January 2022.)

At Hogan Lovells, total lawyer head count dropped a little more than 3%, with a roughly 5% dip in equity partners. Still, the firm increased revenue about 13% while seeing a roughly 26% spike in profits per equity partner.

“Firms that are adding head count, or opening offices, are going to have to absorb that cost, and they’re less likely to report a bump [in profits],” Stark said.

Better leverage in 2021 may have also contributed to profit, as firms saw professional fee earners contribute to a larger chunk of matters.

Corcoran added that some firms were essentially forced into positions that increased their profitability. As general counsel have become savvier at shopping their work, they often don’t go to just one firm for a matter.

He cited the example of a client using a premier and pricey firm to do the “bet the company” aspect of a corporate deal while farming out some of the more mundane work to lower-priced firms.

This would take some revenue away from the “bet the company” firm, but also make the work that is done all the more profitable for them and allow the firm’s lawyers to tackle other premium work.

https://www.law.com/americanlawyer/2022/02/28/how-did-big-law-profits-surge-demand-and-big-rate-hikes-were-key/

Zubair Q Britania

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