Copyright 2009. Incisive Media US Properties, LLC. All rights reserved. National Law Journal Online
I think the word "unprecedented" may be the best way to sum up the past 10 years in the legal profession. It applies to every major trend and development that has affected law firms during this period: unprecedented demand for legal services; unprecedented law firm growth and increase in profitability; unprecedented competition for top talent; unprecedented compensation for first-year associates; and, finally, an unprecedented rapid decline in demand for what we commonly think of as "recession-resistant" legal services.
As we look back at the year 2000, we see that the past decade began with a mild recession, driven largely by the "tech bust," but it did not have a widespread or lasting effect on the demand for legal services. Following this recession, we saw the demand for legal services increase dramatically, starting in late 2001. In fact, demand grew so quickly that there soon was an undersupply of lawyers. This sharp increase in demand triggered an era of what seemed to be (especially to clients) ever-escalating billing rates as lawyers enjoyed a strong seller's market. Through 2007, both revenue and profit grew at near double-digit rates every year, a phenomenon that was unparalleled in the prior history of the legal profession.
Law firms not only were growing at an unprecedented pace from 2001 to 2007, they were consolidating as well. We began to see firms approaching a size and level that we never predicted. There are now 19 firms in the United States with more than 1,000 lawyers and 68 firms with more than 600 lawyers. This compares with 1999, when there were 26 firms with more than 600 lawyers and only five firms with more than 1000.
During this same time period, however, to sustain record levels of hiring of young lawyers, firms increased associate compensation to record levels. Ironically, this occurred at the very time that associate productivity was declining. While, in past talent "wars," the salary increases for top associates had been mainly limited to the New York offices of firms, the multioffice platform of many firms resulted in similarly high salaries being paid to associates in other cities such as Chicago, Los Angeles, Dallas and Atlanta. Because firm profits were growing so rapidly, it was easy to overlook the fact that increases in associate salaries across all markets caused an unsustainable increase in law firm operating costs.
A SLOWDOWN IN 2007
In early 2007, we started seeing signs that the growth train might be slowing down. Law firms were pushing such rapidly increasing costs onto their clients — to pay for new associates, expensive offices, lateral hiring and more — that we began to hear of serious pushback from clients, even clients of the highest quality firms. Around the same time, we also noticed that the cost of law firm operations was generally increasing at a faster rate than firm revenues. In our Client Advisory that year, we forecast that this imbalance between costs and revenues was unsustainable and that change was inevitable. Law firms were still experiencing high levels of demand in most practice areas, so there was little incentive to change.
What nobody foresaw was that, in late 2007, the whole profession turned from a strong demand-side to a strong supply-side curve. Because it happened slowly at first, it took a while for law firms to understand the trends and to react. Little did most of us know at that time that the subprime mortgage crisis and, later, a financial industry and credit crisis were just around the corner.
Starting in late 2007 and then hitting law firms in September 2008 like a sledgehammer, the supply-demand equation shifted dramatically. For the first time in the careers of most lawyers, there was an oversupply of lawyers for the available work. And, just as in other businesses, whenever that change occurs, services become more commoditized, competition increases and pricing pressure goes up. Many firms found themselves overstaffed in late 2008, often seeing whole areas of practice disappear virtually overnight — and in some cases not expected to ever return to prerecession levels.
As we close out this decade, there are several clear lessons. First, every business or industry is subject to the impact of a supply-demand shift. It is now clear that even law firms are not "recession-resistant," as had previously been thought.
Second, it is clear that the manner in which legal services are delivered has changed — perhaps permanently. For example, corporations are disaggregating lower-end legal work and using outsourcing and other approaches to take more control of the delivery of legal services.
Third, the changes for which clients had been pushing before the economic downturn are now a business imperative. It is unlikely the clocks can be reset. Clients now know they can demand different models of practice; they can capitalize upon new providers such as outsourcers, abundant top-quality contract lawyers and other operations to reduce their costs; and they can disaggregate services without necessarily compromising quality. While we do not believe that the billable hour will disappear, the rapid move to use alternative fee arrangements is not just a way to cut law firm rates. It is a recognition that other approaches can save clients money and better align the clients' and law firms' interests.
As we end this decade, we are excited about the changes going on in the legal profession. Some say that the traditional model is completely broken, but this is probably an overstatement. However, it appears clear that some basic changes are in the offing, and many of those changes are being driven by pricing challenges.
Law firms are rapidly considering, even implementing, new business models. We expect there will be a much smaller percentage of lawyers in most firms who are "traditional" associates on track to partnership and many more "career" track lawyers of various roles and types. Firms are redesigning their legal processes to increase efficiency and drive out unnecessary costs — now called process improvement or re-engineering in many firms.
Many lawyers have dreaded the move to alternative fees, but we believe that firms that embrace creative, nonhourly fee arrangements may truly differentiate themselves and achieve a significant competitive advantage, at least in the short term. Firms that can re-engineer and streamline the processes by which legal services are delivered without compromising quality will make money with fixed fees. We are now entering what will be, at least at the beginning, a decade of reorganization, and we are going to see basic changes in the way law firms deliver timely, high-quality services to clients more efficiently and at a better price. Almost every firm in the country is capable of doing this. No matter how you look at it, the changes we will see in the next decade are also likely to be "unprecedented."
