2009: Year of Darkness For Law Firms?

In the legal market, the current economic crisis has exacerbated a slowdown in business that has been evident for several months. In most law firms, productivity dropped significantly in the second half of 2007 driven by sharp downturns in real estate, structured finance, and transactional practices. That slowdown continued into 2008, and has been deepened by the current crisis in the financial system. Moreover, despite encouraging recent signs, the current downturn has not yet been significantly offset by increases in other traditionally “counter-cyclical” practices like bankruptcy, litigation, and regulatory work.

To be sure, these effects have not been uniform across the profession. Indeed, we know of a number of firms – including both large national and global firms, as well as mid-sized regional firms – that have remained busy throughout the year and will end 2008 in fairly strong financial positions. Notwithstanding these exceptions, however, the current year will represent a significant downturn for the legal industry as a whole.

The Current Situation

The current downturn has brought to an abrupt end to the six-year period of unprecedented revenue and profit growth that law firms have enjoyed since 2001. Far from the annual double-digit growth in profits per equity partner that law firms experienced (and came to expect) over the past half decade, we believe that, across the profession, profits per partner in 2008 will on average be flat to a minus 10 percent, as compared to profit levels in 2007. For firms with significant capital markets practices, we expect the decline will be more significant – on average from minus 5 to 15 percent, with a few firms seeing even steeper declines. These results will put a severe strain on many firms and will require steady and level-headed management to calm the inevitable anxieties of partners and others.

Unfortunately, it seems certain that a quick turnaround for the economic crisis will not be possible. Despite the aggressive efforts of governments and central banks around the world to bolster the capital markets and to free up credit, it is apparent that it will take several months to work our way out of the current quagmire. We believe that we are unlikely to see any significant turnaround until late 2009, at the earliest. That said, it is likely that there will be an up tick in legal work during this period as financial institutions are restructured, as “blame” for the current crisis is sorted out through claims and counterclaims, and as a new regulatory system for our capital markets is put in place. Indeed, we are already beginning to see increases in litigation, bankruptcy, and employment law work related to the economic meltdown. It is also certain that the new administration that takes office in January (regardless of the outcome of the Presidential election) will instigate far-reaching regulatory reforms that will significantly reshape financial institutions and the capital markets and create new legal work, particularly for firms in New York and Washington. It is highly unlikely, however, that any such up tick in legal activity will substantially counterbalance the loss of work that will continue to result from the overall slowdown in the economy in general, at least during the first half of 2009.

The implications of the current economic crisis for the legal profession are significant. Obviously, the widespread restructuring and realignment of financial institutions will disrupt many long-standing firm-client relationships and will inevitably lead to more vigorous competition for work in the financial and capital markets sectors. The general economic slowdown will also adversely impact corporate and transactional practices at all levels for many months to come and may well result in increased resistance to billing rate increases for 2009.

All of this will pose serious management challenges for virtually all firms. For some firms – as evidenced by the recent demise of Heller Ehrman – the challenges may prove overwhelming. We expect to see a significant contraction across the industry over the next several months as firms are forced to lay off legal and non-legal staff, slow down the hiring of new attorneys, restructure operations, and weed out unprofitable practices. We also anticipate additional merger activity as firms struggle to maintain their strategic focus. And, unfortunately, we could see additional law firm dissolutions.

Immediate Management Actions

In light of all of this, we believe that there are a number of immediate steps that firm leaders should be taking to help their organizations weather the current storm.

It is critical to focus on collection efforts now; start negotiating your firm’s credit arrangements for next year now; take a close look at the expense side of your firm’s income statement; for some firms, excess capacity will inevitably lead to layoffs within both the legal and non-legal staff; use the current downturn as an opportunity to deal with performance issues throughout the ranks of the firm; shore up those practices that are strategically important to the firm’s future and to consider paring practices that are peripheral or unprofitable; and stay in close touch with your partners and associates, especially those who are critical to the firm’s success.

Stay in close touch with your clients, especially those key clients that are important to the firm’s future. Now is not the time to save money by cutting back on productive marketing expenses. Your clients are experiencing the same anxieties and uncertainties as the firm itself, and ramping up communication to them will stand the firm in good stead when economic conditions improve. Lawyers have time on their hands, so put it to good use with increased focus on client development, client teams, and appropriate business development training.

Longer Term Implications

As described above, the current economic meltdown will have significant short-term effects on the legal market. We believe that there are likely to be significant longer-term impacts as well.

Even during the last six years of unprecedented law firm growth, the significant increases in profitability that most firms enjoyed were disproportionately driven by only one factor – the ability to increase billing rates by 6 to 8 percent every year.

If, as seems likely, across-the-board rate increases will not be possible in 2009, the hit on law firm profitability will thus be particularly severe. In short, we believe that the present economic crisis may lead many firms to re-think the fundamentals of how they do business and how they deliver value to their clients, and, at the end of the day, that may not be such a bad result. Moreover, it is important to remember that the present downturn in the legal market is caused primarily by reduced demand and that demand will return in time.

This post courtesy of Larry Bodine of the Law Marketing Portal