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March 2, 2010 6:40 PM

Report: Partner Ranks (Equity and Non) Logical Place for Cost Savings in 2010

Posted by Drew Combs

The legal industry is in the midst of a fundamental shift as the nation's largest law firms continue to confront the challenges posed by decreased demand for their services, outsize expenses stemming from years of growth, and rate pressures from emboldened clients. This is the conclusion presented in the 2010 Client Advisory released this week by the consultants at Hildebrandt Baker Robbins and the Citi Private Bank division of Citigroup, Inc.

"Managing law firms has been about managing growth and expansion, [but] now, firms have to take more seriously how to deliver legal services in the most efficient and cost-effective way," says James Jones, a managing director at Hildebrandt involved in producing the report.

The advisory analyzes the legal industry's performance in 2009 and offers predictions about how Am Law 100/200 firms as a group are expected to fare in 2010.

Not surprisingly, the report (available below for download) concludes that 2009 was a bad year for law firms, and, in some respects, it was "the worst year for the legal market in at least the past half century." The report supports its finding by referencing the struggle to maintain profitability among Am Law 100/200 firms. Many were forced to implement deep spending cuts and broad staff reductions that would have been unimaginable three years ago. According to The National Law Journal, 5,258 lawyers have been laid off (a decline of four percent) at the nation's 250 largest firms, as measured by lawyer head count. And of course, the layoffs have come amid scaled back recruiting, salary cuts, rescinded offers, postponed start dates, and other cost-cutting efforts.

The fourth quarter of 2009 provided some signs of a bounce back. A number of practice areas, including M&A, general corporate, tax, capital markets, and real estate, saw demand spike at the tail end of last year. But the advisory soberly concludes that 2010 provides "little prospect of a robust recovery" and there is mounting evidence that "the profession is entering an era in which the fundamental economics of legal practice are likely to be significantly different." Says Jones, "The bounce back from the downturn is going to be very gradual."

Why such a grim prediction? Between 2001 and 2007, growth was driven largely by annual rate increases of six to eight percent, the report states. Law firms no longer are in positions to impose such increases. In 2009, demand fell by 4.1 percent compared to 2008 at 193 surveyed firms. This contrasts sharply with activity between 2001 and 2007, when demand increased an average of four percent each year. Also, the drop in demand comes as law firms experience increased rate pressures from clients demanding discounts, fee caps, multiyear rate schedules, and alternative fee arrangements. For the foreseeable future, firms will likely find themselves in a buyers' market when it comes to legal services, the report predicts.

Firms were more successful when it came to controlling expenses. "Many firms did a good job managing the expense side of their budgets," Jones says. Among 193 firms surveyed, year-over-year expenses declined by nearly 5.6 percent in 2009. This contrasts with a 10 percent increase in 2008, according to the report. There was an average 9.5 increase in year-over-year expenses from 2001 to 2007.

This aggressive approach to cost cuts and the spike in activity at the end of the the year did lead to better than expected financial results. Profits per equity partner (PPP) declined only 0.3 percent among the sample group of firms, according to the advisory. Last year, this same group registered a three percent drop in PPP.

Looking ahead, the report predicts law firm revenue will be flat or just slightly higher than last year; profits, too, will remain flat or move up no more than five percent. The key to a firm's individual performance during this period of recovery will be how firm leaders will handle costs that until now have been spared. The reports says firms should look to their partner ranks, both equity and nonequity, in further cost-cutting efforts. According to the report, in the years prior to the downturn, the number of partners grew at a faster pace than the growth of overall lawyer head count, leading to "over-partnered" firms. The report predicts firms will address this imbalance by paring down partner ranks with "tough love" conversations and early retirement packages. Jones states, "We expect this year that additional cost savings are likely to come out of the partner ranks because everything else has been cut extensively, and that is the logical place for future savings."

Download 2010_Client_Advisory

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