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February 10, 2012 1:01 PM

Citi Report: Firms' Profits Grew 3.3 Percent in 2011

Posted by Ed Shanahan

By Dan DiPietro and Gretta Rusanow

For law firms, 2011 was a tale of two years. The strong demand momentum coming into 2011, which continued through the first six months, caused many law firm leaders to believe that a degree of certainty had been attained. The second half of the year was a rude awakening as demand, particularly in transactional work, withered away and has yet to bloom again.

So, while revenue growth in 2011 exceeded the prior year, even greater expense growth squeezed margins and resulted in a PPEP (profits per equity partner) increase of just 3.3 percent  vs. 7.4 percent in 2010. In 2010 the industry was rebounding from a weak 2009 which made higher year-over-year increases easier to attain—not so in 2011. 

Revenue growth of 4.1 percent in 2011 was due to moderate rate increases, a modest shortening in the collection cycle and a slight increase in demand. With low year-end inventory growth, the industry might be in for a slow start to collections in 2012, and if tepid demand growth continues into the year, it will create a challenging revenue environment.  

The preliminary 2011 results are based on a sample of 178 firms (81 Am Law 100 firms, 47 Second Hundred firms, and 50 additional firms). Citi Private Bank provides financial services to more than 600 U.S. and U.K. law firms and more than 35,000 individual lawyers. Each quarter, the Law Firm Group confidentially surveys firms in The Am Law 100 and Second Hundred, along with smaller firms. In addition, we conduct a more detailed annual survey. These reports, together with extensive discussions with law firm management conducted on an ongoing basis, provide a comprehensive overview of financial trends in the industry and insight into where it is headed. [An interactive chart of The Am Law 200 financial results reported to The Am Law Daily is available here.] 

Rate increases continued to grow at a faster rate than the prior two years, but still lag historical averages. While we do not report on realization in the flash survey, our sense from clients is that realization declined last year, dampening the impact of rate increases. With that said, shortening the collection cycle by 1.3 percent contributed to the growth we saw in collections.

Expense growth was significant, so much so that the rate of increase outpaced the rate of revenue growth. The industry growth rate of 4.4 percent reflected increases in compensation more than in overhead. Compensation expense increases included salary increases as lawyers became more senior, as well as higher bonuses such as the surprise spring bonus paid by many firms. The growth in overhead expenses included investment in infrastructure projects, which could no longer be delayed, such as IT upgrades. 

The dynamic of expense growth outpacing revenue growth was also reflected in the results for contribution per lawyer, calculated as revenue per lawyer minus expense per lawyer, and a key indicator of firm profitability. As expense per lawyer grew more than revenue per lawyer, this dampened the growth rate of contribution per lawyer.

We saw head count grow slightly, and mostly for Am Law 1-50 firms. As head count grew slightly faster than demand, we saw a marginal decline in productivity. Looking at absolute productivity numbers, at an average of 1,642 hours per lawyer, we’re still seeing results well below the historical levels of productivity. 

It’s also interesting to note that equity partner head count grew only marginally, reinforcing the view we hear in our travels that it has become a lot harder to become an equity partner and remain an equity partner.

With just a slight change in equity partner head count, and the pressure of expense growth on profit margins, we saw, as we predicted early last year, PPEP growth in the low single digits.  

All said, not a bad year and we suspect likely to be the new definition of a good year for the legal industry at least for the foreseeable future.

Dan DiPietro and Gretta Rusanow are chairman and senior client advisor, respectively, at Citi Private Bank's Law Firm Group. E-mail: dan.dipietro@citi.com; gretta.rusanow@citi.com.

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