September 8, 2010 6:00 AM

Trench Warfare: Citi's Midyear Law Firm Review

Posted by Ed Shanahan

By Dan DiPietro and Gretta Rusanow

Looking at the 2010 midyear data reported to the Law Firm Group at Citi Private Bank by 187 U.S.–headquartered firms in our latest survey, we can best describe the results as "shrinking toward profit growth." We see some bad news and some good news.

During the first half of 2010, revenue was virtually flat, and demand was down slightly, compared with the same period in 2009. Inventory grew by less than 1 percent. When we consider that these results are being compared to a weak first half of 2009, we can hardly describe this as a robust rebound. At best, we may have reached a bottoming out.

The 187 firms who reported their results include 87 Am Law 100 firms, 50 Second Hundred firms, and 50 other firms. Citi Private Bank provides financial services to more than 600 U.S. and U.K. law firms and over 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.

Now for some good news. Expenses have decreased, compared with the first half of 2009, largely due to the reductions in lawyer head count that firms implemented last year. However, since these reductions took effect mainly in the second half of 2009, we will now start to see much flatter year-to-year comparisons.

The impact of those head count reductions has been positive, with productivity up about 4 percent and contribution per lawyer (revenue per lawyer minus expense per lawyer) up almost 20 percent. But we're coming from a low base, and there will be a bump in head count created by the new incoming class starting in the third quarter, so firms may still have excess capacity.

Billing rates also are up, trending at 4 percent. This is a good result, albeit lower than the historic 6-7 percent. But we have two caveats. These rate increases are before realization, and we're still hearing that realization is under pressure (though not falling as steeply as in 2009). Further, since leverage is declining, rate increases may be artificially inflated because a higher percentage of more senior lawyers with higher billing rates are doing the work.

Net income and profit per equity partner for the first half of 2010 show improvement over the same period in 2009. But given the traditional bump in fourth-quarter collections, this may not be an accurate reflection of net income and profit per equity partner for full-year 2010 and cannot be taken as a prediction.

Most firms reduced equity partner head count in the first half of 2010, so it's clear that this is a focal point. We believe it will continue to be a priority throughout 2010.

Global firms are the only sector where demand is up (by almost 2 percent), but bear in mind that these firms underperformed the industry over the last two years. It's too early to say that there has been a turnaround, though anecdotally, we hear that firms with a presence in emerging markets are experiencing improvement. Indeed, in a recent study we conducted of 48 leading law firms (75 percent of which were Am Law 50 firms and 13 percent were other Am Law 100 firms), global firms described BRIC nations (Brazil, Russia, India, and China) and emerging markets as growth opportunities.
 
Given these results, we see the first six months of 2010 as lackluster from a volume perspective but made palatable due to belt-tightening. However, expense cuts have gone about as far as they can, so firms now need to focus on how to increase top-line revenue.

CLICK HERE to continue reading the midyear law firm report form Citi's Law Firm Group.

Dan DiPietro is Chairman of Citi's Law Firm Group and Gretta Rusanow is Senior Client Advisor. E-mail: [email protected]; [email protected].

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