The Score

November 22, 2010 6:00 AM

Citi's 3Q 2010 Firm Results: Flat Revenue, Rising Inventory

Posted by Ed Shanahan

By Dan DiPietro and Gretta Rusanow

In our September article, "Trench Warfare: Citi's Midyear Law Firm Review," we commented that firms were "shrinking their way to profit growth" in 2010. While this continues to be the operative phrase through the first nine months of 2010, the "shrinking" is beginning to wear thin.

The 182 firms who reported their results to us include 86 Am Law 100 firms, 51 Second Hundred firms, and 45 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.

Let's talk about three pieces of good news that are only qualified good news:

1) For the 182 firms who reported nine-month data, revenue is virtually flat (0.5 percent increase) and expenses are down 3.4 percent. However, the expense reduction, as we predicted in our earlier article, is beginning to lessen. When 3Q 2010 expenses are isolated and compared to 3Q 2009, the favorable delta is 1.7 percent, much less than the cumulative 3.4 percent. So, the 2009 expense reductions that favorably impacted the first half of 2010 have begun to burn off. 

2) A lawyer head count reduction of 3.4 percent drove a productivity (i.e., average hours per lawyer) increase of 3.2 percent--positive news with a caveat: This improvement comes off a very low base by historic standards. When we annualized the nine-month data to arrive at average hours per lawyer of under 1,650, we saw that this result is well below the averages seen between 2000 and 2007, when average hours per lawyer were as high as 1,800 and never lower than 1,700.

3) Rate increases (although they're less than 50 percent of historic averages) are at least partially mitigating tepid demand and severe discounting pressure. However, the qualifier here is that equity partners are billing more hours than associates and leverage is also declining. These two factors drive the average rate per lawyer up and, while this benefits firms in the short term, it's not sustainable.

There is one piece of news that appears to be a positive augur: inventory is up 2.7 percent vs. 0.9 percent halfway into 2010. However, even this good news must be tempered a bit: All the inventory growth is in unbilled time, which typically takes longer to collect. So, the good news may be good news for 2011, not this year.  

When we looked at the data based on geographic reach, we saw that only global firms (those with more than 25 percent of their lawyers outside of the U.S.) saw a demand increase. This suggests that geographic diversification is buffering the slow growth in the U.S., U.K., and Western Europe.

In the Am Law Designation cut of the data, Am Law 51-100 suffered a more material decline in demand than either of the other Am Law segments, suggesting that these firms may be getting squeezed by The Am Law 50 going down-market and the Am Law Second Hundred using their lower rate and leverage structures to gain market share from larger firms. Also worth noting is the 1.5 percent uptick in demand for smaller firms (i.e., those below The Am Law 200) that may also be gaining market share at larger firms' expense. We'll share an anecdote that speaks to this:  We recently had two separate conversations on the same topic. An Am Law 50 firm lost three partners to a 110-lawyer firm. The Am Law 50 firm's managing partner expressed relief that these partners had not gone to a "direct competitor." By coincidence, we also met with the managing partner of the 110-lawyer firm who was quite pleased when the three incoming partners reported the reaction of their former firm's leader. "We're glad to still be below the radar screen," the second managing partner said. According to him, the clients of those three partners have come over to their new firm. To us, it's indicative of the shifting competitive landscape. 

As a final point, we would note the continuing trend among all three Am Law segments to shrink their equity partner ranks. We've commented on this before and expect it to continue for the foreseeable future.

These results do nothing to change our view of 2010 results; we continue to believe the industry will have a slightly better year than 2009 due to the benefit derived from expense cutting.

A follow-up article on will share some of the ways in which firms are responding to the ongoing challenges these results highlight.


Dan DiPietro is chairman and Gretta Rusanow is senior client advisor at Citi Private Bank's Law Firm Group.


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