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January 18, 2011 4:58 PM

Running to Stay in Place: Study Sees More Law Firm Cost Cutting Ahead

Posted by Tom Huddleston Jr.

Despite excitement over the recent spike in M&A activity, 2011 could still be a year that sees firms struggling not to lose ground, according to the 2011 Client Advisory released Friday by consultants at Hildebrandt Baker Robbins and the Citi Private Bank division of Citigroup, Inc.

The report predicts that firms will enjoy only modest gains--"lower single-digit rates"--in profits per equity partner in the wake of a two-year lull in demand for legal services. While there could also be modest growth in demand this year, James Jones--senior vice president at Hildebrandt and principal author of the Advisory--tells The Am Law Daily that he does not see the industry returning to prerecession revenue levels anytime soon.

"It makes sense that as the economy improves overall that there would be some uptick. But, I think it's still going to be a pretty challenging year," Jones says. "I mean, we're certainly not going to see a huge, robust recovery anytime soon."

At the roughly 182 firms surveyed, the advisory shows, demand for legal services was down by less than 1 percent through the first three quarters of 2010 after dropping by almost 4 percent during all of 2009. By comparison, the industry saw an increase in demand of nearly 4 percent in 2008.

The advisory says that law firms must accept that they are in "a protracted period of sluggish demand and mounting client pressures for enhanced value in the delivery of legal services." As a result, Jones predicts, firms need to employ innovative methods of cost cutting and achieving efficiency just to attain modest profitability.

Last year, Jones says, slowed hiring and layoffs "fell very disproportionately on the associate side." This year, he says, equity partners could be the ones getting hit. Growth in the equity partner ranks was down last year--a first since Hildebrandt began keeping track, according to Jones.

While many firms, Jones says, are "over-partnered," with some suffering from underproductive partners, the equity ranks are generally the last place "for psychological reasons" that firms look to make cuts.

"But, I think at this point that's kind of the obvious place to go next, so I think you will see, probably, further reductions in the equity partner ranks," Jones says. "I think that's going to be one of the interesting trends of this year." 

Still, many firms appear to eyeing other solutions--including those that involve billing practices--to budgetary pressures. As The Am Law Daily has previously reported, alternative fee arrangements (AFA) are becoming more prevalent in the billing plans of large firms.

The Hildebrandt/Citigroup advisory concurs and cites a 2010 Thomson Reuters survey of legal executives that revealed that 96 percent of 78 large firms surveyed expected to increase their use of alternative fee arrangments over the next three years. That advisory also cites the Thomson Reuters survey in noting other cost-cutting strategies expected to increase over the next three years--ncluding increased use of investments, outsourcing, and contract lawyers.  

Even firms that experienced profitability in 2010 will need to get more creative, Jones says. "When we see results reported from 2010, I think you're going to see a lot of firms that actually did pretty well. But, the question is: Why?" 

In other words, if the firms' growth was driven by cost-cutting measures and layoffs, that is not a long-term solution. Eventually, Jones says, those firms will no longer be able to put off certain expenses and operational upgrades, and the number of attorneys cannot continue to drop. "If that's the case, what's the second act? What do you do now to keep that momentum going? And that's going to be an interesting challenge," he says.

Much has been made of the recent spike in M&A activity and Jones does feel that 2011 could be a positive year in that sector, but gains across the board are still expected to come slowly. "It's all ultimately demand driven," he says.

"It'll be an interesting year to watch," he adds. "I think the market has stabilized in many ways, but certainly stabilized at a much lower level of activity than it had before." 

(Download 2011_Client_Advisory)

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