More Economic Hell for Big Law Firms in 2009

By Larry Bodine, Esq., a business development advisor based in Glen Ellyn, IL, and Tucson, AZ. With the Apollo Business Development Program, he has helped law firms nationwide get new clients and generate millions of dollars of new revenue. He can be reached at 630.942.0977 and www.larrybodine.com.

Two leading advisors to major law firms predicted more economic hell for large firms in 2009, including a declining demand for legal services, a 15% drop in net income from 2008, inability to raise rates, additional layoffs, salary freezes and cost cutting, heavier fee discounting, expenses rising faster than revenues -- and a long wait for better times.

"This recession is significantly different that prior recessions and could lead to fundamental changes in the law firm business model," including more contract and temp lawyers and fewer full-time partners and associates, said James W. Jones of Washington, D.C., Managing Director of Hildebrandt International, speaking at the Marketing Partner Forum in Dana Point, CA. His comments were based on 100 peer law firms that Hildebrandt monitors.

Joining him was Lucinda J. Tambourine, Managing Director and Senior Client Advisor of Citi Private Bank.  "We are in a shift from a decade of growth and expansion to an extended period of reduced demand and resistance to increase in costs of legal services," she said.  Her opinion was based on 151 law firms responding to their surveys.

2009 will be an extraordinarily bleak year because of one key factor, according to Jones: "The single factor that worked consistently to drive profitability in the past was the ability to drive up rates 6% to 8% per year, regardless of what else was happening.  As we are entering a period of extended softness in demand, corporate clients are going to be more resistant to the overall cost of legal services.  You are looking at a fundamental shift in the law firm economic model we’ve lived with for many years."

Five bright spots for law firms

In a client advisory released on February 2, 2009, Hildebrandt did find five bright spots:

• We will see some growth in litigation (including white collar criminal litigation) as “blame” for the current crisis is sorted out and as claims and counterclaims are filed, though such growth will continue to be tempered by the determination of clients to hold down overall legal costs and by the growing tendency in the corporate world to settle rather than litigate major controversies.
• A slow but measured uptick in financial institutions and legislative work as Congress puts in place a new regulatory system for
  the US capital markets.
• Similarly, the Obama Administration’s plans for a broad economic stimulus package should generate some work for firms with infrastructure or government contracts expertise or with specialty practices in the energy or health sectors.
• There is likely to be expanding demand for bankruptcy and reorganization work, as well as for employment law services, as the economic crisis continues to deepen.
• Some economists suggest that there may be an increase in M&A activity as strong, cash-rich corporations seek to take advantage of the current economic crisis to acquire weaker competitors.

In addition to cutting lawyers and staff, law firms have been cutting their advertising, outside services and publications.  Meanwhile, "Law firm mergers continued apace because of the economic downturn.  Healthier firms are absorbing less-healthy firms – pursuing a merger in lieu of dissolution. But it was not business as usual," Jones said.

Tambourine summarized 2008 in economic terms: the demand for legal services is flat, headcount is exceeding demand, equity partner growth leaves little room for further decline, leverage is increasing (a bad thing), a significant decline in productivity; rates have a steadily increased,  margins show severe compression, the collection cycle for fees is lengthening, profits per equity partner are flat to down 10%, and top tier law firms are underperforming the legal industry.

Looking ahead to 2009

And if that wasn't enough to make you want to hang yourself, they said that 2009 will be worse.  At some firms they predicted a decline of 15% to 20% decline in profits per equity partner.

"A quick turnaround of the current economic crisis will not be possible.  Many firms were hoping the crisis would be relatively short lived, but when the credit crunch hit in September 2008 it was clear that it would be a longer and bumpier ride," Jones said.

They said that some counter-cyclical practices will do well:

• Bankruptcy and reorganization work.
• Regulatory work relating to capital markets.
• Contract and related work growing out of stimulus efforts.
• Litigation work related to the economic crisis.

But these upticks are unlikely to offset the losses of work resulting from the overall economic downturn, the warned.

Jones summarized his projections for 2009:

1. Flat to declining overall demand.
2. Modest rate increases, heavier discounting and no uplift from premiums.
3. Modest revenue growth in the 3% range.
4. Additional layoffs and cost cutting (including salary freezes and reductions).
5. Expenses that (despite these efforts) will rise at a faster rate than revenues.
6. Resulting net income that is flat to down 15% compared to 2008.

7. Higher indebtedness by firms, with higher borrowing costs, more restrictive covenants and closer scrutiny of capital structures.  The good news is that law firms will have easier access to the credit markets than other industries.

Building a new law firm economic model

"Firms that are willing to think outside the box will come out of the crisis better than they went into it," Jones said. "Firms will have to go through a right-sizing process to bring their population in line with where demand is likely to be. That will solve the productivity problem.  This is the most important factor – to keep your population in line with demand."

Both Jones and Tambourine urged law firms to move away from the hourly-billing model.  Tambourine said, "The alternative billing conversation sends message to client that we’re trying to think about you."

They offered these new business models for law firms to respond to the recession: