Reading the Tea Leaves: Using Year-End Data to Predict the 2019 Legal Market … and Beyond
If you’re like me, your “year-end” process included a lot of introspection and digging into whatever data were available to help determine what worked, what didn’t and what’s ahead for the new year. This is an important part of the strategic learning process, popularized by Willie Pietersen. It’s the learning loop that helps us figure out how to retool and reconfigure, where needed, to maximize opportunities for success in the future.
In the legal industry, the fourth quarter includes a flurry of reports about how law firms are doing — everything from insider data cultivated from managing partner surveys to analytical reports from a number of the industry’s top consultants. If you’re paying attention, you know that the news was good for the end of 2018 (particularly related to profits per partner), and the prognosis for 2019 is even stronger.
If digging into the mountains of data available isn’t exactly your milieu, I’m here to help. Using a triangulation of data reporting sources, including the 23rd Annual Pennsylvania Managing Partner Survey from American Lawyer Magazine (ALM) — a regional survey that reflected many national trends in 2018 – along with Wells Fargo’s Legal Specialty Group Report on the Legal Industry for 2018, and the Citi Private Bank-Hildebrandt joint 2019 Client Advisory, I have cherry-picked some of the most interesting conclusions about 2018 and some compelling predictions for the 2019 legal market.
A Few Words About 2018
We’re already approaching the midway point of the first quarter of 2019, so too much introspection now could be a waste of time. Universally, the theme of the year was revenue growth, with the Top 50 on the AmLaw list reporting growth (according to ALM) of more than 8%, compared to just over 5% for Nos. 51–100 and just over 2% for the second hundred. This is good news for partner profits, for sure — but there are a few important conclusions from the 2018 data to take note of as we look forward to the rest of 2019.
Demand was up or down, depending on where you are in the AmLaw list
As has been widely reported since early December 2018, every one of the surveys I’ve studied pointed to one of the strongest growth periods for law firms in more than a decade. Interestingly, as both the ALM and the Citi-Hildebrandt reports revealed, the strength of the market seemed to have had the most positive impact on the industry’s largest and smallest firms. Most of the managing partners surveyed in both of those reports said their success was buoyed by strong brand reputation and consistent messaging about firm differentiators, which led to increased demand for their firms’ services.
For those firms reaping the benefits of a strong year, demand growth appeared to be a critical factor, reported for 2018 as anywhere from 2.5% (Citi) to 3.3% (Wells Fargo). In an industry where annual demand growth has been less than 1% nearly every year since 2008, this development is certainly cause for celebration. Reports of demand for legal services were fairly uneven, with firms in the “middle” (between the very largest and very smallest) indicating that demand growth was not necessarily part of their 2018 economic picture.
Despite the struggles of those firms in the lower hundred of the AmLaw list, a small, but strong, subset of firms did cite growth in the demand for their services, according to all three reports. Ultimately, this is a positive growth development that seems to underscore the importance for all firms — regardless of size — to communicate their brand messages effectively and not only identify, but loudly celebrate, their differentiators to the marketplace.
Billing rates went up, but so did the collection cycle
Another contributing factor to the strong economic outcomes in 2018 was the growth of billing rates across the board. The Citi-Hildebrandt survey cited rate growth at 4.3%, again the highest it has been since before the recession (when double-digit rate growth, year over year, was not uncommon). The billing rate growth for 2018 even bested the compound average growth rate of 3.9% for the period from 2010–2017. Unfortunately, the increase in billing rates seems to have affected the length of time clients are taking to pay bills: Both Wells Fargo and Citi-Hildebrandt reported collection cycles of anywhere from 0.8 to 1.1% longer than in 2017.
Expenses continued to rise
Despite good news on the revenue front, fueled by increases in demand and billing rates, law firm expenses continued to take a chunk out of the gains. All three reports indicated law firm expenses increasing by as much as 6% over 2017. Most of these increases were attributed to increased headcount and dedicated spending on technology upgrades, cybersecurity, professional staff and — most importantly — associate salaries, which reportedly topped $190,000 for first-year associates in 2018. Most firms surveyed in all three reports indicated long-term commitments to increased spending on practice innovation and cybersecurity initiatives, reflecting some of the same key priorities for clients in 2019.
Looking at the Rest of 2019
As we look forward to the rest of this year, what clues do the 2018 data give us about the outlook for the legal industry? Most importantly, the most successful firms will look for ways to leverage what went right to sustain the kind of growth experienced last year and set a delicate course aimed at more of the same for 2019. With new client pressures related to diversity, pricing and efficiency of service delivery gaining momentum across the industry, though, firms will also have to turn a critical eye inward to address firm operations and respond effectively to these new market dynamics.
Successful firms will continue to focus on client needs
Reflecting the tone of those surveyed in all three reports, it’s clear that the most successful firms in 2019 and beyond will be those that deliver their services based on client needs. Growth in practices that have low demand should be questioned as the most-successful firms adopt a philosophy of the voice of the client as their guiding principle. For example, as demand for litigation dropped over the last several years, many firms set about the task of right-sizing their headcounts for litigation practices. These firms are very likely to reap the rewards for implementing that strategy through higher utilization and leverage rates for those practices beginning in 2019.
By approaching work from the mindset of the client, the most successful firms will be those that shift from a practice area mindset to an operational focus on the geographies, market segments, and industries where their clients are. All three reports indicate that the majority of firms surveyed anticipate having some level of headcount growth in 2019 (some by as much as 10%) to address this focus on client needs. Since demand is directly related to client needs, it’s easy to predict that the firms that continue to shift in the direction of client need will also continue to realize growth in the demand for their services.
Geographic growth opportunities for 2019 and beyond
Domestically, law firm geographic expansion over the last few years has focused largely in high-tech sector geographies like Silicon Valley, the Midwest Tech Sector (including Chicago and Detroit), and several markets in Southwest (for example, Austin and Phoenix, where tech startups have been proliferating in large numbers). The Citi-Hildebrandt report singled out New York as a geographical growth opportunity in 2019, reflecting the general belief among firms that M&A activity (which is always more robust in financial centers) will continue to be a top area of demand for legal services.
Other domestic markets poised for growth over the next three to five years include Washington, DC, and California, Houston and Dallas. These particular markets are singled out for regulatory-, technology- and energy-related practices, which most firms predict will be the most-likely areas of growth for firms that invest in these geographies.
Outside the U.S., growth opportunity is harder to predict since a wave of anti-local attorney regulations is sweeping through many markets, including China and Hong Kong, as well as in India, where the restriction on non-local firms remains a significant barrier to entry. The economic impact of Brexit, which is slated to happen in March, will likely to determine whether the United Kingdom and more specifically London, becomes a growth center in 2019 and beyond.
As the political climate unfolds in the U.S., law firm investment in Russian and other Eastern European markets is expected to slow down significantly. All three reports indicated that most firms surveyed have no plans to expand any practice in Moscow or other Russian markets, and some firms indicated an inclination to pull out completely. This may reflect a general tone of unease about risks to law firm brands in the wake of potential scandals resulting from the U.S. Department of Justice Special Prosecutor’s investigation into Russian meddling and influence in the 2016 presidential election.
More firms will focus on innovation, diversity and project management
In the face of market disruption on all fronts, including from the Big Four accounting firms, law firms are being forced to address their business models to focus on growth and efficiency. All three reports indicate that the firms surveyed planned to respond by continuing to spending money on efforts to innovate the delivery of legal services.
In addition to greater investment in profitable legal practices and those that are the bedrock of a firm’s brand reputation in the marketplace, both the Wells Fargo and Citi-Hildebrandt reports indicate that firms expect to do more to address low-performing legal practices and office locations. Whether they intend to downsize, refocus or eliminate these practices or offices is unclear, but realizing such significant growth this year has given them legitimate reason to question why certain offices and practices are not in lockstep. ALM’s survey report indicates that law firm leaders expect to introduce more technology into their practice of law, thereby increasing leverage and efficiency, without necessarily sacrificing headcount (since most firms surveyed indicated they don’t expect to have significant layoffs in 2019).
Since the general counsels of the legal industry’s top clients have used an “open letter” to voice their concerns about diversity in the leadership and delivery of legal services, it’s easy to predict that law firms will double down on their diversity initiatives over the next two to four years. If the clients stick to their promise to alter their allocation of legal spend based on diversity, we can expect many law firm diversity initiatives to undergo a dramatic shift in intensity and focus. Personally, I also predict we’ll see a lot more female attorneys elected chair/managing partner at their firms, particularly among the Top 100 firms on the AmLaw list, who seem to have the strongest ties to the GCs who signed the open letter.
There’s a lot to digest from all three of these reports. If you have the time to really dig in (and, like me, you geek out on data), I recommend spending some time looking into each one. You can deduce a lot of valuable insights from looking at the results from the past year that can help inform your decisions for the rest of this year and make practical and reasonable predictions for the future.
Here’s to continued success throughout the industry for the rest of 2019. Cheers!