Large law firms appear to be striking a balance between increasing demand and maintaining staffing levels, according to our analysis.
As we enter the second half of the year, many small law firms are poised to take advantage of the busy times ahead, or hopefully. The recent ones 2022 Midsize Legal Market Trend Report from the Thomson Reuters Institute shows the strong areas in the middle legal market such as the growth of demand, but also focused on different areas such as the results that the market saw average hours for per attorney will be less than five hours compared to the same period last year.
Despite this reduction, it appears that small business owners have been able to cope with increasing demand by choosing to maintain staffing levels. Evidence of this view can be seen when we look at demand and full-time employment (FTE).
For the purposes of this blog, the demand factor is defined as the total number of hours worked by non-legal partners, associates, counsel, and other attorneys divided by the number of hours worked. Dear colleagues. In other words, this formula shows how many hours other attorneys (excluding direct partners) work for every hour worked by a direct partner.
The FTE attribute, on the other hand, analyzes headcount. It shows how many lawyers (excluding direct partners) work for each direct partner.
Generally, the demand factor should be greater than the FTE factor. One reason for this is that the additional responsibilities of direct associates, such as building relationships with clients and networking, may shift their focus away from billable hours, which small-time attorneys can try to be as productive as possible.
In theory, the more time equity partners spend on those additional responsibilities, the more demanding the firm will be; This means that a higher ratio means that the partners are working hard to attract new business and grow the firm, rather than just paying the bills by the hour at a higher rate. In addition, as demand grows, the gap between these attributes becomes very large because they are positively correlated with profit margins. By offloading work to lower-paid attorneys, the fee increases and profits increase over reasonable expenses. Generally, if a firm’s attorneys are billing more hours than their direct partners, that means they are adding income to the “good-for-profit” that direct partners participate in at the end. of the year.
Another reason why these types of results are so important is that they can show how well law firms can handle the growth in demand. Even in short-term businesses there is an incentive to cut energy costs (that is, lawyers are not used), this will come back to the firms in the future. Hiring a lawyer is not a quick thing; therefore, firms that cut short-term concerns risk not being able to meet customer demand when demand returns.
This conflict of interest has been playing out in recent quarters and the balance between the demand factor and the FTE factor has recently shifted towards the middle.
As the chart shows, FTE yield exceeded demand yield in Q4 2021, with a wide margin remaining throughout the year. Of course, part of this expansion can be attributed to seasonal factors. Equity partners often join firms in the first quarter, and other attorneys leave firms at the same time. However, this seasonal trend does not account for the magnitude of this year’s disconnect. The main reason for this imbalance is the fear of the increase of affiliates and the risk of repeating the mistake after 2008 under the influence of the power cut by the average law firm. partners by 10% during the Global Financial crisis. Then, when the demand came back, it became clear that the firms could not afford to hire lawyers fast enough.
The fear of repeating that past mistake and paying the high fees required to bring back familiar partners has contributed to the decision of today’s firms to retain their attorneys. Of course, many seem to have decided to delay the application and look to the bright future.
Data from the second quarter seem to confirm this conclusion. The difference between demand leverage and FTE leverage in mid-sized firms starts to look more normal as demand leverage grows, the reduction of direct employees resumes, and the start of new colleagues to contribute more effectively.
However, even though there is a difference in small firms – in fact, the biggest gap of all the sectors we tracked – it still ends in the first half of the year with the smallest reduction in profit YTD to their Am Law counterparts. Profits fell by just 1.8% in medium-sized firms compared to the overall industry average of 2.3%. Although this figure is explained by the slowest FTE growth of small firms in all sectors, the gap between FTE and demand yield indicates that lawyers still have a lot of room for growth and mid-sized firms contract less than their larger competitors. If this trend continues, the demand factor may top the FTE factor and provide the additional income layer discussed earlier.
The sticky part of this strategy is that when it rests on a hypothesis or expectation, the growth of interest will occur. Although on a YTD basis their Am Law 100 firms outperformed their competitors in demand growth, the second quarter continued a four-quarter decline, ending with just 0.1% growth. A reasonable explanation for this surprising trend is last year’s growth. At 7.7% year-over-year growth, Q2 of 2021 was one of the highest demand growth rates on record for the mid-sized segment. And that means the rest of this year will have to contend with higher schedules, making it more difficult to justify current FTE levels as demand and productivity continue to struggle.Firms are facing stronger demand as they struggle to reduce their inventory, but it’s also important to understand that this is a long-term process. Currently, the gap between demand and FTE yield is trending in a more profitable direction, but it should be noted that even though the yields will change on their own, that does not necessarily mean that profit margins will increase. .
But, of course if corporate demand increases at a healthy rate, adding extra cash to the pool that partners draw on at the end of the year. The success of the second half of the year depends on that”if”, and why small businesses are profitable for the future.