U.S. Legal Industry Performance Analysis

In 2022, the AmLaw 100 announced a collective revenue of $127.4 billion, an increase of 14.8%. The average revenue per lawyer was $1.18 million, up by 12.5% and the average PEP was $2.66 million, up by 19.4%.

Globally, law firms stood resilient against the pandemic and experienced stellar growth in earnings. Previously in the year 2021, U.S. law firms experienced robust growth in demand for legal services with a thrust on the practice areas of corporate, M&A and real estate. Notably, in Q2 and Q3 of 2021, the industry saw its strongest quarterly growth rate in the last decade.

But while the earnings soared, the pandemic proved to be a turning point, throwing new challenges and marking a shift in how U.S. law firms function. Adoption of a hybrid work mode increased legal consumer demand leading to increased hiring and "The Great Resignation" wave threw the spotlight onto employees and talent management. 

Moreover, the three highest risks to U.S. law firm profitability in 2022 according to the Thomson Reuters October 2021 ‘Law Firm Business Leaders Report’ involve:

• Talent acquisition and retention;
• Solicitation by competitors; and,
• Increased compensation.

In contrast, in their 2020 survey, talent management issues did not merit a mention in the top five risks threatening law firm profitability. 

Talent acquisition, retention and attrition, therefore, pose the greatest post-pandemic challenge facing the U.S. legal industry in 2022.

Talent wars

According to the Thomson Reuters 2021-22 ‘State of the Legal Market’ report (‘the Report’), the high consumer demand in the U.S. legal market spurred a hiring spree at a rate “unseen for a decade”.

Note the ‘domino effect’ at play here – increased demand triggers aggressive hiring, which, in turn, triggers increased compensation levels and creates a “talent war”. For instance, in January of 2022, when Milbank announced a pay hike for its first-year associates, within hours, Cravath, Swaine & Moore also announced a similar pay hike.

In another instance, when Cravath announced its year-end bonus, Cleary Gottlieb Steen & Hamilton, Cadwalader, Wickersham & Taft and Boies Schiller Flexner promptly matched the amount, with Boies Schiller offering “extra-extraordinary” bonuses.

The increased compensation levels are also seen in non-lawyer fee earners. The Report noted that while hours billed by non-lawyer fee earners dropped drastically in 2020, in Q2 2021 they enjoyed a salary growth rate higher than that of lawyers.

While most U.S. law firms have hiked salaries or offered signing/referral bonuses, a few have offered paid holidays, gifts, future promotions or flexible work by basing compensation on per task accomplished instead of on hours billed.

Further, in a bid to prevent employee solicitation by competitors, firms have adopted innovative methods such as paying lawyers to stay off LinkedIn, removing biographies from firm websites and discouraging general networking.

But more importantly, the recent movement, popularly termed the ‘Great Resignation’, has influenced legal talent and employees are resuming work after the pandemic with a different mindset. Therefore, the traditional approach of employee recruitment by raising compensation levels alone may no longer work in the post-pandemic environment. As seen in the American Lawyer’s 2021 Midlevel Associates Survey, 60% of those surveyed would consider a job change for a better work-life balance while only 27% were inclined to leave for a higher salary.

Additionally, Georgetown Law and Thomson Reuters’ April 2022 report titled “Law Firms Competing for Talent in 2022: Will Lawyers Stay or Will They Go?” underlines that U.S. associate turnover hit a record high of 14.1% in 2021, despite compensation rising by 12.1%. “Something more than money must be accounting for the advantage Stay firms enjoy in terms of both lower turnover and higher productivity,” noted the report.

Warning hiss before a strike

A red flag for U.S. law firms is that the recently released 2022 Q2 Law Firm Financial Index (‘LFFI’) by Thomson Reuters, notes a downturn for the fourth consecutive quarter and Q2 of 2022 pegs the lowest score in the index’s history. The LFFI finds that law firm direct expenses rose 12.4% in Q2 2022.

While the rise in employee compensation levels has brought law firms under financial pressure, mounting expenses related to technology spending, inflation, hybrid work mode and office operational expenses also factored for the spike in expenses. Some of the report findings include:

• Recruitment spend was 97.2% higher than Q2 of 2021
• Increase of overhead expenses by 13.5% as non-lawyer staff workload increased and firm promotional activities of business development and marketing resumed post the pandemic-induced lull incurring a spend 74.3% higher than Q2 of 2021.

But the low point of Q2 2022 is that legal consumer demand for overall services slowed and demand for corporate and M&A work (which fueled previous growth) fell 4.9% as compared to 2021. Profit-per-lawyer fell 3.6% in Q2 and while profits had increased at a steady pace in 2020 and 2021, they declined for two consecutive quarters in 2022.

Therefore, the 2022 Q2 LFFI score signals that a lean period looms ahead, with expenses soaring and legal consumer demand waning. The year could close on a “weak position”. 

But the angel in the details points out that the technology spend (“at its fastest pace in eight years with growth averaging 10.5%”, said the LFFI) highlights that firms are increasing their investments in legal tech and gearing up for a new work environment. Further, investments in business development activities indicate that life is returning to normalcy. 

Law firms are nevertheless urged to note that the Report also underlines that direct expenses have hit the highest level since the financial crisis of 2007-08 and are expected to impact future law firm profits.

For money or love

The bottom line is that it isn’t always financial compensation that creates loyalty to employers but other tangible factors such as appreciation, personal satisfaction, growth opportunities and a work-life balance. Like the Beatles sang years back, money can’t buy one love - or employee loyalty. The challenge for law firms in 2022 is to create a work environment conducive to employee welfare and nurture relationships that transcend mere pecuniary interests.

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