Thomson Reuters Law Firm Financial Index flashes warning signs amid fourth consecutive quarter of decline
Rate growth remains robust but demand declines as expenses soar
After soaring to record levels in 2021, law firm profitability continues to slide in 2022 because of an inevitable cooling off in demand and rebound in expenses. After surging to an all-time high in Q2 2021, the Thomson Reuters Law Firm Financial Index (LFFI), powered by Peer Monitor/Financial Insights, has now fallen for a fourth consecutive quarter – the longest such slide in the index’s history.
Demand for law firm services slipped 0.5% compared with a year ago as corporate work, which drove much of the growth seen in 2021, fell 0.7%. The decline was even more pronounced for corporate mergers and acquisitions work, which dropped 4.9%.
Expenses continued to surge at double-digit rates, owing to a combination of inflation, competition for talent, and firms moving to hybrid or in-office working arrangements. Direct expenses rose 12.4%, only a slight moderation from the 13.1% increase seen in Q1. Associate compensation, especially for Am Law 100 firms, was the principal driver. Meanwhile, overhead expenses grew 13.5%, as firms restored more staff functions, such as recruiting and business development, that were cut during the depths of the pandemic.
Technology spending grew at its fastest pace in eight years, with growth averaging 10.5%. The significant rise in spend may indicate firms are increasing their investment in legal tech as information technology prices historically tend to be deflationary.
“Last year’s tailwinds have inevitably turned into headwinds,” said Mike Abbott, head of the Thomson Reuters Institute. “Demand was due for a break following four consecutive quarters of exceptionally strong growth in the three-to-seven percent range. In 2021, we saw a sharp rebound in demand along with dramatically reduced overhead expenses. The story of 2022 is more about the rebound in expenses as firms adjust to the current economic environment and wrestle with issues such as how to manage return-to-office or hybrid work. The combination of slowing demand and rising expenses dampened profits in the second quarter, but it’s important to keep in perspective that it’s on the heels of two years of record-high profitability.
“Rates and realisation continue to be strong, helping support profitability,” continued Abbott. “However, warning flags are being raised that conditions may continue to be challenging over the near-term.”
Profit-per-lawyer fell 3.6% in the second quarter compared to a 12-month rolling average that ended in Q1 2021. Profits had risen steadily in 2020 and 2021, even throughout those stages of the pandemic, but have now declined for two consecutive quarters.
Download the Q2 2022 LFFI report here.
The LFFI, produced by Thomson Reuters, is a composite index of law firm market performance using real-time data drawn from major law firms in the United States and key international markets. It tracks quarter-over-quarter changes in drivers of law firm profitability, including rates, demand, productivity, and expenses. For more information on the LFFI, part of the Thomson Reuters Financial Insights platform, visit legal.thomsonreuters.com/en/products/strategic-insights.
