Law Firms Trim Their Ranks to Boost Profits

In boom times, law firms bill tons of hours advising companies on mergers and acquisitions. When things go bust, they rake in fees presented by bankruptcies, reorganizations, and shareholder lawsuits. Yet the billable-hours set was hit especially hard by the crash of 2008 and is only now recovering. Profits per partner (PPP, the industry's generally accepted bottom-line metric) jumped 8.4 percent last year, according to The American Lawyer's 2011 Am Law 100 report, which tracks law firms' financial performance. That came after a flat 2009 and a 4.3 percent drop in 2008.

Law firms' fortunes rose last year in part because of the economic recovery, which allowed firms to bill more hours and discount fees less. What's most notable in the data is the extent to which firms drove profitability by cutting head count—even expensive, but historically untouchable, partners.

"For many years, equity partners were protected from the vicissitudes of firm finances," says Robin Sparkman, The American Lawyer's editor-in-chief. "Their share of the profits may have gone up or down, but their jobs were secure." The American Lawyer reports that overall attorney head count fell 2.7 percent in 2010, the biggest drop since the magazine started its ranking almost 25 years ago. Am Law 100 firms posted an average profit per partner of $1.37 million.

Atlanta's Alston & Bird shows how lucrative keeping the lid on staffing can be. It achieved a 33.7 percent increase in profits per partner (the highest on the Am Law 100) thanks in large part to a 6.7 percent reduction in head count—even as it increased revenue by 3.6 percent in a year that saw it defend Toyota Motor (TM) from safety-related lawsuits.

Shedding attorneys is not unprecedented. Firms jettisoned lawyers after the dot-com crash. What's "stunning" about last year, says Sparkman, is both the rate of head-count reduction and its breadth across seniority. "Previously," she notes, "firms closed offices, shed support staff, and cut back on perks. Now they've taken an ax to some of the senior lawyers, too."

Peter J. Kalis, chairman and global managing partner of K&L Gates, a Pittsburgh firm that ranked No. 70 on the Am Law 100 list last year, with profits per partner at $930,000, pins the industry's brutal cost management on the Great Recession. "What was once taboo—laying off lawyers and cutting a variety of other costs out of the enterprise—became more mainstream," Kalis says.

During the recession, many clients resisted having their accounts handled largely by junior associates, whose relatively low salaries make them profitable for firms, says Bruce MacEwen, a consultant on law firm economics in New York. "If that prop is removed and the law firm wants to keep its PPP up, it has to finally cut equity partners, the denominator," explains MacEwen. "The decrease in that leverage is a secular trend, and I think it's here to stay."

Topping the Am Law 100 in PPP and revenue per lawyer was Wachtell, Lipton, Rosen & Katz, the firm known for mergers and acquisitions, which had PPP of $4.35 million, across 84 equity partners, and revenue per lawyer of $2.29 million. Moreover, its 63 percent profit margin led the industry. (Like Wachtell, top-five performers Sullivan & Cromwell and Cravath, Swaine & Moore chiefly rode Wall Street's dealmaking resurgence.)

The American Lawyer found that the most cost cutting was among the bottom half of its list of 100. Those firms pulled off a 9.7 percent increase in PPP, compared with 5.7 percent for the top half, largely by cutting equity partners at nearly five times the rate of firms in the top half.

It's not all bad for partners: Sparkman says that top-producing rainmakers with lucrative books of business can expect to get unprecedented millions to move to other firms, especially those that have cleared out underperforming partners, and whose cost structures are primed to squeeze more out of incremental revenue.

The bottom line: The Am Law 100 shows that 17 firms exceeded $1 billion in revenue last year. Previously unthinkable cost cutting helped boost profits.

    Before it's here, it's on the Bloomberg Terminal.