Big Law Still Needs to Get a Lot Smaller

It’s known as Big Law for a reason, and right now it’s the “Big” that’s creating challenges for many global law firms. Lawyer capacity is too damn high. If demand doesn’t come back, analysts at Citi Private Bank’s Law Firm Group and those at Wells Fargo Private Bank’s Legal Specialty Group predict the problem will make it harder to achieve revenue growth well into 2014.

The Citigroup unit released its latest Law Watch Quarterly Flash on Tuesday, and observers point to a modest rise in law firm revenue as a hopeful sign. A 2.7 percent increase in the first nine months of the year over the same period in 2012 has been driven in large part by a third-quarter jump in M&A activity. Wells Fargo, meanwhile, cites a 2.5 percent revenue increase year-over-year for the same period. But the remaining quarter could substantially alter the picture that’s so far emerged, and it’s a safe bet that the revenue increase is not a sign of better times ahead.

“The third quarter last year was quite weak, while the fourth quarter was unusually strong,” says Gretta Rusanow, a senior client adviser at Citi’s Law Firm Group. “That performance led to overall growth in revenue for 2012, because all the work that was done last December” tied to uncertainty over taxes in 2013. “So you’ve got that unusually strong base quarter to contend with.”

With few exceptions, America’s largest law firms are still suffering from the effects of the recession. Overall demand for services delivered by well-compensated lawyers has fallen. Clients are scrutinizing legal bills more closely, asking for discounts, and demanding alternatives to hourly billing. The effects on more junior lawyers and those hoping to enter the profession, as well as on nonlegal staff, have been severe. Mass layoffs in early 2009 gave way to decreased incoming associate class sizes, furloughs, increased reliance on legal process outsourcing, and staff cuts.

Now and then, news of more layoffs surfaces. It did in June when Weil, Gotshal & Manges, a firm of roughly 1,100 lawyers in 21 offices around the world, announced it was cutting 60 associates and 110 nonlawyers; it also cut the compensation of 10 percent of its 300 equity partners. Fried, Frank, Harris, Shriver & Jacobson, with about 470 lawyers, recently decided to eliminate 29 staff positions, including legal secretaries, library personnel, and legal assistants, in its New York and Washington (D.C.) offices.

Legal industry consultants and observers have predicted as yet unrealized massive upheaval and disruption. But many law firm leaders have largely stuck to business as usual, holding out hope that things will turn around.

None of the mildly optimistic results in the Citi and Wells Fargo reports—operating expenses, for instance, remained essentially flat through the end of the third quarter, and the billing collection cycle shortened—do much to alleviate the burden of too many lawyers and not enough work to go around. And while increases in lawyer head count slowed (from the second to the third quarter) and equity partner head count dropped slightly (by 0.3 percent in the first three-quarters, compared with the same period in 2012, according to Citi’s numbers), those cuts don’t adequately address the problem. Productivity today suffers from a gap of roughly 100 billable hours annually per lawyer from the five years before the recession—equal to about 6.5 percent excess capacity. Most of that, says Rusanow, is concentrated in the ranks of income partners and of counsel.

“Despite the head-count adjustments firms took, post-recession, we still see this persistent excess capacity,” Rusanow says. Wells Fargo’s Jeff Grossman put it more bluntly in an interview with The American Lawyer: “Not enough partners are being asked to leave.”

It’s a familiar story: law firms operating in a state of denial. It was in full view in the failures of law firms Howrey in 2011 and Dewey & LeBoeuf in 2012. When will reality finally set in?

Law firm consultant Bruce MacEwen, who has written extensively about the evolution of law firm business, says change is coming soon. Given the market dynamic right now, he says, firms really need to keep up equity partner profits to remain competitive for lateral hires and not to shed partners they don’t want to lose. “If you’re not really growing revenue and not really growing profit, the only way to do that might be to cut the denominator,” MacEwen says. “I think that’s what a bunch of firms are starting to do. We’re just seeing the very first glimmers of what could be a serious downsizing of some of these firms.”

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