Law firm profitability is not what it seems

By Yves Faguy January 12, 201812 January 2018

Law firm profitability is not what it seems
Photo by Mike Wilson on Unsplash



The 2018 edition of the annual Georgetown/Thomson Reuters Report on the State of the Legal Market paints a portrait of law firm financial performance very much following the trend of years past, characterized by sluggish growth in demand, a decline in productivity, a modest rise in rates, decline in realization rates and a modest rise in expenses (on account of salary increases at the associate level).

First a quick caveat. The report is squarely focused on U.S firms, mid-size and bigger, but the patterns should be of interest to firms in the Canadian marketplace.

And the takeaway message from this report is that law firms are far less profitable than they used to be before the financial crisis, and that any lingering notion that “law firms are among the world’s more profitable businesses” is pure fantasy:

As described by Chris Johnson, former Chief Global Correspondent for American Lawyer Media, the average profit margin reported for Am Law’s Global 100 firms is 39 percent, with the highest profit margin in the group reaching almost 68 percent – some three-and-a-half times the margin of Apple Inc. and nine times that of Berkshire Hathaway. While such stratospheric profit margins may provide some comfort to law firm partners as well as consternation to their clients, the truth is that they are completely misleading.

The skewed results described above result from the simple fact that, when a law firm reports its “profit,” it takes no account of the cost of its equity partners. It simply pays out all of its net income to equity partners and treats the entire amount as “profit.”

The reason for this, Johnson goes on to explain, is that an equity partner’s draw (therefore not salary) does not represent a cost to the business in accounting terms.

The problem, the report goes on to show, is that this manner of calculating profitability has created a false sense of security among firms, in spite of the fact that revenue per lawyer is lower than it was at the start of the last major economic downturn.  Noting that there have been eight years of economic expansion following the financial crisis, the report sounds the alarm that law firms will have fewer tools at their disposal to respond to the next recession, which is probably overdue.

The report does offer some hope, as it points to some firms who have moved proactively to embrace alternative staffing strategies, improvements in workflow efficiency, and different pricing models, as well as incorporating technology into their practices. Unsurprisingly, these firms tend to score higher in terms of revenue per lawyer and total profit than those that don’t.

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