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So Far So Good for the Legal Industry

By ALM Staff | Law Journal Newsletters |
September 01, 2003

It's been a dramatic year so far for the legal industry, with signs of improvement evident, according to Hildebrandt International's mid-year report. The company provided a summary of the report for Law Firm Partnership & Benefits.

With the number of dramatic events so far this year, and the economy's impact on the legal profession being so difficult to predict – preparing a mid-year report has been challenging.

Operating Performance

The first half of the year can best be described as “choppy.” Many law firms have reported sluggish collections during the first half of 2003. Corporate activity remains relatively modest, although there are recent signs that transaction levels are increasing as financial markets recover from the significant decline in equities that began 3 years ago. Firms that have been heavily reliant on transactional practices, especially in the technology sector, remain under pressure.

On the positive side, litigation, especially intellectual property and products liability, remains strong at most firms. Bankruptcy, while continuing to show strength, is slowing, suggesting a gradual improvement in overall economic conditions. The recent uptick in corporate and M&A transactions is encouraging, although it is too early to say whether those practices have turned the corner.

We also note how well many small and mid-sized firms have performed during the recent slowdown. The strong performers in this category tend to be firms with a well-formed sense of strategic direction and practice focus, as well as a competitive level of profitability and compensation that suits the objectives of most key partners.

On balance, with certain exceptions noted below, the profession appears to be in reasonably good shape. We believe that most law firms will experience revenue and profit growth similar to last year, with revenues increasing about 8-10% year-to-year and profits increasing at a slightly slower pace, in the 8-9% range. With the exception of professional liability costs, where we are seeing insurance premiums increasing by as much as 30% and deductibles rising at a similar or even faster pace, most firms seem to have their expenses under control.

Client Trends

On the client side, friction with outside service providers is always higher during periods of economic softness. Law departments continue to be under constant pressure to hold the line on expenses. We see this reflected in client demands for discounts, cost disputes and displeasure with firms that are unable to adhere to budgets. We also see an increasing trend toward outsourcing, as clients address their legal services needs in the context of internal constraints on law department growth. In addition, we sense that corporate clients continue to take steps to reduce the number of outside law firms they utilize. And clients in the financial services area are moving to adopt legal panels.

Law firms should also be alerted to the growing interest in outsourcing some legal work offshore. If the trend continues, it could have significant impact in firms with commodity practices and could also affect the performance of legal research as well as trademark and patent prosecution. Intellectual property firms are expected to continue to face increasing competition from general practice firms for high-level intellectual property litigation.

Finally, law firms should note the growing impact of The Sarbanes-Oxley Act, which recently celebrated its first anniversary. Over time, we believe that legislation will lead more corporate clients to make outside counsel hiring decisions that will withstand the highest level of independent scrutiny. Sarbanes-Oxley also places renewed emphasis on quality lawyering and risk management.

With few exceptions, we believe all these factors will, in the long run, lead corporate law departments to select larger firms with highly respected and well-established practices.

Dissolutions

On a less positive note, law firm management should draw its attention to the increasing level of firm dissolutions, including several highly publicized failures that have occurred in the past 6 months. These dissolutions are a natural occurrence in the late stages of an overall economic turndown. We believe these failures have common themes:

  • Weak management, often with leaders who have lost touch with their partners;
  • High debt levels (sometimes not fully disclosed to partners);
  • A growth plan based on size rather than a well thought out strategy;
  • An eat-what-you-kill compensation system; and
  • A lack of core values and institutional loyalty.

We would not be surprised to see additional failures in the second half of 2003. Firms that are experiencing difficulty this year should seek advice and address their problems before they join the growing list of failed firms.

Consolidation

Consolidation continues in the profession at all levels, sizes, and geographies. Mergers and rumors of mergers continue to dominate the news, although we expect to see fewer mergers this year than last. However, merger discussions currently in progress involve larger firms than in recent years.

Consolidation also occurs with the move of lateral partners. Lateral partner activity continues to be at a high level. The trend is favoring larger, more well-established firms with the infrastructure, resources and economics to attract the strongest practitioners. The lateral market is tricky, however. And while it is dangerous to generalize, some partners who move sequentially from firm to firm are self-centered and anti-institutional in their behavior. An increasing number of firms are fed up with disruptive partners regardless of their economic contribution. Firms are cautioned to be careful in the lateral market and perform their due diligence well.

Professional Development

Many law firms are placing an increased emphasis on professional development, including improved peer review and even upward review procedures, executive coaching, and a growing recognition of the importance of continuing education and training. The Hildebrandt Institute programs are expanding at a fast pace in these “softer” areas, reflecting a maturation in the legal services industry that mirrors an emphasis on human resources issues that began decades ago in the general business community.

International Investment

Investment by U.S. firms in international operations is growing. At the same time, the economic performance of many U.K. firms reflects a downturn in the market caused primarily by heavy reliance on corporate finance and related work. Domestic firms, particularly large New York firms, have been increasing their investments throughout Europe and we believe they are gaining ground on some of the U.K. firms. It is clear to us that a number of U.S. firms now have very profitable offices operating in London and on the continent – we expect that trend to continue. Unfortunately, there remain a large group of U.S. firms who have invested money and resources in an international presence with no clear strategic focus.

Summary

The economy is showing signs of improvement and should have a positive effect on performance in the second half of this year and, more importantly, in 2004. This is the time for law firms to be planning for investment and the predictable shift in practice emphasis.



Hildebrandt International www.hildebrandt.com

It's been a dramatic year so far for the legal industry, with signs of improvement evident, according to Hildebrandt International's mid-year report. The company provided a summary of the report for Law Firm Partnership & Benefits.

With the number of dramatic events so far this year, and the economy's impact on the legal profession being so difficult to predict – preparing a mid-year report has been challenging.

Operating Performance

The first half of the year can best be described as “choppy.” Many law firms have reported sluggish collections during the first half of 2003. Corporate activity remains relatively modest, although there are recent signs that transaction levels are increasing as financial markets recover from the significant decline in equities that began 3 years ago. Firms that have been heavily reliant on transactional practices, especially in the technology sector, remain under pressure.

On the positive side, litigation, especially intellectual property and products liability, remains strong at most firms. Bankruptcy, while continuing to show strength, is slowing, suggesting a gradual improvement in overall economic conditions. The recent uptick in corporate and M&A transactions is encouraging, although it is too early to say whether those practices have turned the corner.

We also note how well many small and mid-sized firms have performed during the recent slowdown. The strong performers in this category tend to be firms with a well-formed sense of strategic direction and practice focus, as well as a competitive level of profitability and compensation that suits the objectives of most key partners.

On balance, with certain exceptions noted below, the profession appears to be in reasonably good shape. We believe that most law firms will experience revenue and profit growth similar to last year, with revenues increasing about 8-10% year-to-year and profits increasing at a slightly slower pace, in the 8-9% range. With the exception of professional liability costs, where we are seeing insurance premiums increasing by as much as 30% and deductibles rising at a similar or even faster pace, most firms seem to have their expenses under control.

Client Trends

On the client side, friction with outside service providers is always higher during periods of economic softness. Law departments continue to be under constant pressure to hold the line on expenses. We see this reflected in client demands for discounts, cost disputes and displeasure with firms that are unable to adhere to budgets. We also see an increasing trend toward outsourcing, as clients address their legal services needs in the context of internal constraints on law department growth. In addition, we sense that corporate clients continue to take steps to reduce the number of outside law firms they utilize. And clients in the financial services area are moving to adopt legal panels.

Law firms should also be alerted to the growing interest in outsourcing some legal work offshore. If the trend continues, it could have significant impact in firms with commodity practices and could also affect the performance of legal research as well as trademark and patent prosecution. Intellectual property firms are expected to continue to face increasing competition from general practice firms for high-level intellectual property litigation.

Finally, law firms should note the growing impact of The Sarbanes-Oxley Act, which recently celebrated its first anniversary. Over time, we believe that legislation will lead more corporate clients to make outside counsel hiring decisions that will withstand the highest level of independent scrutiny. Sarbanes-Oxley also places renewed emphasis on quality lawyering and risk management.

With few exceptions, we believe all these factors will, in the long run, lead corporate law departments to select larger firms with highly respected and well-established practices.

Dissolutions

On a less positive note, law firm management should draw its attention to the increasing level of firm dissolutions, including several highly publicized failures that have occurred in the past 6 months. These dissolutions are a natural occurrence in the late stages of an overall economic turndown. We believe these failures have common themes:

  • Weak management, often with leaders who have lost touch with their partners;
  • High debt levels (sometimes not fully disclosed to partners);
  • A growth plan based on size rather than a well thought out strategy;
  • An eat-what-you-kill compensation system; and
  • A lack of core values and institutional loyalty.

We would not be surprised to see additional failures in the second half of 2003. Firms that are experiencing difficulty this year should seek advice and address their problems before they join the growing list of failed firms.

Consolidation

Consolidation continues in the profession at all levels, sizes, and geographies. Mergers and rumors of mergers continue to dominate the news, although we expect to see fewer mergers this year than last. However, merger discussions currently in progress involve larger firms than in recent years.

Consolidation also occurs with the move of lateral partners. Lateral partner activity continues to be at a high level. The trend is favoring larger, more well-established firms with the infrastructure, resources and economics to attract the strongest practitioners. The lateral market is tricky, however. And while it is dangerous to generalize, some partners who move sequentially from firm to firm are self-centered and anti-institutional in their behavior. An increasing number of firms are fed up with disruptive partners regardless of their economic contribution. Firms are cautioned to be careful in the lateral market and perform their due diligence well.

Professional Development

Many law firms are placing an increased emphasis on professional development, including improved peer review and even upward review procedures, executive coaching, and a growing recognition of the importance of continuing education and training. The Hildebrandt Institute programs are expanding at a fast pace in these “softer” areas, reflecting a maturation in the legal services industry that mirrors an emphasis on human resources issues that began decades ago in the general business community.

International Investment

Investment by U.S. firms in international operations is growing. At the same time, the economic performance of many U.K. firms reflects a downturn in the market caused primarily by heavy reliance on corporate finance and related work. Domestic firms, particularly large New York firms, have been increasing their investments throughout Europe and we believe they are gaining ground on some of the U.K. firms. It is clear to us that a number of U.S. firms now have very profitable offices operating in London and on the continent – we expect that trend to continue. Unfortunately, there remain a large group of U.S. firms who have invested money and resources in an international presence with no clear strategic focus.

Summary

The economy is showing signs of improvement and should have a positive effect on performance in the second half of this year and, more importantly, in 2004. This is the time for law firms to be planning for investment and the predictable shift in practice emphasis.



Hildebrandt International www.hildebrandt.com

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