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Are We Approaching a Profitability Plateau?

By William G. Johnston and Kristin K. Stark
November 29, 2006

As 2006 comes to a close, it is clear that most law firms are performing very well financially. Throughout the year, firms of all sizes have enjoyed solid productivity and a healthy pipeline of fee inventory. While we will not know the final performance tallies for a few more weeks, we expect firms to post sizeable gains in revenue and profits per equity partner. High single-digit to low double-digit increases in both measures will be common.

As we turn the calendar to 2007, law firm leaders will once again be able to tell their partners that their firm hit ' or exceeded ' budget and that their income will increase. That's the good news.

The bad news is that, as firms have grown more profitable and pushed harder on the drivers of their firms' economics, it is becoming difficult to identify ways to ensure that the double-digit increases in profitability will continue. After all, the economic model of law firms has only a handful of levers (rates, realization, leverage, utilization, expenses). Once firms pull as hard as possible on each lever, there is not much more they can do. For law firm leaders, managing the expectations of their partners will become a more difficult challenge, particularly since a good portion of those partners have come to expect double-digit increases in profitability each year.

In our work with law firms, we are often asked to assess a firm's financials, identify issues and, more importantly, suggest ways to enhance profitability. As the industry has become more competitive, enhancing profitability has taken on increased importance as firms try to figure out how to maximize their profits in order to retain key personnel and attract lawyers to the firm. There is no reason to think this will change anytime soon.

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