Are Law Firms Charging Less or Just Making Less?

One potential response to what Richard Susskind calls the “more-for-less challenge” facing the legal industry is for law firms to “simply charge less.” See, “Should Law Firms Charge Less or Differently?,” American Lawyer.

In a market where clients are struggling to deliver more legal services for less cost (the challenge), Susskind says a law firm may be tempted to undercut its competition on price in hopes of winning more work.

But is it actually happening?

While most agree that clients have more leverage today than in decades past, there's little evidence to suggest that law firms have begun to lower their rates or “charge less.” That said, clients have exerted their power in a number of other ways — demanding discounts; implementing budgets and fee guidelines — that have cut into law firms' realization rates. Even if law firms aren't charging less, they are effectively making less.

For starters, law firm rates rose more in 2015 than any year since 2010, according to the latest Real Rate Report by Wolters Kluwer. The 5.4% average increase in 2015, however, remains well below the 8% growth that was typically seen prior to the recession.

Top-line rates, though, have come to mean less and less as clients have pushed back on paying them in multiple ways. Thomson Reuters Peer Monitor data shows that growth in rates clients agree to pay — what they call worked rates — are growing at a slower pace than that put forth by the Wolters Kluwer data. Worked rates as of mid-2017 had grown 3% from the prior year, which is slightly higher than the increases seen in the past three years.

But the hemorrhage doesn't end there. Realization against those worked rates has recently declined. After holding between 89% and 90% in previous years, realization in the first quarter dipped below 89% for the first time, to 88.6%. It rebounded slightly, to 89.1%, at the midyear point.

All of which means there is no growth in what clients are paying, according to a newer data set that Thomson Reuters uses to track payments by clients.

“Outside of the Am Law 50, we aren't seeing any appreciable growth in the rates law departments are paying,” says Bill Josten, senior legal industry analyst for the Thomson Reuters Legal Executive Institute.

Josten says the biggest hits to realization don't actually come from clients directly pushing back on bills or requesting write-downs. Instead, Josten says Thomson Reuters data shows that law firms' realization has been hit hardest by actions the law firm takes: Discounting their rates up front and taking write-downs from their bills before they head out the door.

“Some of that is from actual pressure by clients,” Josten says. “Part of it is driven by fear.”

There is one other data point that could convince a managing partner that charging less will not boost your profits.

In a study of what made the country's most profitable firms as successful as they are, Josten says he found that higher realization rates than their less-profitable peers, perhaps unsurprisingly, are a major factor. But the difference in realization is not due to a difference in their clients' behavior.

Josten says the two groups have similar drop-offs in realization after their clients receive the bills. The majority of the difference has to do with law firms discounting their fees or writing down their fees before sending bills to clients. That may suggest that “charging less” is more likely to crimp profit margins than it is to bring in new clients.

“I don't know that it's so simple to say that lawyers are going to just have to charge less or will end up charging less,” Josten says. “It will be more about tailoring rates to practices that will allow you to profit.”

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Roy Strom, based in Chicago, covers the business of law with a focus on how law firm business models are changing for ALM. He can be reached at [email protected]. On Twitter: @RoyWStrom.