Law firms, like most industries, have seen significant shifts over the past few years, with 2023 possibly its most daunting year yet. Georgetown Law and the Thomson Reuters Institute’s recent report on the 2023 State of the Legal Market1 indicates falling demand, declining profits and realization, and rising expenses for law firms to be wary of.
Legal Industry in Review
The report highlights that law firm services fell from 3.7% growth in 2021 to 0.1% growth in the fall of 2022, citing a decline in transactional work and uncertainty with the economy. Additionally, firms are experiencing record-low productivity. While the industry has seen a steady decline in hours worked per lawyer for more than 20 years, the average is now 119 hours per month – a record low. Likewise, the report’s findings noted a decline in collection realization across all segments of the market. In the wake of the 2021 hiring boom, law firms are seeing a more than 10% year-over-year increase on direct and overhead expenses, due to a relatively high attorney headcount, return-to-office expenses, business development costs and inflation.
Legal Roles and Challengers
In addition to these challenges, the role of a lawyer and services provided by firms are rapidly evolving. With emerging and advanced technologies, and dynamic changes in both business and political climates, attorneys and law firms must now advise their clients on challenges they could face pertaining to the legal, risk and regulatory issues related to data storage, privacy and security, and the implications of various technologies.
Alternative Legal Service Providers (ALSPs) and Big Four accounting firms are becoming more mainstream, providing digital solutions and services, and moving clients away from seeking out a traditional law firm.
Likewise, technological advances coupled with the client-empowered era are fundamentally changing and threatening operations within the legal industry. With the rise of artificial intelligence (AI) and machine learning (ML), in addition to industry-aligned digital platforms, software, apps and labor-intensive tasks, which are lucrative billable hours for firms, may significantly decline or be eliminated. Generative AI such as ChatGPT software, with its human-like language fluency, looms as a new threat to automate lower value-added legal work.
While AI can automate once billable tasks like research and analysis, document management and billing, it also presents a significant opportunity for firms to augment the abilities of legal professionals to do their jobs. Significant efficiencies and cost savings can be established to free up more time to devote to relationship-building and client-focused activities that drive profitability.
Understanding Law Firm Profitability
With the evolving industry landscape, law firms must look for new and innovative ways to maintain and grow profitability. To maximize law firm profitability, firms need to recognize and invest in their most profitable practices, while culling out the less profitable practices.
While firms might manage to endure changes in the legal industry temporarily, the current situation is not sustainable in the long run. To navigate this increasingly complex and dynamic environment, law firms must adopt new operational strategies. This involves reassessing their market positioning, the range of products and services offered, as well as their operations, workflows, and human capital. Firms should also evaluate which practice areas are profitable or unprofitable, focus on strategic investments, and maximize return on investment (ROI). Ultimately, growth depends on a robust business strategy designed for both immediate and long-term success.
Yet, given the fast cadence of shifting firm and client priorities, reevaluating everything in a law firm end-to-end and building an effective future-ready strategy may be unrealistic. Hiring a strategic consultant to challenge assumptions, and design and deliver strategies that will sharpen strategic focus and evolve with the firm may be one of the smartest investments a firm can make in 2023.
Strategic Transformation at Work
A prominent northeast law firm had successfully served clients for over 80 years. While the firm has made notable gains throughout the decades, since 2021 it has experienced declining profitability. Given their extensive expertise with helping law firms transform profits, Cherry Bekaert Digital Advisory was hired to perform a strategic assessment and position the business for growth. The assessment included identifying and guiding the firm through a top-down, bottom-up approach to increase profitability.
Upon an extensive analysis of the firm’s infrastructure, operations, business practices and talent, the Cherry Bekaert team identified their top challenges: lawyers spend a small amount of time practicing law, and administrative and business development initiatives are key distractors.
Given the focus on profitability, the team analyzed revenue and realization data to determine that the single biggest driver in declining profitability for the firm was realization – the gap between time worked and the percentage of time billed to the client. Although this practice saw a 34% increase in revenues in 2021 and 2022, they were only billing 65% of their time worked.
The team also noted that utilization of attorney and professional support staff was an issue. The firm expected to bill more than 100% of attorney time and 87.5% of paralegal time, yet utilization rates were not being met.
Reengineer for Success
A critical step in any strategic assessment is configuring the business for success. The team noted that for the firm to grow and compete, they needed to establish a target margin of 40%, with applied changes in realization and collections, utilization rates, go-to-market practices and operations.
To address the realization and collections revenue gap, the firm is exploring changing their flat fee structure to a retainer structure to include analyzing fee increases, charging for initial consultations and creating hybrid fee structures in a phased approach. With collections, policy changes are under consideration for no work without a retainer, and shift responsibility to financial stakeholders to pursue collections, creating value-added time for attorneys to generate revenue.
From a go-to-market perspective, the team outlined a bottom-up approach with revenue goals tied to each attorney and practice area. Each practice defines its unique strategy to meet the revenue requirements, including identifying and meeting a target number of prospects turned to client. Process guidelines for time entry, acquisition and case management have been outlined with new performance metrics defined to ensure compliance.
To monitor revenue and profitability progress, Sanger and team also proposed leveraging a legal analytics accelerator dashboard for executives to review monthly highlighting outstanding cases, utilization, revenue vs budget and work in progress cases by practice.
Hiring a strategic consultant can play a central role in bridging the gap between escalating costs, expense management and maximizing efficiencies for the modern law firm. A strategic plan helps define the firm’s long-term goals and provides direction for achieving them through actionable plans with contingencies to overcome challenges. With all these elements in place, a law firm is positioned to better predict, innovate, perform and compete.
About Cherry Bekaert Digital Advisory
Cherry Bekaert’s Digital Advisory team is comprised of strategists who have broad industry experience and keen business acumen. Utilizing an agile and flexible approach, we help examine what you want to achieve with a focus on people, process, technology and culture. We help organizations manage risks, enable growth and support sustainable operations. Leveraging our strategic process, we help digitally enabled organizations – especially middle-market companies – do more with less.
Resources:
1Greggwirth. “2023 Report on the State of the Legal Market: Mixed Results and Growing Uncertainty.”
Thomson Reuters Institute, 9 Jan. 2023, www.thomsonreuters.com/en-us/posts/legal/state-of-the-legal-market-2023/?cid =9073055&chl=pr&sfdccampaignid=PR. Accessed 30 June 2023.
