While revenues and profits have continued to increase as demand for legal services expands, law firms have found it difficult to improve productivity at the same time. This is in spite of higher spending on technology and people, which should bring about efficiency gains.
Our research into the accounts of the top 50 law firms for 2018/2019 show that while revenues rose 7.3% over the year, expenses also rose. This has left operating profit margins marginally lower: down 1% this year. This reverses the improvement seen last year, when operating profit margins rose 1.2%. In other words, although firms are growing revenues, they are becoming less efficient.
Of course, law firms aren’t alone in struggling to improve productivity. The UK as a whole is wrestling with lacklustre productivity growth. Academic research earlier this year showed the productivity growth slowdown since the 2008 financial crisis has been nearly twice as bad as the previous worst decade for efficiency gains, 1971-1981. It attributed the weakness to the amount of time diverted to Brexit planning, the legacy of the 2008 financial crisis and weaker gains from technology.1
These may partly explain the lack of productivity growth for legal firms as well. After all, this year, staff costs are better contained, suggesting this isn’t the source of the problem. The average cost per employee rose 2.8% compared to 4.1% in the prior year. It is likely therefore that competitive pressures on fees are playing a crucial role. Clients are making firms work harder to earn the same fees, while different pricing structures are emerging.
Rising profits have fed through to a greater amount being available for distribution to partners, up 8.5% compared to 8.0% the previous year, but the average profit per member has not grown as much – up 6.8% this year, compared to 5.7% last year. The profits made by each firm are being shared across a wider group of partners, which may imply firms are having to promote partners earlier than they would ideally like in response to competitive threats. Alternatively, they may be choosing to invest more in their younger talent. Or, of course, it may be a bit of both.
Revenue per lawyer grew more slowly over the year, rising just 3.1% compared to 4.8% the previous year. This increase in revenue per lawyer is approximately in line with an inflationary rise in fee rates, suggesting that the underlying volumes of work completed by individual lawyers has remained static over the last 12 months.
The lack of improvement in productivity may be a problem as we enter a crisis. However, it is not readily solved without investment and firms are unlikely to launch a productivity drive in the teeth of a crisis. Tackling productivity is best done when business is buoyant. This is one to bear in mind for the recovery.
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.
This article was previously published on Smith & Williamson prior to the launch of Evelyn Partners.