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In a recent report by Thomson Reuters, it has been revealed that the nation’s top 100 grossing law firms are undergoing a financial recovery that differs significantly from that experienced by midsize firms. This so-called “bifurcated recovery” is characterized by varying strengths and challenges faced by different segments of the legal industry.
According to the Law Firm Financial Index, a composite score measuring financial factors driving firm profitability, the first quarter of 2023 saw a positive but divergent financial improvement. The index rose by 14 points to reach a score of 44, indicating a rebound from its all-time low in the last quarter of 2022. However, it is important to note that despite this improvement, the index remains at historically low levels.
The report attributes this recovery to a combination of factors, including historic rate increases, a slowdown in expense growth, and the emergence of counter-cyclical practice areas. These factors collectively helped law firms break a year-and-a-half streak of decline.
Midsize firms, in particular, have seen some positive developments amid this recovery. Demand for legal services increased by 1.8% in the first quarter of 2023 compared to the previous quarter. Additionally, counter-cyclical practices such as litigation, labor and employment, and bankruptcy experienced a growth rate of 4%. Midsize firms also demonstrated better relative performance in transactional practices, although the overall market for such practices is contracting.
Despite these positive trends, midsize firms face their own set of challenges. They have witnessed a significant growth in lawyer headcount by 4.9% compared to the first quarter of 2022. Moreover, direct expenses, which include compensation and benefits for non-equity partner lawyers, have increased by 8.3% year-to-year.
On the other hand, Am Law 100 firms, comprising the top-grossing firms, have their strengths to highlight. The growth in worked rates and the prices clients pay after negotiations reached a record high of 7.2% since the first quarter of 2022. Additionally, headcount at Am Law 100 firms increased by a modest 2.8% since the same period. Moreover, these firms experienced a significant slowdown in direct expenses, with only a 4.8% year-to-year growth rate.
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However, Am Law 100 firms also face challenges of their own. Demand for legal services decreased by 1.5% in the first quarter of 2023 compared to the previous quarter. Additionally, collection against worked rates has declined more for these firms than for others.
The report concludes that this divergent recovery, with distinct revival patterns for different segments of the legal industry, underscores the precarious state of the industry, as every strength seems to come with a drawback. The varying financial realities highlight the need for law firms to adapt their strategies and navigate these challenging times effectively, irrespective of their size.
In summary, the legal industry is witnessing a split recovery, with top-grossing and midsize firms experiencing different financial trajectories. While midsize firms face challenges related to expenses and headcount, Am Law 100 firms are dealing with declining demand for legal services. Understanding these dynamics is crucial for law firms to devise strategies that capitalize on their strengths while mitigating the associated challenges during this period of bifurcated recovery.
