A quick look at the numbers for the first three quarters of 2011 suggests that there is good news for the law firm industry–and some cause for a little concern. Collections were strong during the third quarter, but growth in demand slowed down, leading to a notable reduction in the growth of inventory–work that has been performed but not yet collected on. Now, as we head toward the end of the year, firms are seeking gains in profitability will need to consider carefully just how hard to push for collections and how many expenses for 2012 to prepay in the fourth quarter of 2011.
For the first three quarters of 2011, revenue was up 5.2 percent across the industry, gaining a bit of momentum from the middle of the year. The increase was driven by the strong inventory levels at the end of the first half of 2011, rate increases holding steady, and a likely continued improvement in realization–all of which would offset the slowdown in demand growth.
The law firm leaders were definitely right to be concerned. Cumulative growth in demand for the first nine months was 1.5 percent, which is down from 1.8 percent during the first six months. This indicated that growth in the demand slowed to only 0.9 percent for the third quarter. This is probably the result of the slowdown in transactional work caused by the market shake-up. The slowdown has hit Am Law 50 firms (which is the 50 highest-grossing firms on The Am Law 100) pretty hard.
The collections in the third quarter of 2011 were so strong that revenue growth outpaced expense growth. This was a reversal of the trend we had seen at the midyear point, when the expenses were growth at a much faster rate than the revenue. The result was an easing of pressure on profit margin across the industry.
At 3.7 percent, the rate increases held steady from the midyear point, continuing to slightly outpace the industry growth rates that were seen back in 2009 and 2010, though they are not back to the levels of 2001-2008. Anecdotal evidence suggests that realization improved or at least stabilized for most of the firms. The rate increases and improved or stabilized realization might have contributed to an easing of the pricing pressure throughout the first nine months of 2011.
The expenses, which had already risen by 4.7 percent during the first half of 2011, continued to gain momentum during the third quarter, as they have now increased 5 percent across the industry for the first nine months of this year. This was driven by a continued increase in operating expenses–and in compensation expenses, since there has been a slight uptick in head court during the third quarter, most likely due to the entry of first-year associates.