Law firm profitability hits lowest level in index history

The previous year's tailwinds "have inevitably turned into headwinds," Thomson Reuters says

Law firm profitability hits lowest level in index history

Law firm profitability has been noting continuous falls for the fourth consecutive quarter due to a low demand for legal services and a rebound in expenses, marking the lowest score in the history of the Thomson Reuters Law Firm Financial Index (LFFI).

It was a sharp contrast to the record levels seen in 2021, when four consecutive quarters saw immense growth in the 3-7% range. Since then, the LFFI noted “it has been precipitously dropping downwards, now reaching a point lower than its nadir during the global financial crisis.”

Although the report said the law firm industry is not necessarily in “dire turmoil,” Mike Abbott, head of the Thomson Reuters Institute, said the peak in the half of 2021 “was due for a break.” This was quickly reflected in the Q2 2022 findings: Demand for law firm services fell 1.5% after significantly being pulled down by a 4.9% slump in corporate mergers and acquisitions work.

Profit-per-lawyer slipped 3.6% in Q2 compared to a 12-month rolling average that ended in Q1 2021. During this period, the growth in non-transactional practices had still failed to counterbalance the slowing count of transactional practices.

Direct expenses also increased 12.4% from higher associate compensation, while overhead expenses increased by 13.5% due to in-office arrangements, inflation and technology spending. Meanwhile, technology spending grew at its fastest pace in eight years at 10.5%.

“Last year’s tailwinds have inevitably turned into headwinds,” Abbott said. “The story of 2022 is more about the rebound in expenses as firms adjust to the current economic environment and wrestle with issues such as how to manage return-to-office or hybrid work. The combination of slowing demand and rising expenses dampened profits in the second quarter, but it’s important to keep in perspective that it’s on the heels of two years of record-high profitability.”

Regardless of these challenges, Abbott noted that rates and realization are helping keep the law firm profitability afloat in the meantime.

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