Position isn’t destiny — especially times of turmoil. Eight charts illustrate the true extent of volatility underlying apparent stagnation in legal markets and give an advance peek at the state of play for 2021.
This post is the third in a 5-part series, #GreatExpectations for the #GreatReset. The aim of this series is to provide a shared foundation of fact and data to help envision the market dislocations likely to occur in the current economic downturn and recovery.
Part I (216) covered a retrospective on the last downturn (with emphasis on debunking a few long-enduring myths 🤥) and commentary on the changing socioeconomic context around the legal market. Part II (217) explored the economic impacts of COVID-19 with emphasis on how a K-shaped recovery leads to widely divergent outcomes for the haves 🧐🎩 and the have-nots 😰💸.
Like Part II, today’s post is a bit experimental in format: a collection of charts to explore a single concept. The central theme of Part III is 🎢 volatility in legal markets, with emphasis on how that volatility leads to second- and third-order impacts on law firm performance as well as strategic prospects for adjacent segments. (The other experimental aspect of Parts II and III — “snack-sized” — did not work out so well. 😇 As I’ve been gently informed by several readers, both parts turned out to be more 🍔🍝🍛 and not so much 🍿🥜🍧🧁 .)
🎊 As a bonus we also dig into preliminary law firm results for 2020 and highlight the firms & trends to watch in 2021.
🌦️ In true 2020 fashion, the early returns are confusing and misleading
The annual Thomson Reuters – Georgetown Report on the State of Legal Market is 🔥 off the presses. Given the economic turmoil of 2020, many will 👀 with interest. As projected by ALM reporting and the annual Citi-Hildebrandt Client Advisory (both relying on on preliminary analysis of YTD Q3 data), law firms collectively turned in 2020 results far exceeding initial expectations from March (which to be fair ranged from 😱 to ☠️). See Post 217 (noting intensity and speed of Coronavirus Correction).
A quick recap of the widely reported headlines.
💰 Notably, law firms across all size-based segments (AmLaw 100 / Second 100 / Mid-size) closed the books on 2020 with projected PPEP growth above the 10% range — a statistic that will surely come back to 🧟 haunt 👻 law firms in 2021.
📉 TR/Georgetown projects a 2.9% decline in demand overall (a figure that obscures the severity of revenue-side headwinds facing legal markets).
🥋 PPEP growth is largely a result of “aggressive” cost-side discipline, with TR/Georgetown reporting a 1.7% decline in lawyer FTE (the first headcount contraction since 2009) and 81% of firms reporting that they halted or dramatically reduced all discretionary expenses.
The graphic below provides an annotated summary of critical KPIs, followed by more detailed commentary.
💸 “Demand decline of 2.9%” distorts reality
The chart to the left breaks down change in demand by practice areas as reported by TR/Georgetown. The x-axis (left to right) indicates percentage change in 2020 from 2019 (both YTD through November). The y-axis (top to bottom) gives a visual sense of the overall percentage share of each practice, one that retains some fidelity to the actual financial impacts experienced by firms depending on their practice mix.
To give further context, I have appended an additional notation (color-coded $$$$) to each practice to indicate the extent and range of price pressure in each practice area. Red and pink $ indicate severe and moderate pricing pressure, respectively; blue $ indicates premium prices up to and including full rack rates. The number of $ roughly indicate the tranche composition of each practice across the value spectrum.
- Bankruptcy & restructuring mandates remain premium-priced, although I suspect the widespread liquidity crunch and insolvency concerns in 2020 may lead to eroding price levels in the SME and mid-cap brackets.
- Similarly, tax has historically been a relatively price-protected practice, although more routine tranches are under attack by renewed vigor in Big 4 encroachment.
- Both corporate and litigation are mixed bags; while “bet-the-company” mandates remain price-protected, larger tranches are coming under corporate legal scrutiny and expectation of AFAs and deep discounts.
- Patent prosecution, and to a lesser extent routine real estate and labor & employment, have long been under intensifying price pressure.
In keeping with our recent themes, demand depression in 2020 was widespread but not evenly distributed. While bankruptcy & restructuring remains the sole “bright spot” in an otherwise abysmal year, two points to curb your enthusiasm:
🥊🥧 More firms fighting for tiny slices from a very small pie (2% share of outside counsel demand).
👩👩👦👨👩👦👦 A space already dominated by top-tier prestige brands (Kirkland, Latham, Skadden, Davis Polk, Weil) becoming very crowded with a majority of firms chasing the cyclical pop in demand.
Litigation, tax, real estate and patent litigation were hit hardest, although an overall decline of 1% in corporate is much more sanguine news than I expected. Across all these practices I suspect demand decline was more severe in price-protected tranches, based on both firsthand observations as well as what I’ve heard across the corporate legal & law firm segments. If that hypothesis holds up, most law firm P&Ls will be hurting on the revenue side, not only in 2020 but also into the front half of 2021.
We will take a closer look at that hypothesis shortly, but first a quick backward-looking analysis of the firms at the apex of the legal market.
⛰️ Recessions make for bumpy roads, even in rarified air
Marketwide characterizations of demand changes are intrinsically misleading because they blend the experience of both winners and losers. The phrase “flat demand,” suggestive of still waters, sounds 🥱 staid and boring 😴. In reality, law firms have been drowning in a 🩸 red ocean 🦈 of intensifying competitive pressure for the better part of a decade.
When demand stagnates, the majority of new revenue comes from takeaways, and displacing an entrenched incumbent is very difficult indeed. Locked in a never-ending street fight for new work, law firms have bled out profits (from self-inflicted wounds as well as those sustained in battle). The results are apparent when tracing back the year-to-year performance outcomes of specific firms, even for the blindingly pedigreed and fabulously successful.
Since 2014, ALM has anointed a select cadre of firms as the “Super Rich”: for the 2020 class (based on 2019 performance), the bars to clear were $1.1m in RPL and $500k in profits per lawyer (to wash out the effects of widespread PPEP inflation by means of de-equitization). The graphic below provides a visual comparison of 34 (current and erstwhile) Super Rich firms:
On the left, three data points indicate both volatility (range of YOY swings) and vector (extent and direction of movement) for RPL in the past five years. To the right, trendlines trace back both inflation-adjusted dollar figures and YOY percentage changes for RPL and PPEP.
Within the context of today’s post, the above data presents five primary points of interest:
🏆 Particularly when adjusted for inflation, analysis of RPL volatility tends to separate the very creamiest 🍨 from the rest of the cream 🍦. Since the subprime crisis, only three firms have posted an unbroken 7-year stretch of RPL growth: Fried Frank, Ropes & Gray and Kirkland. RPL remains the metric most impervious to manipulation in performance reporting and also the best indication of YOY demand volatility as actually experienced by law firms. A product of utilization (hours) and pricing (rates), superb RPL performance highlights demand-led firms performing well on the “stakeholder” side. These firms usually have strong platforms with strategic underpinnings that help match supply-side talent (practice mix and footprint) with demand-side go-to-market (client base composition across industries and geographic markets).
🧐 PPEP (though much maligned and misused) gives some indication of how well firms manage the “shareholder” side of the business. Strong fundamentals in finance and operations, coupled with cost-side discipline and resolute performance management across partner ranks can keep PPEP on track despite demand-side headwinds. The vast majority of BigLaw firms have followed this playbook, and the relative stability of PPEP performance helps explain why: most law firms manage what they can control.
🌦️ Volatility is not necessarily bad. The most prestigious and profitable firms absorb elevated volatility intrinsic to their core business: high-value mandates across big deals (transactions) and big cases (disputes) are mostly episodic and extraordinary occurrences for clients. This presents a much higher degree of difficulty and complexity in the supply-demand matching exercise — one of several economic reasons these mandates continue to command relative price premiums. Cahill and Cravath are good examples.
⚠️ For the firms just below the apex, however, RPL volatility is harder to absorb and poses a much larger threat. A study of the Super Rich is instructive in establishing a natural break between packs. For PPEP, the break occurs in the mid-$3m range; for RPL, in the mid $1m range. Cleary, Williams & Connolly, and King & Spalding are erstwhile Super Rich firms that have fallen off the list. While many firms outside the Super Rich designation will endure and prosper, sustained RPL decline is suggestive of eroding strategic position.
🔮 Lastly, a historical view of the Super Rich gives some indication that 2019 was a softening year with advance headwinds leading into the current downturn. Of the 14 firms above posting RPL declines, we see a few perennial high performers at very low risk (in particular, Paul Weiss and Skadden).
🥊 Competition occurs at the practice level
Put differently, competition is essentially a contest among two or more plausible options for the same opportunity. Thus, actual demand for legal services remains tightly coupled to the nature of the work at hand, and drivers of client need for services also remain tied to business cycles.
This is a blindingly obvious observation with some implications that are not so obvious. We have all heard ad nauseum that litigation is a countercyclical practice and at some level it makes intuitive sense that deal work dries up in a recession:
What is not so obvious is how those principles play out across sectors under varying pressure in recession and during K-shaped recoveries. The below graphic summarizes McKinsey’s practice outlook for 2020 as of May, overlaying market pressures on client sectors onto likely demand patterns across practice areas. Of course, the board changed quite a bit by the end of the summer, with TMT and healthcare enjoying a healthy rebound. See Todd Babitz and Alex D’Amico et al, “COVID-19: Implications for Law Firms,” McKinsey.com, May 4, 2020. See also Post 217 (recapping trajectory of Coronavirus economic impacts).
🤥 Declining demand in 2020 is #BIGLY #FakeNews
As against this context, we return to the earlier hypothesis that widely reported demand trends likely obscure and distort the real story of 2020. A recent article (a) noted that profit growth in 2020 was largely a result of expense control and (b) predicted that slashing expenses and posting record profits may cause prolonged rate pressure in 2021. See Roy Strom, “Big Law’s Windfall Profits May Lead to Prolonged Rate Pressure,” Bloomberg Law, January 14, 2021.
I concur we’ll see client resistance to rate increases in 2021, but I can’t agree with the proof. While PPEP figures from 2020 certainly could inject added vehemence to client frustrations, BigLaw profits are not the primary cause of sustained and elevated rate pressure. That rate pressure has been with us for quite some time. See, e.g. Blog Posts, “6.5.20: COVID-19 Crisis Series LAW FIRM,” Legal Value Network, June 5, 2020 (summarizing flash poll responses of law firm leaders on client requests for cost reduction help and discussing client and law firm pressures to accept work at discounted rates) and “5.8.20: COVID-19 Crisis Series LAW FIRM,” Legal Value Network, May 8, 2020 (implicit client resentments on law firm profitability and the fallacy of buyer-dictated prices).
I’ll restate my case, in 5 parts:
(1) Actual demand — if defined as client-side need for legal services — is (way) up, not down. See Post 216.
(2) The pandemic led to net-new and unplanned uptick in demand. The “more with less” challenge for corporate legal departments was further escalated by the extraordinary demand generated by COVID-19 on heretofore unexamined issues, raised with extreme immediacy and amid unprecedented and widespread chaos (workplace safety, shelter-in-place protocols for employees and customers, the barrage of exotic contracting concerns around force majeure provisions). A ⛈️ perfect storm 🌪️ of unplanned need for urgent advice and counsel on a wide range of non-routine issues suggests non-negligible reliance on outside providers to meet peak workloads. What I saw and heard in 2020 confirms that many clients did indeed rely on outside providers for these unplanned needs.
(3) On balance, I’d guess both in-house staff and outside providers performed 😓 more work 😩 this year than reflected in reported figures. While clients reported in surveys that they performed more work, law firms reported legacy metrics that imply reduced workloads on a per-lawyer basis.
(4) What changed in 2020 is not the total amount of work performed, but rather the composition of that work. I suggested above that demand decline was more severe across historically price-protected practices. As clients delayed or canceled work that was considered important prior to the pandemic, they instead redirected finite resources (in-house labor, time and attention as well as budget for the external supply chain) to urgent and unforeseen concerns triggered by the pandemic.
(5) What declined sharply in 2020 is not hours worked but rather client willingness to pay, followed by law firm headcount. While the legal work necessitated by the pandemic was business-critical for many corporate buyers to maintain operational stability and financial viability, market forces converged to erode providers’ pricing power for these services. Based on multiple factors, my sense is that much of the initial wave of pandemic-related advice and counsel was provided at far below prevailing rates.
🚨 Firstly, the initial chaos and uncertainty in March and April raised serious concerns of widespread liquidity crunch and resulting waves of insolvency. Simply put, clients requested and expected pricing concessions and flexibility payment terms. Some firms were reticent to resist, despite mounting uncertainty translating to the same economic pressures, that haggling over money during a pandemic seemed gauche.
💸 Secondly, many firms were faced with severe concerns regarding excess capacity: as clients halted or deferred discretionary projects, nearly all firms lost booked revenue in mid- to high-margin areas (e.g. M&A) and instead allocated capacity to lower-margin work (#pandemic #helpdesk). Some clients found themselves in pressing need of flexibility from providers; others sought opportunistic reductions to ballooning legal spend.
Let’s take another look at the prevailing narrative around demand, this time focusing on month-over-month patterns:
Worthy of note is that the 2020 demand line roughly tracks the typical seasonality curve seen in most years, but with steeper slopes in March-to-April and July-to-August changes.
After a steep decline from March to April, Q2 figures for billable hours worked are likely artificially depressed due to non-billable time. Most firms allocated significant time and effort to producing pandemic-related resources of varying utility, mostly offered as “value-adds” (and many clients soon reported feeling inundated and overwhelmed by #pandemic #lawfirm #spam). Because the issues at hand were as novel as the coronavirus that caused them, I suspect many partners put touches (and hours) into work that went unbilled. The lift from July to August suggests demand recovery, but I suspect those figures are artificially lifted due to law firm austerity measures, particularly those addressing excess capacity by means of furloughs or reductions.
👀 Trends to watch in 2021
By and large, I suspect what most law firms did in 2020 is much the same as what their corporate clients have done: manage through a tough market environment, on both sides of the P&L. As a result of those efforts, many law firms are reporting better-than-expected profits despite declining revenue, as many clients are doing now. See Martin Baccardax, “Citigroup Smashes Q4 Earnings Forecast On $1.5 Billion Reserve Release, But Revenues Slide,” thestreet.com, January 15, 2020, and Hugh Son, “JPMorgan beats profit estimates on better-than-expected credit, record trading revenue,” cnbc.com, January 15, 2020. See also Blog Post, “The Zacks Analyst Blog Highlights: Amazon, Thermo Fisher, Eli Lilly, Google and CVS Health,” nasdaq.com, January 14, 2020 (noting 67% gain in share price for Amazon, 29% gain for Thermo Fisher, and 20% gain for Eli Lilly).
Of course, performance of individual companies will vary greatly across the changing corporate landscape. Similarly, I expect we will see widening performance dispersion across BigLaw as well as the early stages of structural dislocation in legal markets that will play out over the next five to ten year period.
🧙♂️ BigLaw due for a sorting
🌠 The Kirkland effect. Kirkland’s meteoric (and sometimes bombastic) rise to the top has been the focus of much discussion. An aggressive (and well-financed) lateral strategy coupled with big bets on private equity have paid off so far for Kirkland. See James Fontanella-Kahn, Sujeet Indap and Barney Thompson, “How a private equity boom fuelled the world’s biggest law firm,” Financial Times, June 6, 2019. As the first few waves of three-year guarantees expire, time will tell if Kirkland’s risk-tolerant push to buy upmarket clients along with upmarket clients will sustain for the long haul. In the meantime, expect a rush of copycats to follow Kirkland’s path — and a stampede at the doors of private equity houses to drive up competition (and the pace of discounting) in a market segment that is very well-served by reigning Super Rich and has remained relatively price-insensitive thus far.
💰 Compensation overhaul, up and down the ranks. In the next five years, next-level of frothiness in the lateral market is likely to accelerate the evolution of comp systems, even in the oldest of Wall Street lockstep firms. After years of poaching by U.S. firms with expansionist ambitions, the Magic Circle are overhauling partner compensation to compete more effectively for talent. See Christine Simmons, “Davis Polk Changes to Modified Lockstep Compensation for Partners,” Law.com, September 10, 2020, and Andrew Maloney, “System Update: the Pandemic Is Pushing Firms to Change Partner Comp Plans,” Law.com, November 18, 2020.
🏛️ Litigation boutiques under pressure. Sustained and elevated pricing pressure from clients are likely to intensify competitive pressure even in high-consequence litigation. Watch for significant moves from longstanding prestige brands like Gibson Dunn, Quinn Emanuel and Williams & Connolly as they formulate a strategic response.
💴 Contraction in capital markets practices. A longstanding foundation of venerated New York & London firms, the capital markets practice is not what it used to be. Squeezed between budget pressure from global banks and more fluid (and intensifying) competition across money-center markets around the world, expect increasing performance volatility even for old-line prestige shingles like Allen & Overy, Cadwalader, Cleary, Clifford Chance, and Milbank.
🚀Aggressive competition within category. As law firms increasingly compete across markets, regional powerhouses are between a rock and a hard place, as are specialist firms in price-pressured practice areas. Regional brands that once prospered unchallenged in Texas, Pacific Northwest, and Southeast markets will have to manage with enhanced business rigor and a longer-term view. Both Baker Botts and K&L Gates roughly fit this profile (although they each occupy different RPL/PPEP brackets); reported figures from both firms since 2015 indicate revenue-side lumpiness may be exacerbated by the YOY volatility and investment risk intrinsic to big-ticket contingent matters. See Brenda Jeffreys, “Baker Botts Again Posts Weaker Revenue, Profits, on Fewer Contingency Fees,” Law.com, March 1, 2019. After posting double-digit RPL growth in 2016, K&L Gates saw a double-digit dip the following year, followed by moderate increases in following years; a spokesperson for KLG indicated the firm expects that positive trendline to continue.
🐯🐲 A great leap forward (and upward) from few crouching tigers and hidden dragons. The chart below shows the extent of performance divergence in recent years from firms that were peers just a few years ago. In 2007, IP specialists Fish and Finnegan were both just shy of the $1M RPL mark; at the outset of the current downturn, Fish has pulled away. Weil and Cleary comprise another pair whose financials appeared more similar than different as recently as 2013. Since then, Weil has posted some of the most outstanding and consistent financial results in the market. Polsinelli, Thompson Hine, McGuireWoods, Lowenstein, and Fragomen are all firms to watch, each competing from very different market positions with varying approaches, proving that there is no single Rosetta Stone to unlock perennial profitable growth in legal markets.
🧪 Renewed innovation agendas
Even in the best of times, reinvestment of profits into the business is a benefit offered by strong balance sheets. In times of crisis, most businesses — all across “Corporate Land” far beyond the reality distortion field of BigLaw — pull back on innovation commitments. As the tide turns on both public health and economic recovery, expect firms to renew innovation investments in two categories.
👨🎤 BigLaw goes alternative. A recent report by Baretz & Brunelle provides an overview of AmLaw and Global 200 firms investing in captive alternative legal service capabilities. The chart below plots these firms by size (x-axis) and RPL (y-axis). Only time will tell whether these investments pay off, but worthy of note today is the sheer variety in category and competitive models of firms investing in legal teams focused on tech-enabled, process-driven service models.
💻 Doubling down on legal tech. 2020 proved to be a difficult year all around for legal tech startups. Capital flow took a breather after a breathless pace in both 2018 and 2019, with deal volume down nearly 30% and total deal value contracting by more than 50%. Meanwhile, the always-grueling sales cycle got longer as law firms and corporate legal teams functioned in firefighter mode through spring and summer. Widespread belt-tightening cut into budgets for new tech and austerity measured intensified demands on already-scarce time and attention of critical customer personnel in back-office functions. Look for a dramatic rebound in both investor-side capital and customer-side sales in the back half of 2021.
In the meantime, a few bright spots in an otherwise dreary legal tech landscape from 2020, capped off by a rare 9-figure raise (and implied 🦄 valuation) by Ironclad led by Bond Capital (home to the revered Mary Meeker of Internet Trends Report fame). See Jason Boehmig, “Announcing Ironclad’s Series D – Towards a New Standard for Business Contracting,” January 14, 2021.
👓 Hindsight is literally 2020, but 2021 will require a bit of guesswork 🔮
This concludes our deep dive into the past and present. In the next two posts of the #GreatExpectation for the #GreatReset series, we venture further from the realm of (revisionist) history and (disputed) news into murkier realms of inference on what the future holds.
📺 In Part IV, we’ll keep our focus on the reigning incumbents of BigLaw — but we turn our focus to competitive threats from new entrants and the core capabilities most likely to make a difference in a market environment of intensifying pressures. In Part V, we’ll look at megatrends most likely to push forward disruptive market dislocations in legal markets, with emphasis on the role of emerging and maturing technology. Stay tuned 😊
🙏 As always, thanks for reading!