11/18/11

Thoughts on Third Quarter Trends

Citi posted its Third Quarter Report recently, noting the growth in collections and the slowing of demand. Let’s tackle the headline issues first, then peel back deeper in to more interesting trends noted in the report.
Collections up with demand down means firms are emptying the money pipe faster, while less money is coming in to it. The likely outcome of these two trends is obvious: less money for firms in future quarters - which of course means less money to pay partners.
Deeper in the report we see some other trends to note.
#1 – “Rate increases held steady.” This means any rate increase firms made for 2011 are being paid by clients. Say what? This appears to run counter to all we hear about clients pushing back on law firms about their rates. It makes me wonder what else must be going on here.
#2 – “We continue to see firms controlling equity partner head count.” My 2 cents: expect to see even more of that. A consistent trend reported by many surveys is that firms are generally over-partnered. During the downturn associate head count was reduced, but not so much on the partner side. I have previously posted on the precarious role of the service partner. This trend may be the beginnings of reductions in service partner head count.
#2A – “The rising cost of leverage.” As a corollary to #2, when the associate head count drops, the cost of the remaining head count, on a per-head basis, logically goes up.
#3 – “The widening dispersion in the performance of firms is another key trend.” This trend may be the most important one. As too many firms chase the shrinking bet-the-farm tier of the market, this trend suggest we are now seeing big winners and big losers emerge. This trend could be the fore-telling the next, and larger wave of Howreys.
Law Firm Economics 101 tells us that a percentage drop in revenue equates to triple that amount in reduced profits. With law firm expenses going up (see #2A) and revenue dropping, the likelihood of significant drops in partner income become very real. One report on the “widening dispersion” had some firms at a 10% drop in revenue. Absent significant drops in expenses for such a firm, this will mean a 30% cut in partner pay. If the dispersion and rising cost of leverage trends hold, the New Year could bring some interesting activity.
The Citi article sums this possibility up well: “And if we’re right about the continued slowdown in the fourth quarter, it will mean a rocky start to 2012.”
My advice for lawyers going in to 2012 is to follow the advice of the classic roller coaster operators, “Hang on and keep your hands and arms inside the car at all times.”

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