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Part 1 takes a broad look at what has lead to the current climate of change.
“Change before you have to.”
The Perfect Storm
The legal industry is sailing in a perfect storm of threats to its future. The first storm factor is the economic shift from a sellers’ market to a competitive one. This shift started ahead of the Great Recession. A second factor is the actual Great Recession. With the underlying forces of the market already in flux, this recession greatly accelerated the economic shift. Finally, amongst this economic chaos the pace of technology change continues to accelerate, adding more energy to a raging storm.
The impact of this perfect storm is hitting all corners of the market. It first appeared in the larger firm market, and it has quickly spread. It now includes everything from law schools to the courts, all of which are struggling to deal with vast changes.
To better understand the potential impacts of this storm, let us explore the various aspects of what is happening in different segments of the industry and the forces driving change. As a consequence of this exploration, some predictions will be given, along with some suggestions. However, these comments and various others coming from the market should be weighed against our ability to know the unknown. We have reached a point in human history where predicting the future beyond a few years is quite a challenge. A perfect example is that of Facebook, which grew from zero to 100 million users in less than two years. What things will look like in five to ten years is anyone’s guess. So the best we can do now is keep a vigilant eye on the storm and stay prepared to constantly alter course.
Up through the mid-2000’s, lawyers across the market were raising rates on a consistent year-to-year basis. This action reflected the relative strength in the market they experienced as sellers. A relatively limited supply of lawyers, along with a growing demand for services, produced consistent growth in revenues. But then things began to shift, slowly at first, but truly at a foundational level.
The changes materialized with clients asking for discounts on rates. Discounts had been given by firms before, but now they became broadly requested and expected by clients. Meanwhile, larger firms continued to push up starting salaries for associates and kept them on lock-step compensation plans, driving up firms’ costs of operation. This economic conflict was hardly noticeable at first, since rate increases and a consistent volume of legal work were still coming in.
To better appreciate the nature of this conflict, we need an understanding of the basic economics of law firms, which are driven primarily by leverage and realization. Leverage is the number of non-partner hours to partner hours. Non-partner hours are those that produce the profits which go to pay partners. Realization is the percentage of dollars realized against standard rates. Realization plays a role since each point below 100%, equates to about a three point reduction in profits. This formula and the profit-squeeze conflict noted above will play a central role in the financial health of law firms going forward. It is therefore essential to our discussions and exploration of the forces at play.
In Part 2 of this series we will walk through the first waves of the storm and how the market has been adapting.