By Mark Medice
HILDEBRANDT INSTITUTE’S PEER MONITOR INDEX (PMI), a composite index score representing the quarter‐over‐quarter change in drivers of law firm profitability, broke a string of three consecutive upward quarters by falling 6 points to 56 in the third quarter.
The legal market continues to grow, but at a sluggish pace. Growth in demand for legal services slowed to 0.8%, its weakest reading so far this year. Rates strengthened slightly, up 3.5% compared with the same period a year ago.
For a breakdown of changes in major factors influencing law firm performance, including rates, demand, productivity and expenses, please read our full, detailed report.
Rising expenses are a worrisome trend PMI is closely tracking this year. Following widespread cost reductions by firms in 2009 and 2010, expense growth turned positive early this year. But in 2011, costs have steadily accelerated to the point where they now easily outpace both demand and rate growth, thus impacting profitability.
Costs – both direct and overhead – rose significantly in the third quarter. Direct expenses jumped 5.1%, while overhead expenses were up 3.2%. Both increases were the highest seen in more than two years.
Attorney hiring is one contributing factor, and in the third quarter headcount increased 2.4%, reaching a high for the year. The attorney replenishment ratio has risen to 1.3 for the overall attorney population, indicating a ratio of 1.3 new hires per departure – its highest level in more than three years – as new hires are now easily exceeding retirements, layoffs and other departures.
Until recently, firms had generally been doing a good job of balancing expenses against slowly growing demand. But firms have stepped up their hiring in recent months in a modest return to traditional seasonal hiring patterns, while demand has slowed as the year has progressed. The gap between law firm capacity and available work is widening. Whether this trend persists will depend on the performance of the broader economy and if we see continued recovery in litigation and transactional work. Firms will have to tread a fine line between their desire to add additional lawyers against an uncertain demand picture.
Overhead expenses are also rising as firms are unable to continue putting off certain investments in technology and other strategic areas. With expenses growing and the economy facing continuing headwinds, achieving meaningful top line growth will be crucial for success in the coming year. Growth may be elusive, but firms following market trends closely and adopting a strong strategic focus will be better positioned to capture market share.
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