When looked at as a whole, the 2020 financial performance of the AmLaw 200 looks great. But there are troubling issues for the AmLaw “2nd 100”.
ALM recently released its financial summary for the AmLaw 200 for 2020. (The AmLaw 200 consists of the top 200 firms in gross dollar revenue). On the surface, the picture looks rosy for 2021. But a closer look reveals some clouds on the horizon for the second 100 law firms, which rank from 101-200 in gross revenues.
ALM summarized the results last week in a Webinar held by Gina Passarella, Editor in Chief of the American Lawyer, Ben Seal, Executive Editor ALM, Dan Masopust Senior ALM Research Manager, Lizzy McLellan, ALM Senior Editor, Christine Simmons, ALM Financials Editor, Dan Packel, ALM Reporter, and Dan Roe, ALM Reporter.
First, as the Panel noted, the AmLaw 200 and particularly the 2nd 100 are a diverse group of firms. It includes smaller boutique-type firms, general corporate practice firms, local firms, and regional firms. So while it’s a little hard to generalize, I have written before about the general risks the future legal market might pose to midsize firms, many of which fall in the 2nd 100. Among other things, these risks stem from problems these firms have in spreading the costs of technology and innovation across a limited number of partners, limiting adoption. It’s simple economics.
Midsize firms face a potential loss of work–especially high rate work– to larger, national firms
And, as mentioned before, midsize firms face a potential loss of work–especially high rate work– to larger, national firms with more sophisticated expertise and reach. This risk is exacerbated by the growing ability and acceptance of the ability of lawyers to work from anywhere, allowing larger firms to make inroads in disparate locations.
Midsize firms, in general, already face overall rate and cost pressures. Combine this with a conservative attitude and a stubborn sense of identity and independence, and you have a recipe for future stress.
The AmLaw 2020 Report
First, the good news from the 2020 Report: in the face of a global pandemic, gross revenues of the AmLaw 200 grew some 5.7% in 2020. Net profit rose 13.1%. (This compares to a 6.6 revenue growth and 13.3 increase in profits for the AmLaw 100).
Sounds pretty good. But look closer at the 2nd 100. Gross Revenue rose by a paltry 1.1% compared to 6.6% for the AmLaw 100. But, you say, profits for the 2nd 100 was still outstanding: an increase of 11.6%. But if revenue only rose 1.1%, then that profit could only have been obtained by cutting expenses.
And as Andrew Maloney reported in a recent article, firms of all sizes face increasing costs in 2021 as marketing, travel, and entertainment ramps back up. And the ALM Report also shows another troubling statistic. The 2nd 100 are slower to cut real estate costs than the 1st 100. Whether that’s because the 2nd 100 are more set in their ways or legitimately believe that the prime real estate and fancy offices are essential is unknown. But real estate costs are the 2nd highest expense facing all law firms, as previously discussed.
If 2021 holds true to 2020, the 2nd 100 is facing little revenue growth and higher costs
So if 2021 holds true to 2020, the 2nd 100 is facing little revenue growth and higher costs. Not sure the profit margins can hold.
The 2nd 100 faces other challenges as well. As the ALM Panel noted during its Webinar, the 2nd 100 are slower to pivot to divergent styles of practicing, such as remote work. Many of these firms don’t have the diversification of practices that allow them to move to more profitable areas as circumstances dictate. While (hopefully) the pandemic is over, these inabilities remain and, as the market evolves, limit flexibility.
But the final challenge may be the most challenging and most permanent. As I have discussed, midsize firms like those in the 2nd 100 face threats both from below and above. Automation and advance technology can do much of the lower level work traditionally done and billed for by midsize law firms. Client interest and desire for their firms to apply these tools will only intensify. And the top 100 have the economies of scale to make use of these tools that the 2nd 100 don’t.
Not to mention the proliferation of alternative legal service providers who have the tools and the cost structure to siphon off lower level work as well. And there is a ripple effect as well. If clients move work that can be automated from midsize firms and ALSPs, the bespoke work (work that commands high rates because of it custom and sophisticated nature) that is linked to that work, if any, may more too. This potential is why big four accounting firms like EY are targeting midsize firms, as I reported a couple of years ago.
Which brings me to the concept of death from above again, which I have discussed (AmLaw). There are certainly many lawyers with great experience and expertise in the 2nd 100 who do valuable bespoke work. But larger firms know that and may systematically pick off these lawyers and, for that matter, associates. We have seen that place is not as important as it once was.
Big firms are already setting up virtual offices in remote locations without opening brick and mortar facilities. As Dan Packel recently reported, virtual offices allow bigger firms to take highly talented lawyers in those locastions and their business away from midsize firms with low cost and risk. And for the midsize firm lawyers, being part of a larger firm opens up platforms and opportunities they would not otherwise have, increasing their chance to make more money and have more substantial practices.
The new normal will not be the old normal.
That’s not to say midsize firms are doomed. They often have deep relationships with clients they serve and the communities in which they offer their services. They have cost advantages that the larger firms often can’t provide: they can often offer representation as good as the 1st 100 offers at less cost.
But midsized firms must realize it’s not going to be business as usual as the pandemic lifts. That they face new and different economic threats that require long and short term planning and strategy like never before. The new normal will not be the old normal.