Every year, Thomson Reuters and the Georgetown Law Center on Ethics and the Legal Profession come with a report on the State of the Legal Market. I have written about the reports before; I find them enlightening and generally well done. The 2024 Report is based on data from some 179 U.S. law firms developed by Thomson Reuters’ Financial Insights platform. Data came from 48 AmLaw 100 firms, 49 AmLaw second 100 firms, and 82 midsize firms.
The 2024 Report came out in early January this year and, as usual, is chock full of interesting findings. The Report used the historical demise of Pan Am Airlines as an example to drive home a point. Law firms may be facing a tipping point, a point at which they need to refine how they do business to survive.
While I always take predictions like that with a grain of salt—let’s face it: the demise of the law firm business model has been predicted before. While there have been some changes in how law firms and lawyers actually work, the fundamental business model remains the same. Bill more hours, find more matters, and leverage the hell out of them. But Thomson Reuters raises a valid question based on some findings discussed in the Report.
Rates. Law firms were able to increase their rates on new matters by more than 6% in 2023. We have not seen increases like that since before the Great Recession.
Collections. While rates went up, collections didn’t keep pace. As a result, profitability took a hit.
Transfer of Work. According to the Report, clients are transferring more work to lower cost small to midsize firms to control costs. Indeed, midsize firms saw the most substantial increases in demand. Litigation matters, in particular, were ripe to be shipped off to lower-cost firms.
Staffing. Large firms are cutting back on associates; smaller firms are aggressively adding them. Somewhat conversely, clients are focusing on specialized experience and global coverage when they pick law firms.
The Rise of In-House Counsel. The Report concludes that since the late 2000s, clients have taken much more control over the work being done by outside lawyers. Clients have become more involved in directing how work is being done by outside counsel and what’s being charged for it. As the Report puts it, “corporate clients came to regard their outside lawyers as vendors, rather than trusted advisors.”
The Work. The Report notes that litigation and bankruptcy work are on the rise, and corporate and M&A work is waning. Most in-house lawyers predict substantial increases in regulatory work in the future.
Gen AI. The Report kicks the can down the road on this one but does offer 3 possible scenarios. The first supposes that a few firms will embrace AI and shift how they get work done, thereby gaining more work from clients. The second scenario assumes that clients will leverage AI more and more. Under this scenario, the role of the traditional firm will be reduced. In-house counsel will either use AI to help them do the work or demand changes in pricing. The third scenario is that AI will not significantly impact the work of outside lawyers. Its use will be relegated to back-office tasks (aka nonbillable stuff).
So What’s All This Mean?
It is interesting that the very big firms are cutting costs by reducing the number of associates. This strategy could mean that very large firms are starting to understand that while tech efficiencies may reduce billable hours, they will also lower costs. There may not be the need for as many associates to get work done. That could translate into savings for the clients while preserving profitability for the firms.
The fact that smaller firms are aggressively adding associates is also interesting. It’s tempting to say that this strategy reflects the fact that clients have been sending more work to lower cost firms. Hence, those firms are hiring more associates.
But that could be a post hoc fallacy. Just because one event (more work to smaller firms) preceded another event (hiring more associates), they may not be causally related. In other words, the chronological order of two events does not necessarily prove a cause-and-effect relationship.
Why More Associates?
There are other explanations for the hiring binge. The smaller firms may not be embracing technology. They instead may be still using lawyers to do tasks that technology or other legal professionals could do. If that’s the case and the firms think that more associates are the only way to handle any increased work, that could be a recipe for disaster in the long term.
In addition, if the Report is correct that in-house counsel are much more in control now than before, the inefficiencies of merely assigning more associates to tasks will become evident pretty quickly.
Not All Work Will Be Shifted
There is another factor at play here as well. Understanding the shift to lower price firms requires understanding what type of work is being shifted to predict the future. Historically, large complex, “bet the company” matters were often steered to well known, huge law firms. This is because those firms often had the expertise to get a better result and had the capacity to handle every eventuality that might arise.
Firms with aggressive hiring strategies could be left with a large number of associates with not enough to do
And because, as they used to say, “no one ever got fired for using IBM”: hiring a well-known large law firm was a matter of self-protection. In any event, my guess is that these large, complex matters are not those being sent down to smaller firms.
But it is the smaller, less complex matters that are ripe for more effective cost control. That’s because the amount at risk is not as significant, the consequences of an error are smaller, and the issues tend to be simpler. If true, then the smaller firms could soon find themselves in a bad spot. The imposition of stricter cost controls and demands to use technology to do more could leave the firm hung out to dry. The firms with aggressive hiring strategies could be left with a large number of associates with not enough to do.
One only needs to look at the insurance industry and how it handles litigation to get a sense of this. The industry knows that placing more restrictions on cost control and lowering rates may adversely impact the overall results. But that decrease may be more than balanced by the reduction in overall transaction costs.
We see similar dynamics at work with rates. Clients are sympathetic to the need for law firms to increase rates. After all, inflation took a bite out of profits. But consistent with the notion that clients are becoming more demanding and in control, collections—the measure of what clients are actually willing to pay law firms—went down, according to the Report. Reduced collections means reduced profitability. Clients are more aggressive with write downs where they perceived work could be done more efficiently or by lower cost legal professionals.
We may see clients demand that work be done a certain way and in ways that reduce lawyer spend.
Again, the experience of the insurance industry is helpful. For years, insurance companies have enforced strict guidelines for how their lawyers are to do work. They have aggressively written down bills where those guidelines aren’t met. If clients are generally more in control and stricter about costs than ever, then that same scrutiny and bill reduction could be coming across the board. Which leads back to technology and AI. Clients may soon be much more demanding about using tools like these to reduce charges.
For large, complex matters, the impact may be less. In these cases, the savings of a few dollars don’t matter as much because the amount at risk is so much more significant. But even here, we may see clients demand that work be done a certain way and in ways that reduce lawyer spend.
A Tipping Point?
Yes, there could be a tipping point in how the legal market works. However, it may not mean a different distribution of work that enables smaller firms to be more profitable. It could represent just the opposite.
All of which goes back to the impact of AI. I think the most likely scenario is the second one postulated by Thomson Reuters. AI will enable clients to take more and more control over how outside lawyers do their work, what tools they use, and how efficient they are.
AI and Gen AI will enable in house lawyers themselves to do more with less. As I have pointed out before, in-house lawyers are often overworked and overstressed. When you are overworked and overstressed, you look for any means necessary to alleviate your situation. That inevitably leads to increased automation and the use of AI tools. And in-house legal will expect/demand that their outside lawyers do the same.
Lawyers will be increasingly considered vendors, not trusted advisors.
The Bottom Line
Law firms may be getting ready to experience what insurance defense lawyers have dealt with for some time. Reduced control, increased pressure to do more for less cost, and, for many firms, decreased profits. Like their insurance defense brethren, non-insurance lawyers will be increasingly considered vendors, not trusted advisors.
The bottom line is that clients view the practice of law as a business, and providers need to understand how businesses view what they do. Law firms will need to adjust and use the same cost and risk philosophy as their clients to thrive. That may be the lesson from Pan Am and the 2024 Thomson Reuters Report.
I’m not sure it’s a brave new world yet, but it is certainly changing.