Declining billable hours and increases in overheads means uncertainty and volatility

by | Nov 3, 2023 | Insights

Beyond Borders - LawFlex

Rising interest rates, high inflation, and slow economic growth. Whilst a fully-fledged financial downturn is yet to materialise, legal professionals far and wide are preparing for the worst and having to tighten belts in preparation.

The legal industry of today is plagued by an economic environment of uncertainty and volatility. In the face of pervasive ongoing change, legal professionals are under more pressure than ever to do more with less.

Facing the challenge: the impact on law firms

According to research from the Thomson Reuters Institute, profits at many of the largest international law firms are in decline. A decline in billable hours and an increase in overheads and payroll expenses has hit the bottom line of law firms around the world.

Demand for M&A work for law firms fell almost 14% in the three months ending September 2022, compared to the same period in 2021. Private equity and M&A teams that were once working late into the night are now leaving the office early, plagued by challenging debt markets, a decline in large leveraged buyouts, and stagnating public offerings.

On the in-house front, a survey from the legal-talent provider Axiom revealed that 98% of general counsels are reporting a significant budget reduction due to economic volatility, with 56% stating substantial budget cuts.

While the full effects of a recession are yet to be seen, 2023 has already presented economic challenges to legal departments and traditional law firms. They often say, to know where you are going you must know where you came from, and one way to predict how a slowing economy could impact the legal sector is by looking at one of the most catastrophic economic events of our time: the Global Financial Crisis (GFC).

Learning from the GFC: lessons for the legal industry

The Global Financial Crisis (GFC) of 2008 impacted the legal industry in unexpected ways. The traditional corporate and finance practice, which were the main profit drivers for law firms, suffered significant setbacks. Many top firms underwent restructuring, diversification, changes to compensation models, and some even merged to maintain relevance.

The GFC taught the legal community two vital lessons. Firstly, how to do more with less, and secondly, the value Alternative Legal Services Providers (ALSPs) can bring to traditional law firms.

With legal spend at an all-time low, legal departments and traditional law firms were forced to turn to alternative services to meet resourcing needs. They found that ALSPs enabled teams to accomplish the work without incurring the exorbitant legal expenses tied to full-time associates.

As the legal community braces for the impact of another economic downturn, legal leaders are revisiting the lessons learnt during the last financial crisis. Firm leaders acknowledge deep layoffs during the 2008 recession affected their ability to respond to increased client demand when the economy eventually recovered.

Talent is arguably a law firm’s most valuable asset. It takes years of investment and training to source and retain quality legal talent, and one bad day on Wall Street to lose it. Ultimately, the best firms do not allow short-term profit concerns to dictate their long-term human capital strategies.

During a recession, the threat of AI to the legal industry becomes more pronounced. As companies and individuals tighten their budgets and prioritise cost-cutting measures, the demand for legal services may decrease. In such a scenario, AI technologies can exacerbate the challenges faced by law firms. AI’s ability to automate routine legal tasks and streamline processes may lead to a reduction in the need for human resources, potentially resulting in layoffs or downsizing.

The cost-saving benefits offered by AI can make it an attractive alternative for clients seeking more affordable legal solutions, further intensifying competition within the industry. To navigate this threat, legal professionals must proactively embrace AI as a tool to enhance their services, demonstrate the unique value they bring through complex problem-solving and strategic advice, and continuously adapt their skills to remain relevant in an evolving legal landscape.

History tells us the legal industry is more resistant to a recession than others. Law firms have acted on many of the takeaways from the global financial crisis and are already much better run than they were during the last recession. Law firms with diverse practice groups and tech-oriented business models are best prepared to respond and weather an economic downturn.

ALSPS: Mitigating risks and ensuring viability

In seeking to mitigate the risks posed by an economic downturn, law firms must understand that strategies used post-GFC, such as increasing fee rates, shedding staff, and tightening equity partner ranks may not be so effective in the current legal climate. Billable hours, high partner profiles, and substantial bonuses are all indicators of a traditional business model that would struggle during an economic downturn.

When the GFC hit, the viability of ALSPs was relatively unknown. In the nearly two decades since, the ALSP market has grown exponentially and is now valued at $20.6 billion, according to the Thomson Reuters Institute. Law firms that have partnered with ALSPs to take advantage of their cost-effective services and technological capabilities are more economically viable when businesses start to cut their spending.

The Axiom survey showed that 80% of general counsels are interested in maintaining or increasing the involvement of external support, including 49% ideally seeking to work with more external resources to address their workload. Additionally, nearly two-thirds of general counsels see flexible talent providers as an effective solution to their department’s resourcing issues.

The increased global footprint, quality talent and sophistication of today’s ALSPs have led to a shift in demand away from traditional law firms towards more cost-effective substitutes. As pressure increases from clients to provide discounts or alternative billing arrangements, the economic model of ALSPs allows law firms to deliver the work without incurring costly overheads. Big law firms have integrated ALSPs as a buffer against any anticipated economic blow that may come. ALSPs are a law firm’s best insurance policy.

In the face of economic volatility, ALSPs will fare the best. Providers like Axiom, LawFlex, and Elevate are well-positioned to expand their service offerings, even during downturns. They have a demonstrated history, brand recognition, global footprint and financial backing to invest in the necessary human and technological resources.

History tells us the legal industry is more resistant to a recession than others. Law firms have acted on many of the takeaways from the GFC and are already much better run than they were during the last recession. Law firms with diverse practice groups and tech-oriented business models are best prepared to respond and weather an economic downturn.

Adapting for a resilient future

In the face of financial uncertainty and the potential impact of a global recession on the legal industry, one ally stands out as the best friend of law firms: Alternative Legal Service Providers (ALSPs). These providers have evolved over the years, offering cost-effective solutions and technological capabilities that empower law firms to navigate economic downturns with greater resilience.

As firms tighten their belts and seek ways to do more with less, ALSPs have proven to be invaluable partners, delivering high-quality services while minimising costs and mitigating risks. By embracing the value that ALSPs bring, the legal industry can adapt, thrive, and weather the storm of a global recession with confidence.

This was originally published by PSMG LLP’s magazine, Centrum.