Law firms maintain forward momentum with rising profitability

Bolstered by law service rate growth that has begun to outpace inflation, profitability metrics for law firms continue to improve despite rising challenges in collections. Demand growth for law services was slow but steady in the third quarter of 2023. Transaction demand declined further, but projections imply that the worst is in the rearview mirror for mergers and acquisitions (M&A) activity.

Law firms are striving to lower their expenses while maintaining their pipeline of talent.

As concerns over the economy lessen, sentiments among law firm executives rose for the second quarter in a row, recovering from six consecutive quarterly declines and a historic low in the fourth quarter of 2022, according to the Thomson Reuters Law Firm Financial Index. An increase in demand growth and a decline in direct and overhead expense growth are driving this improvement.

Law firms are striving to further lower expenses, but not at the expense of jeopardizing their pipeline of talent. This delicate balancing act has become more complicated due to the recent U.S. Supreme Court decision to overturn affirmative action, with some law firms now being sued over their hiring practices.

As the Am Law 100 and midsize firms continue down separate paths strategically, key elements to watch are whether productivity improves among the Am Law 100 during a hiatus in hiring, and whether midsize firms will withstand the margin squeeze as they continue to hire valuable staff.

Regardless of firm size, and despite the unknowns regarding economic growth, all firms can benefit from utilizing AI and conducting a cost/benefit analysis of outsourcing to further bring down expenses and prop up profit margins.

As signs of economic cooling continue, the professional services industry has started to feel the impact of an uncertain economy.

Clients are less likely to commit to large capital expenditures quickly, and they tend to delay any spending they feel is discretionary until there is more certainty in the economic outlook. For law firms, specifically, two major trends we will be watching through 2023 are exploring growth opportunities through mergers and acquisitions to bolster decreasing demand and propping up dismal productivity metrics with investments in artificial intelligence (AI).

Professional services firms are in for an unsteady beginning to 2023, as demand growth lessens with economic uncertainty. However, persistent expenses and wavering profits will encourage firms to take action on driving revenue and productivity growth through mergers and acquisitions, and with investment in AI. When investing in AI, it’s critical that firms understand the effort required to structure, cleanse and prepare data for build-and-teach useable models.