The Strategy Series: Economics of practice

Rachel Ellett is the research and analytics manager for the ABA Division for Bar Services. Rachel is the author of numerous publications related to the rule of law, judicial politics, and gender and the legal profession. She has a PhD in political science.

How can your bar understand and embrace the future when the present is challenging, and the pace of change only seems to escalate? It may sound counterintuitive, but this is a great moment to take a breath—to set aside some time to look at emerging trends and have a generative discussion to help identify the best paths forward.

That’s where The Strategy Series comes in.

In this series of four Bar Leader articles, the ABA Division for Bar Services will highlight four big, strategic issues. With each, our goal is not to suggest there are definitive answers, but instead to give bars some information to build from—whether in a board meeting or another forum. Before bars can start assessing, forecasting, and planning for the future, they need to frame the relevant issues for their membership. Acting with foresight positions bars as thought leaders helping to direct change, rather than just react to it.

We recommend setting aside at least one hour and perhaps two, to read each Strategy Series article together, review some of the linked reports and datapoints, identify relevant trends and implications for your bar, and then discuss. At the end of each article, we’ll share some Strategy Tools: a list of questions and some additional resources that can help get your conversation started.

To begin The Strategy Series, this article offers some key considerations to help you understand how economic uncertainty is changing how lawyers practice. As the recently released 2022 Clio Legal Trends Report warns us, “with sustained inflation and increasingly grim forecasts of a recession on the horizon, there are clear warning signs that the industry needs to prepare for a challenging year ahead.”

This article starts the conversation by asking: What are your members experiencing, where are things heading, and how can the bar adapt to stay relevant and help members nimbly navigate economic change?

A difficult, but important role for bars

Understanding the external drivers of change for the practice of law is challenging; especially given the volatility of the global economy and its effects on demand for legal services. More than ever before, bar leaders need a basic familiarity with the varying effects of macroeconomic change combined with a willingness to generate a wide variety of programming responses. Bars must balance reacting to immediate economic trends while maintaining a careful eye on innovating toward the future.

But to serve all membership segments is not just complex; at times, it may position the bar in conflict among types of members. Bars have members practicing in what is colloquially known as BigLaw (bigger firms serving larger corporations and higher-income individuals), PeopleLaw (often, solo or small firms serving small businesses and individuals with more moderate incomes), and everything in between. A bar may also have some members in large, metropolitan areas and others in more rural settings—and those are just two examples of the many ways bar membership may be segmented, with lawyers in each segment presenting different needs.

Post-pandemic revenue exceeds some expectations

Two years ago, lawyers were deep in a rapidly contracting economy, and the future was defined by uncertainty. Yet not all lawyers experienced this equally, and future revenue predictions were strikingly mixed. In the 2020/21 ABA Practice Forward Report, 28% of lawyers said they believed a decrease in revenue was likely or very likely, 31% said they believed a decrease would be unlikely or very unlikely, and 41% were not sure.  

Understanding lawyers’ mixed outlooks requires understanding the relative market share of the different sectors. At his Legal Evolution blog, Bill Henderson (a professor at Indiana University Maurer School of Law) reports that in the 2022 legal market, organizational clients now comprise 74.6% of total law firm revenues, with most of it (69.6%) coming from businesses. Not all sectors have fared equally, and Henderson outlines this change in gross revenues between 2007 and 2017 by type of client:

• businesses—$150.1 billion to $197.3 billion (+31.0%); 
• government—$7.5 billion to $9.1 billion (+20.7%); 
• nonprofits—$3.4 billion to 5.1 billion (+49.3%); and  
• people—$66.3 billion to $72.0 billion (+8.6%). 

However, it is important to note that the PeopleLaw increase is misleading: If we take into account population growth, there is a 90-cent decrease in per capita spending between 2007 and 2017.

A tale of two crises: The Great Recession vs. COVID-19

The 2008 global economic crisis hit the legal profession hard: Layoffs, salary reductions and hiring freezes touched all sectors. So, when the economy came to a virtual halt during the early days of the pandemic, fear and uncertainty came rushing back, compounded further by the accompanying social and personal disruptions to lawyers’ lives. But for many lawyers, those 2008 fears did not materialize. By 2021, according to that year’s Am Law 100 Report, BigLaw profits had skyrocketed, with increases in overall revenue of 6.6%, and equity partner profits of 13.4%.

The pandemic had heightened demand for legal services, and for BigLaw, this translated into record profits. The recently released 2022 Clio Legal Trends Report confirms this demand surge for legal services: Since Clio started tracking in 2019, lawyers have been opening new cases at a rate averaging 10% higher than the 2019 benchmark, and in March 2022, new casework spiked to 24%. 

By 2022, it was clear that the global pandemic and its accompanying economic disruptions also increased demand for legal services among those requiring low-cost or free representation, as outlined in this summer 2022 Harvard Law Bulletin article.  But unlike corporate law, revenue to PeopleLaw and by extension, many small firms and solo practitioners, had not increased.

This is echoed in a 2021 survey conducted by The Missouri Bar on the economic performance of the profession. The bar found that from 2019 to 2020, income increased for 22% of respondents, stayed the same for 23.1%, and decreased for more than half (54.8%).  The lesson here is that data has to be disaggregated, even within BigLaw. The Thomson Reuters 2022 State of the Legal Market Report indicates that growth in demand for legal services in the second half of 2021 was primarily driven by the BigLaw real estate and corporate sectors.

Rising inflation and its effect on expenses

Increasing revenue is not just about expanding business or hiring new lawyers. The 2021 Clio Legal Trends Report found that “stable firms” (Clio’s three-part cohort classification is “growing,” “stable,” or “shrinking,” based on year-over-year revenue) continued to see modest growth overall, with only a slight contraction in 2020. Surprisingly, Clio finds that shrinking law firms appear to have seen slight gains since 2017, including the year that COVID-19 hit. This may be due to improved efficiencies and cost cutting.  

The shift to remote work during the pandemic accelerated the adoption of cloud technologies, such as virtual meeting platforms, efiling, virtual payment systems, cloud document management and electronic document signatures, the 2021 Clio report noted. In addition to improving client experiences, new technologies may increase efficiencies and cut costs by aiding in access to information or automation of certain tasks, as Hugh Logue notes in the 2019 ABA book Automating Legal Services: Justice Through Technology.

According to the 2022 Clio report, the average law firm collects only $748 for every $1,000 of billable work. At the same time, the utilization rate—number of hours spent on billable hours—has increased 18% over the last six years, but there is still more work to be done; particularly given that inflation is now increasing faster than billable hour rates.

While technology may aid in curbing costs, there is no doubt that cost control continues to be a battle. According to the 2022 Thomson Reuters Report on the State of the Legal Market (available for free download), the largest expenses continue to be staff compensation and technology. Meanwhile, office expenses continued to contract in 2021. Inflation increases the costs of basic business expenses, and potentially affects the ability of law firms to raise their billing rates. When you can’t increase the number of hours billed, raising rates is a key mechanism for improving profits.  

But many are now asking in late 2022, as inflation runs rampant, can we expect clients to accept an escalation of fees? Inflation reduces the value of the billable hour, which could represent “a significant threat to the average law firms’ finances, especially when it could eliminate multi-year gains relatively quickly,” Thomson Reuters noted in an analysis of its report. Once again, clients’ capacity to absorb rate increases will vary across sectors.  

As the quick rebound of 2020-2021 has slowed, law firms are now experiencing rising expenses and reduced profits, according to new data from Wells Fargo’s Legal Specialty Group, which surveyed 120 large, midsize and regional firms in the first half of 2022. Respondents saw an increase of almost 17% in lawyer compensation costs and more than 14% in general expenses over the past year.

While the 2022 ABA Profile of the Legal Profession notes that overall, the average salary of lawyers increased by 61% over the last 20 years, “Over the same period, the inflation rate was 49%.” And geographic variation in average lawyer wages is stark: The average lawyer wage in the highest-paid area (San Jose, Calif., at $231,200) is five times greater than the average wage in the lowest-paid area (Aguadilla, Puerto Rico, at $44,290).

Speaking of personnel issues, according to the 2021 Law Firm Business Leaders Report, the three biggest threats to BigLaw and for midsize firms are related to attracting and retaining top talent. This may have implications for costs and efficiency, or in some cases the ability of firms to adequately staff legal matters. Looking forward, the uncertainties in the legal market ultimately mean predicting staffing loads is challenging. But what doesn’t change is the need to pay particular attention to demographic differences in how lawyers experience the workplace and how firms can retain their best lawyers.

The 2022 ABA Practice Forward Report notes the disproportionate rate at which women, lawyers of color and LGTBQ+ lawyers experience stress, misperceptions of their competence, and the inability to bring their authentic selves to work. In a competitive labor market, belonging matters. Similarly, In Their Own Words, a 2021 report from the ABA Commission on Women in the Profession, explores why experienced women are leaving the profession. This may be an area where midsize law firms can outperform BigLaw in terms of attorney attrition, particularly when taking a holistic approach to the working environment beyond just compensation. The latest Thomson Reuters Report on the State of the Midsize Legal Market suggests that in general, retention is a particular strength for midsize firms.

PeopleLaw: A promising market for solos and small firms?

“When facing civil justice situations, people often do not consider law at all. They frequently do not think of these situations as legal, nor do they think of courts or of attorneys as always appropriate providers of remedy.”  — Rebecca L. Sandefur, Accessing Justice in the Contemporary USA

The United States has a well-documented access to justice problem. In 2014, in a joint study by the American Bar Foundation and the University of Illinois Urbana-Champaign, Rebecca L. Sandefur found that Americans can estimate their civil legal needs approximately 9% of the time. In other words, they don’t know they need a lawyer.

For lawyers, capturing these untapped markets and meeting the unmet needs of PeopleLaw may involve educating the public, not simply increasing the number of suppliers of legal services, or the types of suppliers (i.e., regulatory reform). For small or solo practitioners, the potential for growth in certain areas may lie in being strategically agile in responding to the changing marketplace.  

One mechanism that may catalyze lawyers into changing their business model is in anticipating changes to the state regulatory framework. To date, Utah and Arizona have engaged in the most comprehensive set of regulatory reforms; though evidence is still nascent, the 2022 report Legal Innovation After Reform: Evidence from Regulatory Change  notes that “lawyers remain central to the development and delivery of services” and even “traditional law firms are driving innovation by seeking authorization to offer tiered services at different price points.”

Debates around alternative fee structures, such as flat rate or project-based billing, or performance-based models, are not new. Yet Clio’s 2022 report finds that only 37% of law firms actually offer flat fees for any type of legal matter. As a new IAALS report on unbundled legal services concludes, widespread adoption of this practice offers the advantage of providing “attorneys with an avenue to reach clientele who would normally be priced out of their services.”

Regulatory reform speeds up change and the need to pivot in service delivery. In a recent article in the University of Pennsylvania Journal of International Law, researchers suggest regulators should ensure that the public receives “reliable information about their legal needs and the availability of legal services.” Here, the role of state and local bars in simultaneously educating the public and supporting their members through potential change is critical.

Obligations to the public good and supporting the rule of law necessitate innovating around PeopleLaw and better matching the unmet demands for free and low-cost legal services with economic opportunities for solo and small-firm practitioners. The exact mechanisms by which this should be done are a matter of considerable debate. But one thing is clear: When bars take the lead in making those connections, they heighten their relevance—and everyone wins.