chevron-down Created with Sketch Beta.

Litigation News

Fall 2022, Vol. 48, No. 1

2022 Law Firm Profitability Looks Rough @Halftime

Daniel S Wittenberg


  • Law firms experienced a decline in profitability and faced challenges in 2022 after a successful year in 2021.
  • Increased expenses, particularly in attorney compensation and benefits, outweighed gains in demand for legal services and billing rates.
  • The decline in demand for legal services, rising overhead expenses, and warning signs of decreasing profits per lawyer indicate potential trouble for law firms, urging them to be cautious and proactive.
2022 Law Firm Profitability Looks Rough @Halftime
filo via Getty Images

Jump to:

2021 was a banner year for law firms. Revenues and profits were at all-time highs for many of the nation’s largest firms; 2022, however, is turning out to be a different story. The first half of the year revealed consecutive quarters of declining profitability, according to Law Firm Financial Index reports. The legal sector reported nearly 9,000 jobs lost in August. Is it time to worry about a crash? Hopefully not yet, but key quarterly economic indicators at large and midsize law firms fell to their lowest points in the past 16 years. Let’s look at the numbers.

By the Numbers—Q1 2022

According to the Law Firm Financial Index, which tracks economic indicators at large and midsized law firms, law firm profitability slowed in the first quarter of the year, with bloating expenses overshadowing gains in both demand for legal services and lawyer billing rates. The Q1 2022 index score, which is based on a multitude of factors, hit its lowest point since the third quarter of 2009.

“If you ignore the expense categories, this would be a remarkable quarter,” stated William Josten, St. Paul, MN, manager of enterprise legal content for Thompson Reuters Institute, in a recent Reuters article. “But you can’t ignore the expense categories—particularly the direct expenses which are attorney compensation and benefits—because those are up so substantially, and so is headcount. Every associate costs more money, and there are more of them.” The quarter saw payouts of unusually large bonuses, as well as three retroactive associate pay scale increases, which many firms scrambled to match. Associate compensation increased 12 percent year-over-year at all firms and more than 17 percent at Am Law 100 firms, according to the report. Firms on average also spent 121 percent more on recruiting than in the previous year.

The 100 top-grossing U.S. law firms tracked by American Lawyer all reported gross revenue growth, buoyed by high demand in mergers and acquisitions (M&A) and other transactional work. That demand led to a talent war that pushed starting associate salaries from $190,000 to $215,000 at many major firms, on top of numerous bonuses. Overhead expenses, including support staff compensation, technology, and knowledge management and library services, all grew moderately. But other support staff benefits, office expenses, and business development costs all grew significantly. Recruiting grew the most, by approximately 121 percent.

More Profitability Red Flags—Q2 2022

According to the Law Firm Financial Index report for Q2 2022, a continued decrease in demand for legal services, combined with an increase in pay and overhead, poses more challenges to law firm profitability in the second quarter of the year. A quarterly composite index score of demand for legal services, expenses, rates, productivity, and additional economic indicators fell to its lowest point since 2006—even lower than during the global financial crisis. Much of this is attributed to the fact that in prior years, increased expenses were offset by demand and rate increases. Not this year.

Significantly, in prior years, in addition to transactional practices, other practice-area growth buoyed firms’ profitability. Not so for this quarter. While transactional practices grew approximately 5.7 percent, non-transactional practices were down. Litigation practice growth demand was down 2.2 percent. Intellectual property was down 2.3 percent. Labor and employment down 1.2 percent, and tax down 2.7 percent. The largest declines were in M&A and bankruptcy, down 4.9 percent and 11.2 percent respectively. Overall, profits per lawyer were down 3.6 percent from the prior quarter.

Return-to-work continues to be a noteworthy factor in the downward profitability trend. Overhead expenses were up more than 2 percent compared with the first quarter of 2020, which is used as a more stable pre-pandemic baseline to gauge firms’ cost structures. Compared with the same quarter last year, overhead expenses were up 13.5 percent. Average technology spending, a component of overhead, increased 10.5 percent, the largest increase in eight years. This was in part affected by inflation, but according to the report, it appears firms are making longer term investments in this regard. The biggest three overhead expense factors all increased significantly from the prior year. Recruiting expenses were up 97.2 percent. Marketing and business development expenses were up 74.3 percent, and office expenses were up almost 40 percent.

Direct expenses, those generally connected largely to compensation, payroll taxes, and benefits, continued to increase meaningfully due to associate compensation. These were up 12.4 percent from the same period last year, with first year salaries still around $215,000 in many of the largest U.S. firms. Retention has played a large part here too, as bonuses continued to be a substantial factor.

Proceed with Caution

Law firm profits are down, expenses have increased, and demand for legal services appears to be declining. Time to panic? Not yet. But law firms should heed the warning signs. According to the Law Firm Financial Index report, “[f]irms enjoyed growing profits per lawyer for seven consecutive quarters; but as momentum reversed, the [Index] score and average profit-per-lawyer began to likewise decline.” The report also noted that “[w]hile firms have two more quarters before they realize their profits at the end of the year, this downward trend should serve as a warning of potential trouble.”

“Much like a lane-departure system on a modern car, the (Index) does not exist to signal when the car has crashed. Rather, it serves as an early warning for when firms drift away from profitability growth,” illustrates a Reuters report. It further states, “The Index, having hit its lowest all-time score, serves to warn firms that they must keep a tight grip on the steering wheel now as future revenue tries to measure up against a spectacular second half of 2021.”

“I don’t know where we’re headed, but it’s probably not in a good direction,” predicts William Henderson, Bloomington, IN, an Indiana University Maurer School of Law professor who studies the legal profession, in another report. Henderson also noted that law firms learned some tough lessons from the global financial crisis. “When the market rebounded, they had big holes in their talent.” Henderson also noted that trying to fill those gaps was difficult, with law firm leaders pledging not to “make the same mistakes as 2008.”

Zeughauser Group consultant Kent Zimmermann, Newport Beach, CA, suggested that firms get ready for rough times and make proactive cuts now. The strongest firms “going into a down economy tend to be the strongest coming out the other side,” according to Zimmermann in Reuters. Following years of extraordinary revenue and profitability, there’s “nowhere to go but down for some firms,” added Zimmermann.

How can attorneys help themselves in this type of environment? Given the current legal market conditions, unlike last year when firms were seeking legal talent able to handle the abundance of work, firms are now looking for attorneys who can produce work, remarked Jay Harrington, Traverse City, MI, president of Harrington Communications, LLC, in Reuters. “Firms will be looking for lawyers to step up and generate more work to keep themselves and others busy,” said Harrington. Isabel DuPree, Atlanta, GA, a director at VOYlegal, noted in the same article that she does not foresee massive layoffs but added that associates who “don’t try to stand out and do well may be the ones who suffer.”