New dynamics, high expectationsAfter 18 months of managing profit through uncertain times, the days of low revenues are coming to an end. Demand for legal services in the third quarter of 2021 was 4.4% greater than the same period last year, following second-quarter year-over-year demand growth of 7.3%, according to Thomson Reuters. Additionally, RSM’s Middle Market Index reached an all-time high of 145.5 in the third quarter, showing that middle market business conditions point to continued robust economic growth, rising revenues and net earnings. We do expect this optimism to level out slightly in the fourth quarter, as frustrations over prolonged labor market supply challenges and inflationary pressures are proving to be persistent challenges. But optimism will remain relatively high as firms continue to adapt their internal operations to capture the strong demand. That said, there’s no guarantee that strong demand and rate increases will result in another year of record profits for law firms. A return to normal also means a return of costs. Direct expenses in the third quarter increased 7.2% from the same period last year, a jump Thomson Reuters attributes to increased associate compensation. Meanwhile, year-over-year overhead costs grew in the third quarter (1.1%) for the first time this year. And costs are expected to continue to rise through the remainder of the year. The increase in expenses is largely driven by how firms are reacting to higher associate salaries and a hot labor market—58% of all middle-market companies already have increased compensation and 70% intend to increase it further, according to the third-quarter RSM US Middle Market Business Index survey. Additionally, overhead expenses, such as travel and business development costs, are being reintroduced as workplaces continue to open.
There’s no guarantee that strong demand and rate increases will result in another year of record profits for law firms. A return to normal also means a return of costs.