– Law firms are recognizing that salary increases are not sustainable because of lasting impacts on profit margins, and they’re updating their workforce strategies accordingly.
– As lawyer billing rates increase, clients will value productivity and efficiency from their law firms more than ever.
– Digital solutions will be key to profitability and retaining talent.
As law firm executives reflect on their performance in 2021 and plan for 2022, we expect a widespread acceptance of persistent labor challenges—and anticipate firms will adapt to this new normal by adjusting strategies to remain profitable. Fortunately, the firms that focus on improving productivity and justifying rate increases by bringing greater value to clients will reap the benefits of these strategic shifts long after labor challenges subside.
Same labor challenges, new strategy
Hopes that a new year would bring a reprieve to law firms’ labor challenges have been dashed, as the number of vacant positions continues to rise. With the unemployment rate in the United States down to near pre-pandemic levels (3.9% overall and 2.1% for those with a bachelor’s degree or higher, according to Bloomberg data), it’s clear that most qualified lawyers who wish to work are doing so.
To combat the supply-side labor constraints in 2021, law firm executives relied primarily on salary increases to attract talent from other firms. Associate compensation was up 11.3% year over year in November 2021; that contributed to a corresponding associate turnover rate of 23.2%, as lawyers made lucrative moves to other firms, Thomson Reuters data shows.
Although that proved to be an effective short-term strategy to compete for talent, law firm executives are recognizing it is not sustainable because of lasting impacts on profit margins. An updated approach is necessary, though, because the supply-side challenge remains.
In fact, the U.S. labor market ended 2021 with approximately 1.8 million business and professional services job openings, and an unprecedented gap between job vacancies and hires.
The volume of hires and offers remains fairly steady compared to pre-pandemic levels. However, the vacancies have continued to climb, widening the gap considerably over the last 18 months or so, showing that the competition for talent will remain top of mind for executives throughout 2022.
We expect firms to continue to update their plans to protect profit margins and respond to increased demand despite labor shortages. To that end, two critical strategies include rate increases and technology investments to boost productivity.
Increasing billing rates—and value
The effect of raising salaries to attract and retain staff is evident in the sharp increase of direct expense growth in 2021. Historically, direct expenses have increased at a slightly higher rate than lawyer billing rates, a difference of about 1%. In the third quarter of 2021, however, direct expenses increased by 7.2%—a staggering 3.5% difference over lawyer billing rate increases, Thomson Reuters reported. These direct expenses were driven by salary increases and are unlikely to decrease due to the sticky wage theory.
Another indicator that billing rates will rise is the relationship between inflation and lawyer billing rate growth. Persistent inflation is likely to drive rates up to compensate for heightened indirect expenses as well.
Since 1986, legal services have experienced an average inflation rate of 3.84% per year, compared to the overall inflation rate of 2.6% during the same period, according to the U.S. Bureau of Labor Statistics. In 2021, however, inflation surpassed lawyer billing rate growth, which is historically unprecedented.
RSM Chief Economist Joe Brusuelas forecasts that inflation will peak in the first quarter of 2022, and the impact of the omicron variant will likely cause inflation to stay elevated through the second quarter. Expect billing rates to respond accordingly.
On the demand side, we expect the 2021 rebound to be followed by a strong 2022. That will provide some comfort to law executives looking to raise billing rates to protect profit margins and offset the sharp increase in direct and indirect expenses.
However, that does not mean all clients will embrace higher billing rates. According to Thomson Reuters, 22% of firms believe there is a high risk of clients exerting downward pressure on fees this year. In general, clients have come to a better understanding of how lawyers’ fees work, which underscores two key ways law firms can deliver more value: being cheaper and more efficient.
In other words, as rates increase, clients will value productivity and efficiency from their law firms more than ever. Firms, in turn, will share those priorities because of the labor shortage, high demand for services, and clients’ insistence on justifying billable hours. As a result, firms in 2022 will emphasize the importance of productivity metrics, such as utilization, realization and collection rates.
The many benefits of technology
With the current shortage of available lawyers, every billable hour is precious to a firm. Ensuring that lawyers and staff have the tools to minimize administrative tasks, maximize availability for billable work, and enhance their personal work-life experiences will be key to profitability and retaining talent.
Unfortunately, nonbillable tasks commonly stand in the way of productivity and profits. Executives who recognize this roadblock within their firms can shape their 2022 information technology road maps accordingly by identifying areas for automation to increase efficiency and reduce administrative tasks.
The use of technology to achieve efficiencies is far from a new concept, of course. But it gained momentum as pandemic disruptions encouraged widespread technology investments to enable employees to remain productive in a remote working environment. Legal professionals and organizations have followed suit by embracing those changes, says Neil Araujo, CEO of iManage, a developer of legal document management software.
“This evolution is ushering in a new era in improving productivity, data-driven decision-making, and work/life balance for the fee earner—all of which, ultimately, will lead to better business outcomes for firms and their clients,” Araujo recently told Legaltech News.
Law firm executives are looking to enhance productivity not only using new, groundbreaking technology, but also by upgrading existing systems.
According to Thomson Reuters’ 2021 Law Firm Business Leaders Report, published last October, 35% of respondent firms planned to upgrade their e-billing system, one of the most widely used technologies within a law firm today; and 42% planned to upgrade their financial management information systems, also known as enterprise resource planning systems or ERPs.
Meanwhile, two of the most common new investments firms are planning this year include customer relationship management systems (18% of firms) and AI-enabled modeling, matter budgeting or cost tracking (16%).
Strong demand for law firm services in 2022 will help turn ongoing labor challenges into opportunities for firms to adopt new technologies that satisfy clients’ desire for efficiency and productivity. In the current inflationary environment, firms that recognize the greater value in investing in technology as opposed to raising salaries will improve their competitiveness and profitability over the long term.