Tuesday, April 14, 2009

Law Firm Economic Cycles – Part I

For the next few days I will be serializing here some findings from analyses I did last fall as my law firm clients were considering how best to respond to the economic downturn. To help them, I parsed US law firm performance data to identify precursors to and impacts of previous recessions on law firms’ financial performances since the late 1980s.

Because I have long since shared the insights gleaned from my analyses and their early warning benefits with my own clients, it’s now appropriate to share them with a larger audience. Seven months later, some of my findings from last fall look like a big duh, although others still offer useful insights. All the findings endorse the good advice offered in December 2008 by Bruce MacEwen at http://www.adamsmithesq.com/ that we all should “read fewer newspapers [and study] more history.”

Last fall, I found strong parallels between the current recession and the 1990-91 recession. I remember 1991 well because it was the year I first entered the legal marketing scene. At that time, I lived in California where the economy was suffering terribly from overextended and failing banks and S&Ls, tanking real estate prices, rising unemployment, high oil and gasoline prices, a US war, stock market losses, and plummeting consumer confidence. Therefore, one focus of my research last fall became: What happened to the legal services industry (specifically big law firms) during and after the 1990-91 recession that can help us appreciate how our industry will be affected by the current recession? Here’s some of what I found.

1. The highest increases in large law firm revenues presage recessions.

My review of all Am Law 100 performance data since the late 1980s shows that those years in which the Am Law 100 firms’ total revenue increased by the greatest percentage (compared to the previous year’s performance) were in each of the three years preceding the appearance of the three recessions since 1984. Those banner total revenue increases occurred in fiscal years 1989 (17.8%), 2000 (17.0%), and 2007 (13.6%).

Apparently, an economic tide that lifts law firm revenue so high cannot sustain itself. This pattern announces that a downturn is imminent, due to imbalances in the marketplaces that feed large law firms.

2. Recessions can hurt large law firm performances for a long time.

Based on Am Law firms’ performances in the early 1990s, I foresee that the current recession’s impacts on large law firms, particularly on partner profitability, will be felt for four years or longer by most firms. This forecast is based on how long it took many firms to recover after the 1990-91 recession.

As noted earlier, 1989 was a banner year for Am Law firms. Eighty firms were included in the Am Law lists for all eight fiscal years 1989 through 1996, and I took special interest in those firms. From 1990-1993, more than half of those eighty firms produced profits per partner no higher than they had enjoyed in 1989 (see Table 1 below). The second year of the recession saw even more firms failing to exceed their 1989 PPP levels. It was not until 1994—four years after the recession began—that more than half of the Am Law firms in this sample finally produced partner profits beyond their 1989 levels.

It is possible that large law firms may indeed recover faster from this current recession than from the one in 1990-91 . This time around, firms have more quickly pared troublesome practices and unneeded resources, actions that law firm leaders were slower to take in the early 1990s. However, most firms and their partners must still prepare for multiple years of lower profits per partner.

Note: A fuller description of the research summarized above and in future postings is provided in a chapter I contributed to Leigh Dance’s new book,
Bright Ideas: Insight from Legal Luminaries Worldwide. For more information about this book, which will be published in May 2009, please contact Leigh.

Coming soon:

Watch here for future posts re “Observations about Law Firm Economic Cycles,” e.g.:

3. Higher-end firms suffer longest from recessions.
4. Lower-end firms tolerate recessions better and recover from them faster.


Doug Cornelius said...

Isn't this just tracking the broader economic cycles of the economy?

Particularly on the transactional side of practice, activity at the law firm should be governed by the activity in the market as a whole.

You then should get some counter-cyclical activity from litigation, bankruptcy and regulatory practices as the economy reacts to the downturn.

Ann Lee Gibson said...

Doug, thanks for your comments. A few thoughts to offer:

1. Yes, I agree—it is clear that law firm performances do parallel the larger economic health of the business and consumer environments, particularly on the transactional side of firms’ practices.

2. However, during and following the 1990-91 recession, those vaunted counter-cyclical litigation, bankruptcy, and regulatory practices were not sufficient to overcome the downward gravity of the reduced deal stream, at least not for the next four to five years.

3. Likewise, it seems probable that during and following the current recession those counter-cyclical practices will not amply supplement the revenue losses due to the smaller dealstream we will likely see for years to come.

4. A lot of people are optimistic right now about the coming recovery. Optimism is a wonderful thing—I’m a natural optimist, myself. But optimism is a personality trait, not a tactic or a strategy. If the past can tell us that law firms suffered badly during and after less severe recessions, it behooves us to understand as clearly as we can what that history is. That’s the primary contribution I hope today’s post offers as we try to see over the horizon to our industry's future.


This article is very timely and relevant. As I quote Cameron Muir, an economist, "Home sales are unlikely to fall much further..That being said we expect home sales not to decline much further."

But it's never too late, with the right business plan set up, it will lead to valuable outcome. This is what most counselors would give as an advise.

Darryl Cross, Rainmaker Fitness said...

Ann Lee, you are brilliant. The more I read, the more I learn