However, one key area remains to be explored — specifically, how are clients reacting to these large jumps in hourly rates?

It should be noted from the outset that the fact that rate growth is higher in 2023 than last year surprises basically no one. Nearly every observer of the legal industry knew that the pace of rate growth would accelerate this year, and the only question was, by how much. We now have an indication of that answer, and it’s an appreciable amount.

Gauging client pushback

Many legal market commentators have also been speculating that clients will likely start pushing back more aggressively on rates. This is a nuanced proposition as there are several different ways clients may do this. Let’s explore some of the possibilities.

First, clients may be inclined to ask for larger discounts off published standard rates. In truth, this may or may not be happening, but it’s not particularly germane. Standard rates are the advertised top rates from a law firm, similar to the rack rate on a hotel room — it’s a number they publish, but almost no one actually pays it. The point of trying to increase the discount on standard rates would be to attempt to exert some influence over the actual rates being charged by law firms. Whether clients are requesting larger discounts or not, the fact remains that worked rates still went up by quite a bit. Even if clients are pushing back on standard rates, they are not doing so to a large enough degree to place much of a damper on the growth of agreed-upon rates.

Nearly every observer of the legal industry knew that the pace of rate growth would accelerate this year, and the only question was, by how much. We now have an indication of that answer, and it’s an appreciable amount.

Second, clients may be expressing price sensitivities to their law firms throughout the course of their matters, encouraging firms to increase the amount of the potential fee the firm writes down before the client receives an invoice. There is some evidence that law firms are, in fact, increasing the amount of potential fees they proactively write-down prior to invoicing, which is contributing to the reported decline in realization. Whether this is the result of actual or simply perceived pushback from clients is an open question. It seems more likely that any increase in write-downs is due to perceptions of possible client objections by law firm lawyers rather than anything proactive on the part of clients.

Third, clients may be seeking larger discounts on their invoices, once received. If this were the case, we would see a widening gap between what we call billing realization (the percentage of the agreed rate that’s billed to the client) and collected realization (the percentage of the agreed rate that’s collected from the client). If the gap between these two figures widens, it’s an indication that clients paid a smaller percentage of their invoice. While there is some evidence that the gap between billing and collected realization widened for the quarter, it is difficult to tell at this point if this is the start of a trend or just part of the regular realization cycle.

Finding the value proposition

While there may be additional actions clients could take in reaction to rising rates, there is one that merits particular attention: Clients might just vote with their feet.

An unhappy client has a plethora of potential law firms and alternative legal services providers from which to choose, particularly if the main issue of contention is cost.

At a series of roundtable discussions in which I’ve participated with general counsel this year, I often have heard of concern over the increasing costs of outside counsel at a time when in-house law departments are facing an uptick in their overall matter volumes along with pressure to curtail their budgets — clearly, a difficult conundrum.

For many of these GCs, one option that comes immediately to mind is to shift to lower-cost law firms for some of the legal work needed. This phenomenon of demand mobility is something we explored in our Report on the State of the Legal Market earlier this year, as well as our State of the Corporate Law Department, released in March. Indeed, clients are not shy about discussing their feelings on this among their peers. They will freely discuss not only the fact that they’re doing it, but what types of matters they’re shopping around, how they’re identifying potential new law firms, and even which specific law firms to whom they are giving additional work.

At a time when half of legal service buyers report switching at least some portion of their panel of outside law firms, we are in a time of nearly unprecedented volatility in terms of legal demand shifts. That’s not to say that all work is at risk or that every higher-cost law firm should be worried, however. Another observation I have heard frequently from GCs is that for some firms, cost is no problem because of the value the firm delivers.

Of course, value is a bit of an amorphous term in that its meaning is very much in the eye of the beholder, i.e., the client. But there is some commonality of definition: quality, efficient legal advice that meets the client’s need — without exceeding a reasonable scope — and which recognizes the client’s broader business objectives.

For those law firms that deliver value well, clients will often tell me something along the lines of, “I have no problem with what they charge me, because they’re worth it.”

Such a characterization would be a worthwhile goal for every law firm. Truly understanding what the client values and delivering against that value proposition requires a lot of discussion with and understanding of the client, their goals, and their business. But for those firms that can do it well, it is, perhaps, one of the best ways to ensure the long-term strength of the relationship with the client.

Fears of missing out on opportunities or alienating rainmaking lawyers trap some firms in the ambiguity abyss — that largely undifferentiated position of saying, We are a full-service firm that’s able to meet the complex needs of sophisticated clients.

Our analysis of the last 15 years of law firm brand positioning, recently reviewed alongside law firm financial data, has produced a compelling argument for law firms to build a differentiated approach to the legal market.

A differentiated approach

There are four ways to think about segmenting and differentiating a firm’s approach to the market:

1. 1. 1. Expertise — We are smarter than other firms in this area of law.
      2. Client type — We understand this kind of client better than other firms (e., public vs. private companies, start-up vs. mature companies, etc.)
      3. Geography — We offer strength in a defined geographic region.
      4. Sectors — We can navigate the dynamics of this sector and are well-positioned to serve all client needs in this space.

While law firms need to consider each of these factors as part of their strategic plans, competitive advantages are created when one factor is considered the key strategic priority that then informs the other three. Let’s look at this concept in action.

Case Study 1: A sector-focused approach to the market

Law firm ABC has a clear sector-focused approach to the market and is heavily entrenched in the technology sector — from traditional tech companies to fintech and e-retailers, this firm serves them all.

The good news for Law firm ABC is that their stated strategy is strongly corroborated when looking at our research of more than 2,300 General Counsel and senior corporate law department leaders. (Sadly, this isn’t always the case, which may indicate a poorly executed strategic plan.)

When looking at the types of companies that keep Law firm A top-of-mind, nearly 70% of those senior legal decision-makers are from organizations in a tech-related sector. This, unsurprisingly, also means a large proportion of these companies are based on the West Coast of the United States.

More proof of Law firm ABC’s effectiveness in executing this strategy comes when assessing the firm’s ability to gain access to new work or generate more legal demand.

Our Market Insights team undertook a conversion analysis, which involves looking at what proportion of legal buyer respondents who name a law firm top-of-mind then go on to say that firm is the one they consider hiring for different types of legal work. In other words, how well does a firm convert mindshare into market share.

Law firm ABC is twice as effective at turning awareness in new work with legal buyers in the technology sector compared to all other sectors combined — an impressive proof point that underscores how the firm’s focus in this sector is more than just lip service. And the firm’s financial performance? When looking at demand (billable hours), this firm has nearly 50% higher demand growth than the average firm over a three-year timeframe.

Why differentiation works

Of course, lots of factors go into a law firm’s ultimate success, and brand differentiation is one of the levers that law firms can control. In the case study above, Law firm ABC uses a sector-focused strategy to differentiate itself from other firms in the (extremely crowded) market.

And Law firm ABC is not a one-off example.

Our ongoing research with General Counsel shows that many outside law firms identified by clients as having deep sector knowledge earn, on average, 43% of their clients’ external legal spend — that’s nearly 2.5-times the typical firm.

With lack of time being one of the most pressing issues that General Counsel and other law department decision-makers face, a differentiated brand helps buyers quickly understand how your law firm can help them — rather than trying to figure out if yours would be the right firm to call in a specific situation.

For more on how your firm can differentiate in various ways, check out our latest video, which digs deeper into understanding the various ways firms can differentiate — and measure the success of their approach to the market.

Yet the growth rate shown in the most recent report still came as a bit of a surprise: a 20% compounded annual growth rate (CAGR) for the past two years, resulting in a current market size of $20.6 billion. In interviews with leaders from more than a dozen ALSPs, respondents said they expected standout growth in the sector to continue, and survey data from the client side supports these expectations. Among respondents from the largest law firms, 26% said they plan to increase spending on ALSPs, while only 3% said they expect their spending to fall. Within corporate law departments, 21% expect to be spending more on ALSPs in the future, with just 8% expecting spending to drop.

Interview respondents consistently referred to the ALSP market as “opening up” over the past two years, citing a variety of catalysts: changes wrought by the global pandemic, the impact of the Big Four auditing and accounting firms, and the shrinking size of many corporate legal departments, among others. ALSPs are taking advantage of those changes to greatly expand their service offerings; and while the industry is young, a number of ALSP leaders said they’re beginning to see a trend more commonly associated with mature industries: consolidation.

More growth ahead?

A sales director at a U.S.-based ALSP says that ALSPs have moved through the very early stages of the growth curve associated with any new innovation and are now poised for accelerated take-up. Among customers, the innovator and early adopter segments of that base have been using ALSPs for years, and their positive experiences are clearing the way for a wider mass market. “All of a sudden, people will say, ‘Okay, it’s safe now,’” the sales director says, “which will lead to even more expansion.”

He also pointed out that the traditional legal market leaves behind a lot of unmet demand. “Clients simply cannot afford all of the legal and regulatory advice they need to buy,” he says, especially if law firms remain wedded to the billable hour. “There’s this latent demand out there, and if you change your model, you can grab more market share, because [clients] just cannot afford to buy answers by the hour.”

The Big Four have also had a positive effect, says the founder and CEO of a U.S.-based ALSP, admitting that “this is going to sound strange.” The Big Four have convinced many general counsel, CFOs, and CEOs that business and law shouldn’t be so separate, the founder explains. “We found that the Big Four moving into the space has actually just opened up the top of the funnel — it’s so much larger now.”

ALSPs also get a boost from the fact that corporate law departments are shrinking — even though their workloads are not. A founder of an independent U.K.-based ALSP echoes that sentiment. “One of the things we see is that a bigger client doesn’t mean a bigger law department,” the founder says. “Inside legal counsel and inside legal operations are shrinking.” Meanwhile, he adds, inside teams have too much work, or work that isn’t a good fit for their capabilities. Legal departments are even bringing in procurement professionals — a relatively new part of the legal landscape — to try to close that gap in a cost-effective way.

Not surprisingly, the pandemic had an impact as well. “The stigma of offshore support has worn off,” says the vice-president of a U.S.-based ALSP. “We all ended up working from home, and we learned it doesn’t matter where the person is that you’re talking with.”

New opportunities

Together, these trends mean opportunities for ALSPs. The largest seems to be in regulatory & compliance work and advisory work, as well as in technology consulting. ALSPs are also looking to expand into specific service areas, such as labor & employment law, and into new geographies.

The impact of regulations such as the General Data Protection Regulation (GDPR) in the European Union and the California Consumer Privacy Act (CCPA) have produced “a huge focus” on privacy, says a U.S.-based ALSP leader. His firm is partnering with a technology company to provide faster and more focused data breach review. They’re also spending “a significant amount of time” helping clients update their contracts to reflect the new laws.

The new regulations are especially hard to navigate for those organizations that do business across countries and regions. “It’s increasingly complex to operate businesses in multiple jurisdictions and try to manage all of them,” explains the CEO of a law firm captive ALSP in the U.S. “For a lot of our clients, some of their biggest needs are just better use of some of the tools that exist that make it easier to have a good lens on the range of matters our clients have in different jurisdictions.”

Technology consulting, as mentioned in the ALSP 2023 Report, is also a growth area — one that overlaps significantly with legal operations. A partner at a law firm ALSP says his firm is regularly asked to weigh in on matters such as how to manage work, how many lawyers to hire, and where those lawyers should be located. On the technology side, his clients want advice about which technology solution to buy, how it should be implemented, and how it can be made to work best for them. The partner described a typical request as one in which clients say: “I bought some technology, and it’s crap, and it doesn’t work. Help me, because I’ve spent half a million pounds on it, and I can’t admit it doesn’t work.”

Growth through acquisition

As ALSPs grow, it’s not surprising that they become more attractive acquisition targets, fueling consolidation. “In the early stage of this industry we were trying to say, ‘Who do we acquire?’” says the co-founder of a U.S.-based ALSP. “There was nobody of any size to acquire. They were all tiny.” Another ALSP founder expects consolidation to continue, as companies that are strong in one service area — for example, discovery — look to buy a competitor that is strong in a complementary area, such as legal operations.

A partner at a law firm ALSP is already noticing that his competitive set is smaller. “Four or five years ago, I think there were 10-plus providers in the market. There might still be, but you certainly don’t see them. You probably see three or four at the most.” Now, he’s finding his clients are using ALSPs quite heavily, and hire just a handful of providers. His diagnosis of his market segment could just as well apply to the ALSP market as a whole: “It’s grown up,” he says. “It’s matured as a service offering.”

For next steps on how you can elevate your firm’s position through tailored intelligence programs and market leading data-informed strategic consulting, click here

Following the aftermath of a second year of persistent inflation, many experts had anticipated a substantial surge in rate growth, with aggressive projections ranging between 7% and 8% for the first quarter. Although the actual results fell slightly short of these optimistic forecasts, the 5.5% rate growth achieved by the average law firm still stands out as the swiftest increase observed during a first quarter period since the end of the Great Financial Crisis (GFC).

These positive outcomes were observed throughout the market, with all segments exhibiting higher growth rates than their previously most significant post-GFC increases. Specifically, Midsize law firms saw rate growth of 4.9%, while Am Law Second Hundred firms saw their rates rise by 5.2%. Notably, Am Law 100 firms led the way in terms of rising rates, achieving a remarkable growth rate of 7.2%, surpassing the segment’s previous all-time record in the history of the Thomson Reuters Financial Insights program.

Navigating inflation & expense pressures

Last year marked the first time when the Q1 Core Personal Consumption Expenditures (PCE) inflation rate surpassed the average firm’s Q1 worked rate growth. This trend continued throughout the year, with rate growth consistently falling below core PCE.

In the current quarter, firms have returned to the status quo, in which worked rate growth once again outpaces inflation. While this development is encouraging, the difference between inflation and firms’ rates remains relatively small compared to historical norms, which is particularly pertinent for less assertive Midsize firms.

Although expenses are growing more slowly both in aggregate and on a per-lawyer basis, the aftermath of rapid compensation hikes — combined with inflation-driven overhead growth and return-to-office strategies — is exerting tremendous pressure on firm profitability. In light of these factors, substantial rate adjustments were not only expected but necessary to ensure that firms remain competitive and financially sustainable in the long run.

On a practice area basis, the most significant upward adjustments occurred in counter-cyclical practices — such as litigation, bankruptcy, and labor & employment practices — which also experienced the greatest surge in demand. Conversely, transactional practices suffered contractions in demand across the board, and their growth rates were comparatively lower suggesting some degree of price elasticity. Thus, the remarkable growth in counter-cyclical practice rates was able to offset the weaker rate growth observed in other areas and propelled this quarter’s overall improvements. Indeed, across all segments, counter-cyclical work commanded higher price increases than transactional work, and this behavior was most pronounced in the top end of the market, where Am Law 100 firms recorded counter-cyclical rate growth that was more than two percentage points higher than their transactional rates. Of course, this phenomenon mostly resulted from these firms experiencing the greatest declines in demand for transactional work.

Looking at rate growth from lawyer-title perspective, a familiar stair-step approach was observed among the segments, with Am Law 100 attorneys recording the highest rate growth, followed by Second Hundred and Midsize attorneys. However, a divergence in results emerged from the relative rate increases between partners and associates within each segment. The rates for associates at Am Law 100 firms were raised much more aggressively than their equity and non-equity partners. By contrast, associates at Am Law Second Hundred and Midsize firms did the opposite, with partners commanding higher rate increases than their associate counterparts.

Law firms’ Third Law of Motion

Sir Isaac Newton famously stated that for every action, there is an equal and opposite reaction. Fortunately for the legal industry, this law of physics does not apply here. While it is true that firms’ rate hikes caused collected realization to dip below the mark set at the end of last year (in Q4 collected realization for the average firm was 91.0%), this is a typical seasonal trend and is likely to be the worst realization rate of the year as clients adjust to new prices.

However, in contrast to Newton’s third law, the reaction was not equal. In fact, compared to other first quarters, Q1 2023 resulted in one of the best realization figures in recent years. There is, almost expectedly, one exception to this trend. Am Law 100 firms, which have a transactional-focused practice mix and often serve more cost-sensitive clients, pushed their rate growth at an all-time pace and potentially suffered the greatest amount of pushback. The results of the last quarter, however, tell us that the average firm is holding onto a higher percentage of their worked rates than typical first quarter results despite the significant price hikes.

In summary, the financial performance of law firms in the first quarter of 2023 showed significant improvement compared to the previous year, thanks to rate growth which acted as a catalyst for positive change, with all segments posting some of the highest growth rates seen in recent years.

Despite the external challenges and high expenses that many law firms continue to face, not only were firms able to navigate the situation, they were also able to retain a greater percentage of their worked rates than before. As we move forward, it will be interesting to see if firms can sustain this aggressive approach and continue to reap the rewards.

While 2023 seemed to be off to a strong start, the collapse of several regional banks, continuing war in the Ukraine, and the uncertainty wrought by rising interest rates have both clients and law firms a bit uncertain about the direction of economic trends. It’s not clear where overall demand will come in for the first quarter; and while expenses continue to increase, they are offset somewhat by rising rates that firms are able to charge. This heady mix makes continued revenue growth even more important.

On the client side, demand for legal services is projected to remain strong — 41% of clients say they plan to increase legal spending this year, and only 20% expect legal spending to decline. Clients are also looking for legal advice to be delivered in combination with significant industry and sector knowledge, noting that advice presented along with commercial context has more worth than that same advice presented in a vacuum.

Law firms’ marketing & business development teams, of course, play a significant role in turning these projections into actual revenue. But much of marketing & business development was turned upside down by the pandemic. With the temporary loss of in-person marketing channels such as events, many marketing & business development teams were forced to experiment with new types of digital outreach, and they are now in a position to better compare their effectiveness.

On average, law firms are allocating 1% to 2% of revenues to marketing & business development budgets. CMOs are right to wonder if that’s adequate. Along with those budgets come admonitions to get creative and of course, do more with less, even though live events — generally quite expensive — are coming back into the marketing mix.

Balancing the short- and long-term

To meet that mandate, CMOs need to narrow their focus to those initiatives most directly aligned with their firms’ strategic aims. Those aims, of course, need to reflect client priorities: the type of work clients need done, how they want advice delivered, and which geographies are most active, for starters.

The firm’s strategic aims also need to be informed by market insights. A data-driven approach, or even a data-informed one, helps reduce internal debate. Strong, reliable data that comes directly from clients helps teams focus and move ahead. Equally important, it prevents them from using resources on initiatives that may not have much impact.

Responding to clients’ legal needs requires a two-step approach. First are clients’ immediate needs, which our data identifies as most urgent in the regulatory, legal & employment, and litigation practice areas.

While firms are handling urgent client requests, they must also be laying the tracks to support clients’ future needs. That way, when clients are ready to address, for example, data privacy head-on, firms will already have the right legal team with the right relationship at the ready. Right now, clients’ longer-term needs appear to be in areas of regulation, data privacy, cybersecurity risk, and environmental, social, and governance (ESG) issues.

Balancing clients’ short- and long-term priorities requires a balancing act of its own on the part of CMOs, who often are all too aware that they can’t do everything at once. Yet, no matter how urgent or busy short-term needs seem, it’s imperative to carve out the time to look at longer-term client priorities.

The increasing profile of marketing & business development

Other members of firm leadership seem better positioned than ever to help CMOs perform this balancing act. Those in leadership roles in marketing & business development report that the firm leadership is working together better than ever, which makes it easier for leadership to support other functions, including marketing & business development.

In addition, CMOs say that the value of marketing & business development is now better understood by law firm leadership. CMOs are spending less time convincing lawyers of the value of brand strategy, for example, or defining the importance of marketing to law firms.

CMOs are also starting a bit of a reckoning over their data strategy — or lack thereof. They’re understanding the importance of client data, especially client feedback, client insights, and the priorities that are on their clients’ horizons. CMOs also believe there might be valuable insights within their firms’ own datasets; but they also understand that their firms might not have the skills to unlock those insights. Clearly, they see that there is a skills gap when it comes to data analysis. And without the ability to mine the most important insights, they’re concerned about getting bogged down in data without taking effective action — the dreaded analysis paralysis.

CMOs, like their clients, are being asked to do two things at once: grow the current business, and transform their efforts to better capture new business over an indefinite time period. Yet growth and transformation require different skills. Growth often requires intensifying existing efforts for bigger results — and is all about faster, bigger, more. Transformation is a different beast entirely, requiring reflection and iteration.

Law firm CMOs seem well-prepared to do both, and equally importantly, firm leadership seems to understand the urgent need to support them in this critical task.

You can learn how to build a feedback dialogue with your clients that will deliver value and growth, here.

To understand this development further, the Thomson Reuters Institute has released its 2023 State of the U.K. Legal Market report, highlighting the current condition of the legal marketplace for both buyers and providers of legal services in the U.K.

For many U.K. law firms, this potential reduction in legal demand coincided with a period of increased competition among their peers. In fact, nearly half of all legal clients added law firms to their roster of advisers during the year, according to our research. The report, based largely on interviews conducted with U.K.-based senior buyers of legal services, further found that it’s becoming harder for many law firms to differentiate themselves, with a good deal of legal work being commoditized into standard packages in which price is the main differentiator. This is a bit of a reversion to the mature market for legal services compared to what had been experienced prior to 2020.

At the same time, U.K. law firms have been feeling an additional competitive pinch as a result of aggressive investments made by law firms based in the United States that are looking to expand their operations in the U.K. in order to grow their share of the market in the U.K. and Europe. The result of these efforts remains to be seen, however, as U.S.-based law firm operating in the U.K. tend to rely heavily on transactional practices, which have struggled of late, while U.K.-based law firms tend to rely on a more complete suite of client service offerings.

Further complicating the competitive landscape, according to the report, is that U.K. clients are looking to keep more work in-house, as part of a drive for efficiency and cost savings. That is not to say that there will not be work for law firms and other external legal advisers; however, it will be crucial for legal service providers in the U.K. market to understand clearly what it is that clients want and expect and then adapt their services accordingly.

You can download a copy of the 2023 State of the U.K. Legal Market report, here.

The current reliance on competitive pricing advantage seems likely to prove insufficient for many U.K. law firms. Indeed, the efforts of these firms to ensure they have the necessary expertise in all relevant areas will likely leave clients looking for greater value. Price advantage can easily be lost as firms look to become more competitive and comprehensive expertise becomes a given for most firms.

Rather, in the U.K. (more so than in many other regions of the world), clients are focusing on the quality of the whole relationship with their advisers rather than just individual factors. In a major shift over the past 10 years, the historical reputation of a law firm is no longer enough to keep it top-of-mind in the market. That is not to say that reputation is unimportant, rather, it is simply becoming less influential as factors such as legal expertise demonstrated by specialist knowledge and the commercial viability of advice provided to the client become more critical in clients’ minds.

The message of the report is clear: Firms need to re-consider how they present and deliver value to their clients. The key lies in understanding and meeting client needs — both in the context of the general counsels’ departmental responsibilities but also in the company’s broader strategic goals. In short, law firms need to demonstrate that they can act not just as a legal adviser but also as a business partner.

Many firms will say they do this already — and of course, some do. However, the evidence suggests that clients have a narrower and more limited perception of what law firms currently are offering. For those firms that can act as both legal adviser and business partner, the potential outcome could be lucrative. Some 35% of buyers of legal services in the U.K. anticipate that their overall legal spend will increase in the coming year, compared to just 26% who anticipate a spending decrease.

Increasingly, as the report denotes, clients are looking to send more of their legal spend to those law firms where the whole of the relationship between lawyer and client is one in which value is discussed, defined, and delivered.

However, the recovery is divergent in nature, with Am Law 100 firms and Midsize firms facing different sets of challenges and exhibiting varying strengths. In addition to improved performance across all major practice areas in Q1 2023, we are seeing the rise of macroeconomic counter-cyclical practices, led by litigation, labor & employment, and bankruptcy, while transactional practices continue to struggle.

Key takeaways in Q1:

• • The LFFI score improved from last quarter, but remains at historically low levels

  • Expense growth slowed for firms at the top of the market, but remains a struggle for most other firms

  • Demand for counter-cyclical practice areas and rate growth increased significantly, resulting in overall financial improvement

The divergent paths

These practices have driven Midsize firms to post the fastest demand growth for three consecutive quarters, as well as seeing better relative performance in transactional practice areas. These firms, however, still struggle with high expense growth, due to their historic hiring.

Am Law 100 firms’ challenges, on the other hand, include the largest demand decline of all tracked segments, primarily driven by a significant shortfall among the Top 50 law firms. However, these firms have found new strength in their ability to slow expenses, which relieves pressure on the LFFI score overall. Layoffs in Q1 appeared at first to be more widespread among Am Law 100 firms, but they remained relatively shallow and factored into direct expenses’ slowing pace.

This bifurcated recovery highlights the current state of the legal industry, with every strength coming with a weakness. Am Law 100 firms’ market-leading worked rate growth has offset some of its demand shortfalls; but in response, these firms’ collection realization against worked rates has declined more than in other segments. Meanwhile, Midsize firms’ headcount and expense expansion surpassed their strong demand and revenue growth, resulting in shrinking productivity and profitability.

Although law firms have not fully recovered from poor operating environment that led to Q4 2022’s all-time low LFFI, all metrics have improved to a certain extent. However, the rise of counter-cyclical practices provides additional caution for economic stability throughout the rest of 2023. The challenges faced by firms of all types could still feel overwhelming, but each segment’s differing trend in hiring and expenses may provide insight into what law firm leaders believe their prospects will be in the near-term and perhaps for the long-term future.

You can download the full “Law Firm Financial Index report” by filling out the form below:

Yet, many law firm leaders fall into the trap of thinking their firm’s brand strategy is a nice-to-have element rather than a necessity. They talk about brand positioning as an exercise for the marketing department to tackle — and one that is typically separate from the strategic business planning conducted by the firm’s Executive Committee.

When brand strategy is separate from business strategy it is typically less embraced by lawyers, and that results in individuals focused on building their own personal brand at the (unintended) expense of a differentiated firm-wide market position.

What does a distinctive brand look like?

Understanding where your firm sits in the minds of clients is the critical first step to ensuring your brand and business strategy are working together and not undermining your firm’s true growth potential.

Measuring business success is largely a straightforward undertaking. There are scores of financial and operational metrics that help law firms understand how they are performing year-over-year and against others in the market.

Measuring brand success is more complicated because not every firm takes the same path to reaching their goals. You wouldn’t assess the brand success of Hyundai and Ferrari using the same metrics. Despite both being car manufacturers, the underlying business strategies and value propositions of these two companies require looking at different brand metrics to understand how well each is positioned for future success.

The same is true for law firms.

Below we will walk through a few variations on how a law firm might assess brand positioning based on their business strategy. At the end of this article, there is an interactive brand strategy landscape to create a custom view of the metrics most strongly aligned with your firm’s growth strategy.

The common denominator for each market landscape is the horizontal axis. This represents top-of-mind awareness, which is defined as how many buyers of legal services name a particular law firm when asked which five law firms they think of first. This metric is critical to understand how “sticky” your firm is in the minds of buyers.

Legal services buyers are more likely to hire the firms they think of first. Additionally, as a firm’s top-of-mind awareness grows, there is a correlated growth in revenue. This makes monitoring the trajectory of your firm’s top-of-mind awareness over time a fundamental component of any brand tracking.

The key difference in each brand landscape below is in its illustration of how well a firm converts its awareness into consideration for specific work types. The vertical axis in each chart shows the proportion of clients that think of a firm top-of-mind and say they use that firm for the work type listed. Conversion metrics are particularly effective at taking the firm’s size out of the picture and can further illustrate if your firm is building relationships with the type of clients your strategy is targeting for growth.

For example, Figure 1 below focuses on cross-border litigation needs through the eyes of global organizations with $1 billion or more in annual revenue.

In this chart, more than 18% of global legal buyers name Baker McKenzie as one of the five firms they think of first when asked as an open-ended question — this is shown on the horizontal axis. The vertical axis shows that 80% of that 18% also consider Baker McKenzie for their cross-border litigation needs. The takeaway: Baker McKenzie has built a strong differentiated brand for this work type.

In contrast, the law firm Quinn Emanuel sits on the left-hand side of the chart. This means the firm doesn’t generate as much top-of-mind awareness as Baker McKenzie (not surprising when you look at the headcounts of both firms on a global scale.) However, Quinn Emanuel garners more consideration for cross-border litigation than the firm generates for top-of-mind awareness. Hardly an earth-shattering analysis when you consider that Quinn Emanuel’s core strategy is to be the litigation boutique that clients call for their most pressing — albeit not every day — legal needs.

Which is precisely why this view of the market is one way for these firms to test if their brand position truly reflects their business strategy. Alignment between brand and business strategy drives more efficient growth. However, those firms with a misalignment in brand and business strategy can struggle to overcome pre-conceived perceptions of the firm and often leave the market confused as to what differentiates the firm from other market leaders.

Figure 2 below is a more focused view of the legal market, looking only at the firms that legal buyers based in the United States think of as top-of-mind and how well those firms convert this awareness into consideration for top-level M&A work.

However, many law firms can be even more granularly focused on their market segmentation. Figure 3 goes a step further to look at this same set of variables and shows the firms mentioned by buyers based in the Western part of the U.S.

The right metrics for your firm

The link below will take you to an interactive chart built on data Thomson Reuters collected from more than 1,500 General Counsel and senior legal decision-makers at companies with $1 billion or more in annual revenue.

At the top of the chart are filters you can apply to align the data to the market segments upon which your firm is most focused for 2023.

This allows you to look at the data by:

• • • Region — Either global, Asia-Pacific, Canada, Mainland Europe, the United Kingdom, or the U.S.
    • Buyer type — General Counsel or other legal decision-makers. (Firms focused on more transactional work types tend to build stronger relationships with secondary decision-makers, such as the Assistant General Counsel for litigation or Deputy General Counsel for transactions.)
    • Work type — We’ve provided a select list of the metrics Thomson Reuters tracks in our ongoing research with legal buyers including cross-border litigation, top-level M&A, and firms most-used for high-value work.

Once you’ve determined where within the market your firm is positioned, the next step is to make any needed adjustments. For example, if your firm is not as strongly positioned in certain segments in which it is looking to drive growth, provide your lawyers with the brand message that you want them reinforcing in the market. As the firm’s brand ambassadors, lawyers have the biggest impact on how a firm is perceived in the market.

When business and brand strategy align, a more differentiated position in the market is established, making it more difficult for competitors to beat your firm in its market segment.

If you’re interested in learning more about taking our insights to the next level and advancing your firm’s brand strategy, please reach out to Jen Dezso, Director of Client Relations, for next steps on how you can elevate your firm’s market position with current, unbiased, and irrefutable competitive intelligence.

Replenishment is a metric the Thomson Reuters Institute tracks to essentially account for timekeepers leaving a firm compared to timekeepers joining it. A replenishment ratio of 1.0 indicates a 1:1 ratio of timekeepers going in compared to those going out. Anything below a 1.0 indicates a shrinking timekeeper group.

It should be noted from the outset that both non-equity and equity partner tiers are in a long-term pattern of contraction. In fact, each tier only shows a single quarter of replenishment above 1.0 since 2010, with the tiers frequently trading places in terms of which is being replenished more robustly.

But since early 2020, a clear and often widening gap between the tiers can be observed. Replenishment of non-equity partners has hovered around 0.8. In contrast, replenishment of equity partners has varied relatively widely, dipping as low as 0.54 before recovering to 0.75 at the end of 2022. At that same time, however, non-equity partner replenishment jumped to 0.94, the first time that non-equity partner replenishment reached that high since 2016.

An increasing population of non-equity partners could be both a benefit and a detriment to law firms with two-tier partnership structures.

On the downside, non-equity partners naturally tend to bear little responsibility for business development and new client generation. Their contribution to the firm’s bottom line, therefore, depends on their productivity and individual profitability. One might hope that a lack of business development commitments would mean that non-equity partners have more time to devote to billable work. However, long-term patterns indicate that non-equity partners consistently underperform their equity partner counterparts in terms of hours worked per lawyer per month.

Going back to 2005, as far back as our data exists, there have been rare examples of non-equity partners approaching parity with equity partners in terms of productivity. However, the typical gap between the average equity partner and the average non-equity partner is between 7 and 11 hours per lawyer per month. Given the typical billing rates of these lawyers, that can translate into a sizeable gap in revenue.

On a more positive note, non-equity partners usually contribute to firm profitability in other ways. First, as the nomenclature would suggest, non-equity partners’ salaries do not vary based on firm equity, so they represent a fixed cost for the firm. In heady times, this can be a particular benefit as the payout to these partners will not vary as greatly as it would for equity partners.

In that same vein, the existence of a non-equity partnership structure creates an opportunity for law firms to offer a place of relative prestige — within the ranks of partnership — to lawyers who otherwise might not meet the criteria for full partnership. Many of these lawyers might be high performing in their own right and bring value to the firm in other ways, and they also might be at a greater risk to leave the firm if not for an upward option to non-equity partner status.

On a related point, the existence of a non-equity partnership tier can allow law firms to create upward mobility options for lawyers within the firm, while still closely protecting the denominator in the ever-important profits-per-equity-partner metric.

The upside of fixed-cost, non-equity partners, could potentially count against law firms during times of economic contraction, however. As these partners are a fixed cost, their relative share of firm expenses could grow as a percentage of revenue should the firm’s share of legal demand decrease, creating negative pressure on firm profitability.

Non-equity partners may also create profitability pressure based on the realization percentage of their rates. As partners, non-equity partners typically command among the highest rates at the firm; perhaps not as high as equity partners, but certainly above those of associates. Looking at the realization of non-equity partner rates against their equity partner peers, it is quickly evident that non-equity partners are once again trailing the pack.

There is a persistent two-percentage point gap between the collected realization of an equity partner’s standard rate compared to a non-equity partner. This will likely have a detrimental effect on the non-equity partner’s relative profitability.

Some of this differential may be due to compensation structures and who has ultimate billing authority. It would be natural to suspect that, if an equity partner is the billing partner on the majority of matters and that equity partner’s performance is based in part on realization, the equity partner would be more likely to pass write downs or discounts on to other timekeepers, including non-equity partners. This could explain why non-equity partners also lag in terms of billing realization itself. If non-equity partners absorb a larger share of write-downs and discounts, this will predictably drive their billing realization downward, and their collected realization will decline along with it.

There is no clear answer as to whether a two-tier partnership structure is beneficial to a law firm. Indeed, there are myriad factors at play, well beyond those examined here.

Perhaps the clearest answer to whether a two-tier partnership structure is right for a law firm, is also a clichéd yet popular lawyer answer of It depends. If non-equity partner costs structures and profit margins, coupled with the potential to retain additional experienced talent, can work in a firm’s favor to outweigh the potential downside of a large, high-priced fixed-cost staffing tier, then it certainly can be beneficial.

Given the complexity of the question, however, this is far from assured.

This article was written in cooperation with Bruce MacEwen and Janet Stanton of Adam Smith, Esq.

This growing trend was highlighted recently published Alternative Legal Services Providers 2023 Report, a data-driven report produced every two years by the Thomson Reuters Institute in partnership with The Center on Ethics and the Legal Profession at Georgetown Law and the Saïd Business School at the University of Oxford.

And the growth message wasn’t lost on the report’s survey respondents. As one U.S.-based CEO and co-founder of an independent ALSP says: “We’re probably at literally 10 times the number of conversations from a year ago about, how do you mature your legal department? How do you adopt the next tech? How do you do a three-year tech plan? How do you do the organizational change? How do you transform your services?”

Interviews with more than a dozen additional ALSP leaders found that more strategic considerations are becoming a routine part of ALSP discussions across multiple service areas. For example, concerning using ALSPs to fill secondment arrangements, one partner in a law firm ALSP explains: “It has become much less of an emergency service — it always used to be, ‘Someone’s left, we’ve got a gap.’ Now it has become built into the way that large clients manage talent.”

You can download a copy of the Thomson Reuters Institute’s Alternative Legal Services Providers 2023 Report here.

In other service areas, this ALSP leader says client requests “are far less ad hoc in their nature, and clients are increasingly looking to explore how they can do things differently.” Once clients use the ALSP’s services in one area, they’re quick to see the ALSP’s applicability to others, and they’re putting their other partners on notice. “Some of them are very clear,” notes one survey respondent. “They are preparing the market and their suppliers. They are saying, ‘This is coming. We are going to shift work and we want it delivered in a different, more cost-effective way, and you need to start getting ready for that.’”

Data strategy is another opportunity for both ALSPs and their clients. “I’ve met with a few [General Counsel] (GCs) over the years and one of my questions was, ‘Tell me about your data strategy’ — and five, six years ago, they looked at you funny,” says the chief innovation officer of a U.S.-based law firm ALSP. “Now they understand they’re sitting on a mountain of data.”

Indeed, some ALSPs are helping clients with work related to the General Data Protection Regulation (GDPR) and the California Consumer Privacy Act (CCPA). Others are giving GCs better visibility into the activities of their teams, both internal and external. “It’s a one-pane-of-glass view for a general counsel of what’s going on in their organization which, believe it or not, a lot of general counsels don’t have,” says the sales director of an independent U.S.-based ALSP.

The influence of procurement & legal operations teams

This newfound reliance on ALSPs as both business and legal partners has several causes, according to the interviews. First is the maturation of the ALSP market itself. As ALSPs have grown, law firms and corporate GCs see them as more stable partners, less likely to run out of funding or be bought by a bigger player that may not be a good fit. Corporate clients are increasingly requesting that their law firms perform more efficiently, and ALSPs can present a good long-term solution to that request.

However, larger factors in the rise of ALSPs seem to be the increasing importance of legal operations and procurement teams within corporate law departments themselves, as well as ALSPs’ standing as experts in legal technology and processes.

No longer does a GC rely only on relationships to find outside legal partners. With procurement and legal operations teams joining in the decision-making, efficiency and cost become more important. The result, says one founder of a U.S.-based independent ALSP, is that “now we’re able to sit down at the table with them and talk about utilization of contract lawyers as a strategy — not to replace your outside counsel.”

“We’re probably at literally 10 times the number of conversations from a year ago about…”

More tech-forward ALSPs use similar meetings “to help customers design what their strategy should be, their target operating model, their technology strategy, their key performance indicators (KPIs), their sourcing, their spending, and their supply management,” says the founder, chairman, and CEO of a U.S.-based independent ALSP.

In these cases, ALSPs benefit from offering a more integrated solution. “We’re definitely past the part of the movie where the CIO or CFO buys discrete parts for the IP management group and the litigation group and the commercial and contracting group and the antitrust and legal ops group,” says the CEO and co-founder of an independent U.S.-based ALSP.

Instead, corporate clients and law firms are looking for a holistic solution with a true partner that has both business and legal expertise — and in an increasing number of cases that means an ALSP.