But, how does a law firm go about calculating carbon emissions, also referred to as greenhouse gas (GHG) emissions, which is the first of many topics that U.S. regulators among others are starting to require? The process for quantifying this is known as carbon accounting.

Components of carbon emissions

The most common elements of the firm’s operations that are key to calculating carbon emissions are categorized in Scope 1, 2 and 3 type emissions.

Scope 1 emissions overview — Law firms are office-based and usually serve as tenants. Direct emissions (known as Scope 1) come from activities under control of the firm. Not surprisingly, law firms generally have smaller amounts of Scope 1 emissions. Typically, these emissions will come from any fuel and gas related to the operation of the building as well as from refrigerants (i.e., refrigeration, air conditioning) and fall into several areas of combustion:

• • • stationary (fuel and gas onsite);
    • mobile (firm-owned vehicles using fossil fuels); and
    • fugitive emissions (vapors directly released, like refrigerants, fire suppression).

Details of Scope 2 and 3 — Law firms will have most of their emissions come from Scope 2 and 3 categories. For Scope 2, indirect emissions come from purchased energy in the form of electricity, steam, heat, and cooling. Purchased electricity is the biggest emissions area in Scope 2.

For Scope 3 the most common indirect emissions are in the categories of measuring business travel, commuting, and purchased goods & services, including paper and waste. In the commuting category, some firms will include remote work by staff. Remote work emissions include emissions generated by equipment, such as lights, laptops, and other office equipment at home.

Key factors in carbon emissions calculations

Quantifying GHG emissions can get complicated pretty quickly, and this is why it is important to identify the subcomponents by Scope and focus on data collection first.

For Scope 1 and Scope 2, law firms will use their metered (or sub-metered) data, such as utility bills or purchase receipts and contracts. If they don’t have this, estimates based on square footage by region is the next best option.

For Scope 3, travel data can usually be found with the firm’s corporate travel agency or in the expense management system with purchase records. Commuting data and data related to remote work emissions can be obtained through surveys to employees.

In the area of purchased goods and services, it’s best to first try to obtain the data from the provider, but if the data is not available, using external databases, such as the data from the Intergovernmental Panel on Climate Change (IPCC), is the next best option. For water, the data can be obtained through sub-metered data or water bill. For waste, it is best to work with the building management.

Gather a multidisciplinary team for emissions data gathering & calculation

Compiling a cross-functional team within the support functions of the firm is necessary for the most efficient way to initiate and complete the data gathering process.

• • • Real estate, facilities & operations — Facilities and operations need to work with the building management to obtain critical data for utility data, water, waste, etc. The internal real estate department can be helpful as well.
    • Procurement & finance — Members in the procurement and finance function can help to view and track spending within the supply chain to gather Scope 3 data. Many positions within the procurement team now encompass the responsibility of emissions and decarbonization.
    • Technology — The firm’s IT group also play a role in emissions management by providing more insights on data centers, energy usage, life-cycle assessments, etc. from the procurement and e-waste perspectives.
    • Human resources — HR has a critical role to play in obtaining commuting data, sending out surveys, helping to determine remote work emissions, and other items related to the workforce.

Doing the calculation

Combining the carbon emissions is the next step once the Scope 1, 2, and 3 data sources are collected. The challenge in this step is understanding what emission factors to apply — not surprisingly, this is the point when some organizations choose to hire a consultant.

Some of the emissions factors, which is a representative value that attempts to relate the quantity of a GHG being released to the atmosphere with an activity associated with the release of the GHG, can be found on the Environmental Protection Agency (EPA) web site in the U.S., and on the U.K.’s departmental websites for the Department for Business, Energy, and Industrial Strategy; and the Department for Environment, Food & Rural Affairs. For other jurisdictions, the IPCC also has an emission factor database.

Measuring emissions will continue to evolve with the ability to gather more emission factors to create higher quality baselines. While it is important to start with the data collection, it is imperative for law firms to prioritize the biggest areas of emissions, such as travel, with low-quality data. This is where there is the opportunity for significant improvements, and law firms can refine the calculation over time.

Driving the need for continuous improvement in the calculations are the RFP requests to measure and disclose carbon emissions data from clients. Indeed, this number is likely to increase exponentially, and there will be increasing pressure for third-party verification and assurance.

An enhanced reputation is a huge benefit of carbon accounting and is a big driver to making meaningful change. Striving for this incentivizes law firms to find better ways to do things to reduce inefficiencies, waste, and consumption, which benefits everyone.

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.

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:

First, while this is a metric we have reported for some time, the NSA nomenclature has only recently been standardized. Notably, the methodology behind its calculation hasn’t changed: it is calculated by asking a relatively simple question and then denoting the gap between positive and negative responses.

During interviews with corporate general counsel, we ask them whether, within the next 12 months, they expect their legal spending to increase, decrease, or stay the same. The NSA chart below shows the percentage of those who answered the question in the positive (41% anticipate their legal spend to increase over the next 12 months), and those who answered in the negative (20% anticipate spend would decrease). The actual NSA metric is then calculated by subtracting the anticipated decrease percentage from the anticipated increase percentage. For the most recent quarter, the responses give us an NSA figure of 21, up slightly from the prior quarter.

For much of the time we have been reporting this metric, we did so without a formal name for it. When we decided to formalize it, our first attempt was using the name net spend optimism, which seemed appropriate as the metric generally tends to show legal spend increasing over time — which often is unsurprising and can cause a general sense of optimism on the part of providers of legal services, as there will likely be an increasing amount of wallet to capture.

However, as we heard feedback from many general counsel, much of it fell along the lines of “I may be anticipating an increase, that doesn’t necessarily mean I’m optimistic about it” — a fair assessment.

As the State of the Corporate Law Department report highlights, cost control is among the top five strategic priority areas for GCs around the world — and it’s number one in the United States. Increasing legal spend potentially runs contrary to this strategic priority and may even invite greater levels of budgetary scrutiny for many GCs, something they would definitely prefer to mitigate.

So, we adopted their vernacular: they’re anticipating an increase in their legal spend.

Drivers of legal spending

In an era of growing cost pressures, what is driving the potential for increasing legal spend? There are likely several factors. First, as the report discusses at length, regulatory compliance is an increasing challenge for GCs, and each layer of regulatory complexity adds with it an increasing level of cost of compliance.

At the same time, certain legal practice areas such as litigation are incessantly more expensive. Given that litigation lawyers cost more, and the high costs associated with eDiscovery are almost unavoidable, the resulting increased costs of litigation undoubtedly factor into the anticipation of higher legal spend. And last but not least, as reported in last year’s Legal Department Operations Index, 65% of corporate law departments are experiencing an increase in their overall matter volume. With all this in mind, it’s unsurprising that many GCs anticipate their spend to increase.

That raises the question, however, whether these anticipated spend increases a good thing or not? While, to a great extent, they are likely unavoidable, as businesses of all sorts face continued economic uncertainty, it is quite understandable that GCs would be apprehensive. So, what can be done?

For some time, law firms have been reporting rising pressure from their clients around rates and fees. Yet, we see a continuing pattern of ever-higher rate increases.

For many GCs, turning to technology to help automate workflows and increase efficiencies in their operations has become a primary way to increase departmental productivity. Some 71% of legal operations professionals see using technology to simplify workflows as a high priority. And they are also looking for help from the outside.

For some time, law firms have been reporting rising pressure from their clients around rates and fees. Yet, we see a continuing pattern of ever-higher rate increases. For those law firms looking to maximize the likelihood of a client agreeing to a rate increase, capturing a greater share of a client’s spend, increasing the firm’s market share, or minimizing the amount of business potentially under threat as clients look to optimize their outside counsel panels, the focus needs to be on how value is delivered to the client and how that value is communicated.

At a recent event I attended with a large number of GCs, the discussion inevitably turned to law firm rates. Surprisingly, many of those in attendance said that they actually paid little attention to the top-line rate the firm charged, but instead were much more attuned to what the business received in exchange for that rate.

For example, one GC shared that she paid nearly double the hourly rate to one firm for the private equity work she needed, but she was more than happy with that firm — which she named specifically to a room full of GCs — because they consistently delivered expert, timely advice that met the goals of her business, doing it in one-half to one-third of the time it took other firms. What a great testimonial for that firm. The factors the GC valued — quality, timeliness, commercial soundness — were all things this law firm delivered routinely. As a result, she agreed to their rate increases, she paid the firm’s bills quickly (and fully), and she was actively promoting them to other GCs who might be in need of similar services.

In an era where GCs know they will likely have to spend more money and don’t necessarily love the idea, law firms would be well advised to follow such a model for the benefits it can deliver to both their clients and the firm itself.

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.

Indeed, it is a very apropos conversation. The Thomson Reuters Institute has found that 65% of corporate law departments are experiencing increasing matter volumes, while 59% are dealing with flat if not decreasing budgets. This, and much more analytical data has been compiled into the just-published 2023 State of the Corporate Law Department report, which examines how corporate law departments, by and large, are managing these pressures to control outside counsel costs while anticipate increasing legal spend across practices, global regions, and industry sectors.

The report also delves into such topics as what law department leaders see as their main priorities, developing trends in corporate legal spend, and what strategies leaders are pursuing for 2023 and beyond. The findings in this report are the results of 1,569 interviews conducted throughout 2022 with professionals from corporate law departments within companies that have more than $1 billion in global revenue.

You can download a full copy of the Thomson Reuters Institute’s 2023 State of the Corporate Law Department report here.

Key findings in the report

Some of the critical developments and trends noted in the report include:

• • • Compliance with changing global regulatory developments has become the top priority for many law departments
    • Managing and mitigating their companies’ overall risk and cost is a key component to departments’ broader cost-control strategies
    • Overall, far more law departments anticipate an increase in their legal spend in the coming year than anticipate their spend to decrease
    • Increased legal spend is a common trend across nearly every global region, key practice area, and industry sector
    • There is growing evidence that corporate law departments are shifting work among outside law firms as a way of managing costs
    • While exact best practices remain a work in progress, most corporate law departments globally have settled on some form of hybrid work arrangements for their staff

Identifying global priorities

In their own words: What law department leaders are saying about their departments’ mission

“Always keep focusing on longevity and consolidating objectives, avoiding high risks, for any business sector or activity. So, the highest strategic contribution is to see the opportunities, limit risks, and diversify the scope of action.”

— Energy company from Mainland Europe

 “To provide practical legal and commercial support to a growing business.”

— Transportation company from the U.K.

“To promote the growth in the business, which involves implementing technological solutions to some of the challenges around labor and others, and so dealing with those, supporting the clients in that manner is one of our main priorities.”

— Hospitality company from the U.S.

The LFFI in Q4 2022 continued a six-quarter slide which started from its highest score of all time, recorded in the second quarter of 2021, and which has now set new all-time lows. While this quick decline in fortunes may have left many legal market observers a bit stunned, it’s critical to look at which of Q4’s factors signal promise and which point to greater uncertainty.

On the back page of the recent report, we broke down how much yearly profit the average lawyer full time equivalent (FTE) made since the beginning of the pandemic era and how this changed from one quarter to the next. During its rise, we saw an average growth rate of about 3.4% per quarter for eight consecutive quarters, ending in Q4 2021.

Then came 2022, a year that many law firm leaders thought could be a return to more normal times as the pandemic largely waned through most of the world. However, fears of inflation, geopolitical uncertainty, and recession sank much of that optimistic thinking right out of the gate. Indeed, as we’ve demonstrated in the 2023 Report on the State of the Legal Market, the steep drop-off in corporate and transactional practices helped lead to a substantial slowing in legal demand throughout 2022.

Unsurprisingly, this sour dynamic, in addition to greatly increasing lawyer headcount, began to work its way into the revenue column. Revenue per lawyer (RPL) growth peaked in Q1 2022, with 12.9% growth as compared Q1 2020. With a historic level of rate growth implemented in Q1 2022, history would suggest that RPL should have continued its trend northward. Instead, revenue tapered off due to a drought in demand.

The main culprit for RPL’s difficulties is overcapacity. Despite strong hourly gains in rates, firms’ revenue per lawyer has sat at similar levels from Q4 2021 to Q4 2022, as the productivity losses of 2022 effectively erased all the gains seen in hourly rates. This is a crucial loss as rate growth has been the primary driver (and specular industry feature) of revenue growth for large law firms, not to mention that inflation meant that a dollar in 2022 was worth less in terms of purchasing power than a dollar in 2021, meaning that firms were losing on two fronts.

This did not just impact revenue figures however, as this overcapacity was notably more expensive than normal. Many lawyers were brought in at increasingly higher salaries during peak demand times in 2021 and early-2022, which led to dramatic increases in direct expenses (those expenses related to lawyer compensation). In addition, return-to-office plans resulted in a rapid acceleration in overhead expenses (expenses related to everything else). As a result, lawyers became innately more expensive over the last two years.

If you look at the acceleration in direct expenses, you see that the average lawyer’s direct compensation at the end of Q4 was 14.7% more expensive than before the pandemic began, while RPL on the same basis is only 11.7% higher. This, of course, led to the deceleration in profit per lawyer through much of last year.

What’s interesting is that, again looking at the profit per lawyer chart above, you can clearly see that despite the downdraft, lawyers — and by extension, their law firms — are still more profitable (12.7%) than they’ve been over the past two years. This is due to the far greater impact revenue has on firms’ balance sheets than expenses.

So, what does all this say about the outlook for 2023? For starters, the new year provides another heap of rate increases that appear to be historically high, which may be able to outpace a moderating inflation. And if you look at the expense growth chart between Q3 and Q4 of 2022, you see both categories saw the least amount of acceleration since back in 2020.

This may mean that firms are beginning to get their costs per lawyer under control, which is vital if firms do not want to enact serious measures like layoffs. However, from a seasonal perspective, this trend could be short lived as lighter bonuses and prepayments may be the reason for the slowing pace in Q4 2022, and costs could resume their upward trajectory in 2023.

In conclusion, lawyers are still more profitable than where they were a couple of years ago, making the dour data and trends of 2022 appear less negative in retrospect. And, while the downward trend continues to be worrisome, a new set of rates and some corrective action on the compensation side, may make room for cautious optimism in 2023. However, if the last three years have taught us anything, it is that conditions can change quickly. Thus, the burden is on law firm leaders to have the conviction to judge their operating environment and adjust strategy accordingly.

Even if generously viewed, this represents a reversal of fortunes for the legal industry that can only be regarded as remarkably stunning. And while significant challenges and obstacles have hampered many law firms in 2022, what does this score point to as a primary reason for this downturn?

Market observers might be wise to look at law firms’ exceptionally poor performance in productivity — a metric that is included in the LFFI score calculation — which contracted 7.2% in Q4. This decline in productivity was a result of firms’ continued efforts to expand attorney ranks, growing their full-time equivalent (FTEs) 3.6% in Q4. Firms pursued this full-employment strategy even amid the strong contraction in overall legal demand, which itself fell 3.9% in Q4. This heady mix of more attorneys with less work to do only has one clear result — plummeting productivity.

When this productivity question is looked at from a billable hours perspective, we can see that, after a steady downward trend over the past 15 years — one which has greatly accelerated since early 2021 — lawyers billed the fewest hours, 112 hours per month per lawyer, at the end last year since at least 2006.

One key reason for this all-time low billed-hour total, as we discussed in the 2023 Report on the State of the Legal Market, was the substantial drop in demand in transactional practices (a mix of corporate general, mergers & acquisitions, tax, and real estate practices), which had fallen off steadily over the latter part of last year after being a key demand driver throughout 2021 and the early part of 2022.

Who is being less productive?

The drop in productivity seemed to be experienced across the largest types of attorney titles with Q4 seeing the worst billed hours per month recorded for associates, non-equity partners, and equity partners since at least 2006. These attorneys accounted for 76% of all billed hours in Q4, but even less impactful lawyer titles, such as of counsel and other lawyers (which are not represented on the graphic below), recorded their worst billed hours per month since at least 2006 as well.

As the above graphic shows, this past quarter caps off a four-quarter slide for these three lawyer titles and one that places an exclamation point of sorts at the end of a very bad year for productivity.

There are some mitigating factors, of course. For example, there is a seasonal aspect to hours-billed per month in which typically, lawyers bill the fewest hours in the final quarter of the year. In Q4 2022, however, we saw a stiff 6-hour drop recorded for all lawyers, which was the largest drop between the third and fourth quarters ever recorded. Even by individual title, the numbers were bracing: a 6-hour drop-off for equity partners in Q4 was the largest fall between the third and fourth quarters ever; and the 5.5-hour and 6.2-hour drops for non-equity partners and associates, respectively, were the biggest drops between the third and fourth quarters since Q4 of 2008, amid the Global Financial Crisis.

Practice areas of impact

In addition to the variations of lawyer title of lawyer, we also can see which particular practice areas had the largest impact on the drop in year-over-year productivity.

As mentioned earlier, transactional practices experienced the greatest declines in hours per month per lawyer logged, with corporate-general and corporate-M&A each experiencing steep falls in hours billed in Q4 2022 compared with Q4 of the previous year.

Beyond that, every single practice area saw lawyers bill less hours in Q4 2022 than in pre-pandemic times, less than 2020, and considerably less than the same quarter in the year previous.

On an interesting side note, the chart also shows that the only practice area that has consistently declined in productivity over the last few years is litigation, which currently makes up 27% of all legal demand. However, it may be that litigation’s downward stair-step trend in productivity is the result of law firms continuing to add litigation attorneys while i) the nation’s courts are backlogged; ii) lower-value litigation work is being handled by alternative legal services providers; and iii) corporate law departments are taking on more of their own litigation work.

The focus on the performance in transactional practices is not misplaced, which is why its current trendline is so worrisome. However, as the LFFI report mentioned, if inflation continues to moderate and interest rates stabilize, transactional work may well recover. And if this recovery happens, it will certainly play in role in returning law firms’ productivity growth onto a more solid, positive footing.