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LAW FIRMS INSIGHTS Forward Thinking Thought Leadership Law Firm Trends, Opportunities, and Challenges: A Changing Landscape and the Road Ahead in 2015 As indicated in the 2015 Report on the State of the Legal Market1, law firm financial performance was modestly better in 2014 than in 2013, with revenue growth across the market stronger than in the previous year, when demand growth was negative. Yet, while the rise in demand growth signals a healthy road ahead for the legal industry, law firms remain confronted with challenges precipitated by the economic downturn. The dynamic shift in the economic market nearly seven years ago generated fundamental change within the legal profession. As such, maintaining a competitive edge within a changing landscape requires law firm leaders to gain perspective on the new realities of the legal market and to adjust existing strategies in order to best position their firms for growth. What are the significant factors reshaping the legal market? CohnReznick examines trends leading into 2015 and discusses how these shifts will impact strategy and operations of law firms immediately and in the future. Challenges Remain for Smaller Firms as the Revenue Gap Widens One area in which small to mid-sized firms stand to benefit is the absence of conflicts of interest that can prevent some large law firms from representing certain clients. For example, in many cases, conflicts of interest that bar law firms from investigating banks they have previously represented have left lucrative assignments on the table for smaller firms. As the number of lawsuits against banks continues to rise, small to mid-sized firms have greater opportunities to solicit banks as defense clients. Recently, firms with more than 150 attorneys saw revenue per lawyer jump by 8.5% over the previous year, according to the Survey of Law Firm Economics. At these law firms, revenues and hours paid by clients have increased, while smaller law firms continue to struggle, according to recent studies. However, small firms with less than nine attorneys saw revenue fall by 8%. The most recent data available to CohnReznick indicates that while demand for legal services has been flat since 2013, large firms were paid about 10% more by clients in the first half of 2014, according to a study by TyMetrix2. Yet, the bump is incongruent with an overall 11.6% year-over-year drop in demand for legal services. The main difference between small and large firms is the type of clients they attract. While large firms count corporate clients as loyal clients, smaller firms often rely on individuals and small business owners that typically put off legal work or are slow to pay their attorneys. Small law firms may also be at a disadvantage as many laws and ordinances are available on the internet and at the library, as is how-to information, legal documents and forms, prompting many laypeople to attempt to represent themselves. Individuals who go to court “pro se” (for themselves) often feel that legal services are overpriced and that the law is less complex than it is. Small law firms, especially sole practitioners, lose business to people who represent themselves and do their own legal work, rather than hire an attorney. Laws vary from state to state, as do attorney licensing requirements, because state governments regulate the practice of law. Attorneys typically need to be licensed in states where their clients do business, unless the state grants reciprocity. To meet state requirements, many national or multistate corporations often hire law firms in each state where the company has a presence. Many large corporations, however, prefer to have one law firm handle most of their multistate legal needs, which has led to law firm mergers, bigger practices, and tougher competition for small firms. Merger Activity on the Rise Mergers occur among law firms of all sizes and increase revenue and boost client count at a time when demand for legal services remains flat. As the economy recovers, CohnReznick believes more small and mid-size firms will continue to merge and acquire other firms as a way to grow. Large firms are also joining together in efforts to broaden their geographic reach and reduce expenses. The global economy contributes to large corporate clients who require a wide range of legal services domestically and abroad, and desire one law firm to handle most of their legal needs. As a result, large law firms are getting larger, adding expertise like antitrust and international law. Regional and mid-sized law firms merge to better compete by adding staff and expertise that clients desire. 1 http://www.law.georgetown.edu/academics/centers-institutes/legal-profession/upload/FINAL-Report-1-7-15.pdf 2 http://www.americanlawyer.com/id=1202676074751/Am-Law-Firms-See-Slowing-Demand-for-Hours-but-Higher-Fees CohnReznick is an independent member of Nexia International cohnreznick.com Effect of the Economy Law firms with a large transactional business, such as for real estate or financing matters, are strongly affected by swings in the local and national economy. U.S. Gross Domestic Product (GDP), an indicator of potential demand for legal services, can fluctuate up to 5% yearly; law office employment, a reflection of demand, can vary even more. Changes in local demand for transactional services affect the amount of business law firms do, which impacts billing rates and employment levels. Most U.S. law firms are small, local and may earn a large percentage of revenue from a few clients. Loss of a major client can be devastating, especially to small law practices serving a limited geography. Firms that specialize in only one industry, such as real estate, airlines, or investments, depend highly on that industry’s well-being. Economic forces that negatively affect an industry in turn impact specialized law firms disproportionately. Trends in Law Firm Management: Shadow Juries, Billing Arrangements, Dispute Resolution Methods, and More Litigation attorneys and firms are increasingly hiring “shadow juries,” individuals who attend a trial solely to help litigators shape their cases. These juries are demographically matched to the actual jury and observe the trial as it happens to provide instant feedback to litigation attorneys on their reaction to trial proceedings and witnesses. Shadow juries require low administrative overhead and wages, which generally are about 1% of trial costs. Another trend that began during the global recession in 2008 and is gaining popularity is the accommodation of alternative billing arrangements. Large law firms are increasingly willing to accommodate alternative billing arrangements, and more firms now offer flat fees for some legal matters. Previously, such arrangements were unpopular; however, clients now pay 15% to 30% of their legal bills through non-hourly methods. The trend has gained more popularity among clients who desire billing arrangements that are more predictable and fair. CohnReznick anticipates the demand for alternative fees to continue. Similarly, alternative methods to resolve legal disputes are on the rise. Attorneys, courts, and clients are turning to the use of mediation and other forms of Alternative Dispute Resolution (ADR) due to court backlogs, and the time and expense required for a court resolution. These alternatives for resolving disputes use an independent mediator to determine a binding settlement, rather than go to court for a legal judgment. New rules are encouraging attorneys, law firms, and corporate law departments to engage in pro bono work more frequently. When attorneys help people with limited economic means, some of the Technology Trend More than 30% of lawyers use a tablet computer, according to the American Bar Association’s Legal Technology Survey, and that number is growing. Tablets allow lawyers to work anywhere and access documents and other information remotely. This trend is important because law firms are allocating less space per timekeeper than in the past. This can impact other areas including real estate, office space, construction, etc. Oversupply and Law School Applicant Shortage—“Right Sizing” the Profession Fewer people are applying to law school. In the first half of 2014, the number of law school applicants was down by more than 37% compared to 2010, according to the National Law Journal, which analyzed data from the Law School Admission Council. Several factors have contributed to a drop in interest in the legal profession. Salaries for first-year associates have dropped from a high of $160,000 in 2009 to $125,000, according to the National Association for Law Placement. The financial crisis forced many law firms to reduce staff, and competition for existing jobs has become fierce. Meanwhile, record numbers of law students enrolled and graduated from law school, creating an oversupply of lawyers. Many view the reduction in law school applicants as “right sizing” in the profession. Oversupply has left many lawyers struggling to find work in the legal field. Some have left to explore other professions. Law firms were forced to cut staff during the late-2000s recession, and there continues to be an overcapacity in terms of the number of lawyers available to work compared to demand for legal services. As a result, more new lawyers are being hired on terms less favorable than their counterparts enjoyed before the recession. customary rules about conflicts of interest are suspended so that law firms cannot be disqualified from representing regular clients. A study by the American Bar Association indicates that nearly three-fourths of lawyers in the U.S. do pro bono work, providing more than 20 million hours of free legal services per year. New York recently required lawyers to perform 50 hours of pro bono work as a condition of getting a license. Law firms gain goodwill from providing legal services to the needy or to non-profit organizations. Law firms with new business models are attracting attorneys and clients who desire a different pace than offered by traditional law groups. Usually these newer law firms pay attorneys only when they work, but do provide benefits between client assignments. These law firms can charge less, because they reduce overhead by not having to pay full-time salaries or bonuses, rent offices for attorneys who work at client sites or from home, or maintain high-priced partners. Clients benefit from the more affordable legal services offered by such firms. Law firms with a high risk tolerance are accepting equity in startup companies, especially in high-tech and biotech companies, in lieu of receiving cash payments for fees. Startups and young firms require legal work and business advice, but often can’t afford fees until products come to market, which can take years in biomedical fields. Legal firms take an equity position, usually in the form of stock, in these small, private companies with the intent of sharing in the sometimes large profits that occur when firms are sold or go public. Differentiation by Expertise The largest law firms have grown by adding expertise across a number of areas of law, such as corporate, tax, labor, environmental, and intellectual property. Others have expanded by adding other legal specialties and some non-legal services, including lobbying. Changing political and economic circumstances has led to more demand for legal advice on current issues and topics, such as immigration law, securities law, corporate governance, health care and pensions. CohnReznick foresees an increase in demand for legal services due to the greater complexity of conducting business, particularly for global companies and in specialty industries related to science and technology. Rapid advances in fields like biotechnology and pharmaceuticals will result in more legal transactions and litigation. Analysts predict demand will increase for specialized areas of law, including intellectual property and technology law that support these industries. Corporations are expanding their in-house legal departments as they deal with new regulatory challenges and increased litigation. Some of these teams, which often are very specialized, have even started offering their services to other companies in the same industry as a way to bring in additional revenue. This model could hurt existing law firms that serve specific industries. Contact What Does CohnReznick Think? The trends addressed above require law firms to establish a well-structured plan to guide their firms. Understanding a firm’s strengths and marketing them accordingly is crucial. “The blueprint for success will be a quality product, excellent service, value added-expertise, and a competitively priced service,” says Richard Puzo, a CohnReznick partner and the Firm’sLaw Firm Industry Practice Leader. To accomplish this, timekeepers should embrace these fundamentals and management should set forth a plan to bolster the expertise of practice groups. A budgeting process should be established to keep the costs of services competitive. By reengineering how a firm delivers services, it is possible to achieve great success even during these turbulent times. For more information, please contact Richard Puzo, a CohnReznick partner and the Firm’s Law Firm Industry Practice Leader, at [email protected] or 973-364-6675. To learn more about CohnReznick’s Law Firm Industry Practice, visit cohnreznick.com/lawfirms. February 2015 About CohnReznick CohnReznick LLP is one of the top accounting, tax, and advisory firms in the United States, combining the resources and technical expertise of a national firm with the hands-on, entrepreneurial approach that today’s dynamic business environment demands. Headquartered in New York, NY, and with offices nationwide, CohnReznick serves a large number of diverse industries and offers specialized services for middle market and Fortune 1000 companies, private equity and financial services firms, government contractors, government agencies, and not-for-profit organizations. The Firm, with origins dating back to 1919, has more than 2,700 employees including nearly 300 partners and is a member of Nexia International, a global network of independent accountancy, tax, and business advisors. For more information, visit www.cohnreznick.com. © 2015 CohnReznick LLP This has been prepared for information purposes and general guidance only and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its members, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.