This July, Cravath Swaine & Moore hiked its starting salary for first year associates by 11 percent to $180,000, reigniting a battle between law firms to offer competitive associate pay in a way that hadn’t existed since 2007.
In the months that followed, law firms across the country raised their associate compensation scale to match Cravath — and now those pay increases, which affected associates across the board, are showing up as profit growth slows at some law firms, according to a new report on the first three quarters of 2016 compiled by Citi Private Bank.
“This is the first quarter we have an opportunity to see that,” said David Altuna, a senior vice president and client adviser in the Citi Law Firm group.
Altuna said that the associate salary hikes, which started in July and continued to spread during the summer, are causing expenses to grow faster across the industry. While the most elite firms have been able to grow revenues faster than expenses, all other firms felt the strain of high lawyer compensation expenses.
In the overall picture, there was growth in revenue, driven by rate growth, a modest increase in demand and also faster collections, according to the report. And Altuna said profits increased, but not as much as in 2015. At most firms, expenses grew faster than revenue, which put pressure on margins, he said.
Other factors besides associate salary raises that contributed to stagnant growth include the presidential election, which has been creating a slowdown in the amount of regulatory work as clients take a wait-and-see approach, and the uncertainty as a result of the Britain’s so called Brexit vote to leave the European Union, according to Altuna
Released Tuesday, the report is based on a survey of 188 law firms including 79 in the AmLaw 100, 52 in the AmLaw 200 and 57 other firms.
Below is an edited transcript of an interview with Altuna.
Big Law Business: What are the main takeaways from this report?
Altuna: We’re seeing momentum slow. I can point to two numbers: One is demand, which is measured by the total billable hours. It was up 1.8 percent at the end of the first quarter and now it’s only up 0.3 percent. This is a comparison of the first nine months in 2016 versus the first nine months in 2015. So we’ve seen what we could call modest growth.
Big Law Business: And this applies to law firms in all market segments?
Altuna: Not necessarily. It is quite clear that the Am Law 50 is outperforming. They’re reporting the highest revenue growth. They have the highest growth in expenses, but their revenues are growing faster, so their profit is improving.
They have strong inventory, above the industry average. They were actually the only segment to quicken their collections. If you shorten your collection cycle, that means you’ve driven revenue through the door faster. So what that means is they dipped into the inventory, but they were able to replenish it.
For a law firm, revenue is driven by four primary things:
- Realization, which is the amount of discounting you’re doing on your standard rate.
- Demand, or the amount of hours billed.
- Collection, which is timing, or how many days it takes you to bill a certain number of hours and the time it takes to collect that.
The Am Law 50 were the only firms to use collection to drive revenue. But they saw strong inventory growth, meaning they’re well positioned for the end of the year.
Big Law Business: What about the Amlaw 51 – 100 firms?
Altuna: It’s more mixed. They had the second highest revenue growth. But, they were way off. For the Am Law 50, revenue was up 5.4 percent, but the second 50 revenue was only up 2.2 percent.
And for the second 50, expenses are up higher than revenues, which means its putting pressure on margins.
Big Law Business: What about the Am Law 200?
Altuna: The second hundred are seeing revenue flat, up 0.1 percent. They saw the lowest rate increase, 2.4 percent on average, and they have the lowest inventory growth, about 1.7 percent.
Big Law Business: What’s driving the increase in expenses?
Altuna: That’s the second takeaway. We saw expenses accelerate. They were at a 3.1 percent increase at the halfway mark of 2016, and now they’re up 3.4 percent at the nine-month mark. What is driving that is an increase in lawyer compensation expenses.
Lawyer compensation expenses went from 3.0 to 4.1 percent. That’s the growth. To really zero in on that you have to look at headcount. Well, headcount was up 1.8 percent at the halfway mark and it came down to 1.6 percent. It wasn’t an increase in headcount that drove compensation growth and so we think it’s the associate compensation increases.
This is the first quarter we have an opportunity to see that at all. The first movers put this forward in June and these are the nine-month results, so it includes July, August and September. This is a first look at the effect.
Big Law Business: What do you see for the last quarter?
Altuna: It looks likely that 2016 will come a bit short of 2015 in terms of profit and revenue growth, and we can point to a lot of factors — the change of administration, the implications of Brexit, associate compensation.
UPDATED: This article has been amended. Altuna stated that the AmLaw 50 firms had above average inventory, and clarified that he was talking about four primary drivers of revenue growth at law firms.