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How well can law firm leaders predict the results of their own firms? In our second-half 2016 issue of the Citi Private Bank Law Firm Leaders Confidence Index (LFLCI), published in July 2016, law firm leaders expressed lukewarm confidence about the second half of 2016, as compared to the second half of 2015. They were less confident about the macro economy, both domestically and globally, than they were about the fortunes of their own firms. In fact, law firm leaders were particularly confident about their firms’ ability to grow demand, despite the modest average annual growth in demand we’ve seen during the post-recession years. Now with the luxury of hindsight, via our Citi Quarterly Flash survey, we can explore how accurate law firm leaders were in those growth projections.

Citi Private Bank’s Law Firm Leaders Confidence Index is a semi-annual, forward-looking measure of confidence levels within the legal industry. The second-half 2016 confidence index values are based on a sample of 155 firms (72 Am Law 100 firms, 39 Second Hundred firms and 44 niche/boutique firms). One response is accepted from each firm and is submitted by either the firm’s managing partner, executive director, chief operating officer, chief financial officer or equivalent member of the management team. The result is a composite index that shows the relative level of overall confidence based on a series of component indices. For each index, 0 indicates very low confidence, 100 indicates neutrality, and 200 indicates extreme confidence. We then compared the second-half 2016 LFLCI projections with the actual second-half 2016 results, based on 141 common firms (65 Am Law 100 firms, 41 Second Hundred firms and 35 niche/boutique firms) from the Citi Quarterly Flash surveys conducted for the first half of 2016 and full-year 2016. Citi Private Bank provides financial services to more than 600 U.S. and U.K. law firms and more than 35,000 individual lawyers. In addition to the Law Firm Leaders Confidence Index and the Quarterly Flash survey, we conduct a more detailed annual survey. These reports, together with extensive discussions with law firm leaders, provide a comprehensive overview of current financial trends in the industry as well as forward-looking insight.

Overall confidence in the industry was reported at an index value of 112, just 12 points above neutral. It is important to consider the timing of the survey itself. The opinions that form the second-half 2016 LFLCI were collected during April 2016. This was before Donald Trump was the presumptive Republican nominee and won the U.S. presidential election and before the United Kingdom voted on Brexit, and it was also before many firms in the industry raised associate compensation. While the compensation increase may have come as a surprise, the uncertainty regarding the U.S. elections and the Brexit vote was certainly palpable. This is evident in the relative lack of confidence law firm leaders expressed in the U.S. economy and, more so, in the global economy. Both had confidence index values below the overall level, and at an index value of 93, the outlook on the global economy was the only result that fell below neutral.

What interested us was how confident firms were in the outlook for their own firms, given their muted outlook for both the U.S. and global economies. This is particularly evident in their outlook on growth in demand, as defined by the total number of billable hours. At an index value of 127, confidence in demand growth far exceeded overall confidence. In fact, only 20 percent of respondents expected demand to decline from the second half of 2015. Demand performance is an indicator that we have studied closely, particularly in the years since the recession, as the industry has experienced very modest demand growth—just 0.6 percent per year on average. Behind the averages, we continue to see dispersion in performance during each post-recession year, with nearly half the firms reporting demand increases and the other half seeing demand decline—essentially indicating that one firm’s success comes at the expense of another. Given this trend, the second-half 2016 LFLCI projections suggest that there is a positive bias in the results. In other words, law firm leaders are confident that their firms are properly positioned to be one of the 50 percent of “takers” of demand and not one of the 50 percent of “givers” of demand. Indeed, despite this high confidence level, the actual results for second-half 2016 showed that industry demand was down 0.3 percent, with 59 percent of firms reporting a decline.

Confidence in revenue growth was also positive, but more muted than the demand results, at an index value of 114. However, firms were still unable to accurately predict a decline in revenue. Only 13 percent of firms expected a decline in revenue, while 32 percent of firms actually saw a decline. Part of the positive revenue story is law firm leaders’ expectations regarding realization. At 102, there is some expectation, albeit slight, of an abatement of pricing pressure. In fact, only 22 percent of firms expected realization to decline. It is important to note that we do not interpret this as an indication that clients are asking for fewer discounts, and we certainly are not hearing that from our law firm clients. However, this might reflect confidence that some of the internal measures firms are taking to improve profitability and realization are working. Among these are a focus on project management and effective pricing—whether this means hiring full-time project managers and pricing specialists, or simply training lawyers in project management skills. Unfortunately, while it is promising to see some level of confidence in the industry, the second-half 2016 realization results do not support the projections. On average, realization fell for the industry in second-half 2016 by 1 percent, and 55 percent of firms saw realization decline. That said, 45 percent of firms saw realization improve, suggesting progress for many.

At an index value of 108, confidence in net income growth came in well below that of demand and revenue growth, and the relationship of the net income predictions with the revenue predictions is interesting. It implies that law firm leaders were concerned about the missing piece, which is expense growth. As we now know, if expense growth was already a concern in the industry when this survey was taken in April 2016, it became a bigger issue for many firms as they moved to increase associate compensation in the second half of 2016. In fact, while firms seemed able to actively control operating expense growth during the second half of 2016 to just a 1 percent increase, lawyer compensation expenses grew by more than 7 percent on average, compared to just 3 percent growth in the first half of 2016. These average results also understate the pressure that individual firms may be feeling because not all firms in the sample increased compensation at all, and for those who did, not all made the move at the start of the second half.

Law firm leaders were also relatively bullish in their expectation to grow lawyer head count, particularly with regard to associates. With the highest index value in the report at 131, law firm leaders expressed significantly more confidence in their firms’ plans to add associates in the second half of 2016 than to add to other categories of salaried lawyers or to grow the partnership. The projections were borne out in part, as the industry saw associate head count increase 2.3 percent during the period, and equity partner head count growth was very close to flat. However, growth in salaried lawyers other than associates outpaced both at 3.1 percent, running counter to the predictions of the law firm leaders, but consistent with the trends we have seen in the broad composition of the average law firm’s leverage model. As firms have seen growth in the number of higher-cost lawyers and, at the same time, have turned more to the use of lower-cost lawyers, the use of associates as a proportion of all salaried lawyers has declined. It will be interesting to see how the increased cost of an associate will affect both this trend and law firm leaders’ projections. Further, while the head count projections were relatively in sync with the expectations regarding demand growth, we now know that actual results were not. This led to a 2.1 percent decline in lawyer productivity during the second half of 2016, surely not the desired outcome.

The difference between law firm leaders’ positive outlook for their own firms and actual industry results underscores the wide dispersion and volatility we see in what is an essentially flat-growth market. The vast majority of law firm leaders believed that their firms would achieve demand growth during the second half of 2016, only to find that more than half of the firms in our sample experienced a decline. The differences between their positive outlook and the more sobering actual results also tell us a good deal about what motivates law firm leaders to compete in this challenging environment—the belief that in this flat-growth, dispersed and volatile law firm services market, their firms will be the ones to grow.

How well can law firm leaders predict the results of their own firms? In our second-half 2016 issue of the Citi Private Bank Law Firm Leaders Confidence Index (LFLCI), published in July 2016, law firm leaders expressed lukewarm confidence about the second half of 2016, as compared to the second half of 2015. They were less confident about the macro economy, both domestically and globally, than they were about the fortunes of their own firms. In fact, law firm leaders were particularly confident about their firms’ ability to grow demand, despite the modest average annual growth in demand we’ve seen during the post-recession years. Now with the luxury of hindsight, via our Citi Quarterly Flash survey, we can explore how accurate law firm leaders were in those growth projections.

Citi Private Bank’s Law Firm Leaders Confidence Index is a semi-annual, forward-looking measure of confidence levels within the legal industry. The second-half 2016 confidence index values are based on a sample of 155 firms (72 Am Law 100 firms, 39 Second Hundred firms and 44 niche/boutique firms). One response is accepted from each firm and is submitted by either the firm’s managing partner, executive director, chief operating officer, chief financial officer or equivalent member of the management team. The result is a composite index that shows the relative level of overall confidence based on a series of component indices. For each index, 0 indicates very low confidence, 100 indicates neutrality, and 200 indicates extreme confidence. We then compared the second-half 2016 LFLCI projections with the actual second-half 2016 results, based on 141 common firms (65 Am Law 100 firms, 41 Second Hundred firms and 35 niche/boutique firms) from the Citi Quarterly Flash surveys conducted for the first half of 2016 and full-year 2016. Citi Private Bank provides financial services to more than 600 U.S. and U.K. law firms and more than 35,000 individual lawyers. In addition to the Law Firm Leaders Confidence Index and the Quarterly Flash survey, we conduct a more detailed annual survey. These reports, together with extensive discussions with law firm leaders, provide a comprehensive overview of current financial trends in the industry as well as forward-looking insight.

Overall confidence in the industry was reported at an index value of 112, just 12 points above neutral. It is important to consider the timing of the survey itself. The opinions that form the second-half 2016 LFLCI were collected during April 2016. This was before Donald Trump was the presumptive Republican nominee and won the U.S. presidential election and before the United Kingdom voted on Brexit, and it was also before many firms in the industry raised associate compensation. While the compensation increase may have come as a surprise, the uncertainty regarding the U.S. elections and the Brexit vote was certainly palpable. This is evident in the relative lack of confidence law firm leaders expressed in the U.S. economy and, more so, in the global economy. Both had confidence index values below the overall level, and at an index value of 93, the outlook on the global economy was the only result that fell below neutral.

What interested us was how confident firms were in the outlook for their own firms, given their muted outlook for both the U.S. and global economies. This is particularly evident in their outlook on growth in demand, as defined by the total number of billable hours. At an index value of 127, confidence in demand growth far exceeded overall confidence. In fact, only 20 percent of respondents expected demand to decline from the second half of 2015. Demand performance is an indicator that we have studied closely, particularly in the years since the recession, as the industry has experienced very modest demand growth—just 0.6 percent per year on average. Behind the averages, we continue to see dispersion in performance during each post-recession year, with nearly half the firms reporting demand increases and the other half seeing demand decline—essentially indicating that one firm’s success comes at the expense of another. Given this trend, the second-half 2016 LFLCI projections suggest that there is a positive bias in the results. In other words, law firm leaders are confident that their firms are properly positioned to be one of the 50 percent of “takers” of demand and not one of the 50 percent of “givers” of demand. Indeed, despite this high confidence level, the actual results for second-half 2016 showed that industry demand was down 0.3 percent, with 59 percent of firms reporting a decline.

Confidence in revenue growth was also positive, but more muted than the demand results, at an index value of 114. However, firms were still unable to accurately predict a decline in revenue. Only 13 percent of firms expected a decline in revenue, while 32 percent of firms actually saw a decline. Part of the positive revenue story is law firm leaders’ expectations regarding realization. At 102, there is some expectation, albeit slight, of an abatement of pricing pressure. In fact, only 22 percent of firms expected realization to decline. It is important to note that we do not interpret this as an indication that clients are asking for fewer discounts, and we certainly are not hearing that from our law firm clients. However, this might reflect confidence that some of the internal measures firms are taking to improve profitability and realization are working. Among these are a focus on project management and effective pricing—whether this means hiring full-time project managers and pricing specialists, or simply training lawyers in project management skills. Unfortunately, while it is promising to see some level of confidence in the industry, the second-half 2016 realization results do not support the projections. On average, realization fell for the industry in second-half 2016 by 1 percent, and 55 percent of firms saw realization decline. That said, 45 percent of firms saw realization improve, suggesting progress for many.

At an index value of 108, confidence in net income growth came in well below that of demand and revenue growth, and the relationship of the net income predictions with the revenue predictions is interesting. It implies that law firm leaders were concerned about the missing piece, which is expense growth. As we now know, if expense growth was already a concern in the industry when this survey was taken in April 2016, it became a bigger issue for many firms as they moved to increase associate compensation in the second half of 2016. In fact, while firms seemed able to actively control operating expense growth during the second half of 2016 to just a 1 percent increase, lawyer compensation expenses grew by more than 7 percent on average, compared to just 3 percent growth in the first half of 2016. These average results also understate the pressure that individual firms may be feeling because not all firms in the sample increased compensation at all, and for those who did, not all made the move at the start of the second half.

Law firm leaders were also relatively bullish in their expectation to grow lawyer head count, particularly with regard to associates. With the highest index value in the report at 131, law firm leaders expressed significantly more confidence in their firms’ plans to add associates in the second half of 2016 than to add to other categories of salaried lawyers or to grow the partnership. The projections were borne out in part, as the industry saw associate head count increase 2.3 percent during the period, and equity partner head count growth was very close to flat. However, growth in salaried lawyers other than associates outpaced both at 3.1 percent, running counter to the predictions of the law firm leaders, but consistent with the trends we have seen in the broad composition of the average law firm’s leverage model. As firms have seen growth in the number of higher-cost lawyers and, at the same time, have turned more to the use of lower-cost lawyers, the use of associates as a proportion of all salaried lawyers has declined. It will be interesting to see how the increased cost of an associate will affect both this trend and law firm leaders’ projections. Further, while the head count projections were relatively in sync with the expectations regarding demand growth, we now know that actual results were not. This led to a 2.1 percent decline in lawyer productivity during the second half of 2016, surely not the desired outcome.

The difference between law firm leaders’ positive outlook for their own firms and actual industry results underscores the wide dispersion and volatility we see in what is an essentially flat-growth market. The vast majority of law firm leaders believed that their firms would achieve demand growth during the second half of 2016, only to find that more than half of the firms in our sample experienced a decline. The differences between their positive outlook and the more sobering actual results also tell us a good deal about what motivates law firm leaders to compete in this challenging environment—the belief that in this flat-growth, dispersed and volatile law firm services market, their firms will be the ones to grow.