Baked into the financial data released this week by ALM on the world’s 100 largest law firms are the often-volatile movements of the world’s currency markets. ALM reports law firm revenue and profitably in US dollars. This means that if a law firm bills in any currency other than dollars – which nearly every Global 100 law firm does – those billings are exposed to risks created by currency fluctuation.
That, in turn, has important implication for management and operations within certain types of firms.
UK Firms and the Devaluation of the British Pound
The impact of currency volatility on law firm financials can clearly be seen within the 2016 Global 100 by looking at UK-based firms. Twelve out of the 13 UK firms in the Global 100 reported year-on-year revenue declines in dollarized terms in 2016. Ten out of the 13 reported revenue per lawyer (RPL) declines, and eight reported profit per equity partner (PPP) declines. If these figures are examined alone, UK firms appear to be in a disastrous situation.
Once UK law firms’ financials are controlled for currency volatility, however, the story changes significantly. Instead of 8% of firms reporting revenue increases, 83% of firms do so. A majority of firms also saw increases in RPL and PPP (see graph above). The reason for this large difference between the unadjusted and currency-adjusted performance of UK firms is the recent devaluation of the British pound against the US dollar. Between 2014 and 2015, the UK pound to US dollar exchange rate declined by 7%, effectively shaving off nearly a tenth of revenues from UK firms, once converted into dollarized terms.
The Impact of the Rising Dollar on US Firms
UK firms were not the only ones impacted by currency exchange rates. Many US firms have a significant portion of their business outside the US.
Among US-based Global 100 firms, nearly a third have 20% or more of their lawyers abroad. Many have well over half of their lawyers outside the United States (see table below). In total, the 81 US-based firms in the Global 100 have more than 25,000 lawyers outside the US. A significant portion of these lawyers bill in currencies other than dollars, exposing their firms to the same currency risk as UK-based firms.
Since 2014, a wide range of currencies have depreciated against the US dollar, including the British pound, the euro, the Australian dollar, the Russian ruble, the Mexican peso and the Brazilian real. As global currencies decline against the dollar, law firms earning revenue in foreign currencies show lower revenue and profitability when expressed in dollar terms. This has created financial headaches for law firms that earn revenue in other currencies and report earnings in dollars.
As with UK firms, US firms’ currency-adjusted financials appear stronger. This is particularly true for the most globalized firms (see table below). Baker & McKenzie, for example, reported earning $2.62 billion in 2015 ALM estimates that once the firm’s financials are currency-adjusted, to account for the fact that 85% of Baker’s lawyers reside outside the United States, the firm’s revenue would rise to $2.84 billion. If these estimates are correct, the firm’s revenue growth between 2014 and 2015 would be 17%, as opposed to the reported figure of 8%. Additionally, the firm’s PPP would have risen by 23% instead of the reported figure of 14%.
How Exchange Rates Impact Law Firm Operations
While the impact of currency fluctuations on law firms’ reported financials is relatively clear, it is less clear what impact they have on their day-to-day operations.
In practice, most of the revenue that law firms earn across the world never gets exchanged into a different currency. Take the example of a UK-based lawyer who works for a US law firm. This lawyer would predominantly bill in UK pounds, which for reporting purposes would need to be translated into US dollars. It’s important to note that this translation would only occur on paper. In actuality, the pounds that the lawyer billed would probably never be exchanged into dollars. Instead, they would be used to pay his or her salary, which would be denoted in UK pounds. They might also be used to pay rent and other overheads and even might be used for equity payments for UK-based partners.
This situation illustrates that the losses law firms realize in accounting terms may not be realized in operational terms. While this is true in many cases, it is important to note that some losses are operationally realized.
Any time law firms fail to match their costs and revenues, they expose themselves to real currency risks, which may jeopardize the firm’s financial health. The most common example is global firms that have a large portion of their administrative staff in a single country. If a firm’s marketing, finance or human resources staffs are predominantly in the United States, and a significant portion of their lawyers are abroad, this creates risk. The salary of these administrative staffs will need to be covered by revenues billed abroad, which may depreciate over time.
Another common example is firms with global partnerships. If equity shares for partners in the United States are being funded, even partially, through revenues and profits earned abroad, the firm is exposing itself to currency risk.
These examples suggest that smaller, less global firms are, paradoxically, most at risk. Global behemoths like Baker & McKenzie certainly earn a larger share of non-dollarized revenue than smaller global firms. At first glance this may create the impression that these larger firms are at a higher risk. Their costs, however, are more likely to be matched with their revenues. Baker, for example, has large administrative centers in the United States, Europe and Asia, ensuring that local revenues can be used for local costs. This suggests that the accounting losses that these firms incur from currency fluctuations are probably never realized operationally.
Smaller firms, on the other hand, cannot spread their costs so easily. A firm with 500 lawyers in the United States and 50 lawyers in London will need to have the majority of its leadership and administrative staff in the United States. This suggests that some portion of the firm’s UK-based revenue will need to be exchanged into dollars, creating real, as opposed to simply paper, losses. This suggests that smaller firms should think carefully before opening a satellite office abroad.
ALM Intelligence Notes:
- Law Firm Global Expansion: A look at six key markets for global law firms displays how law firm leaders are being forced to rethink the conventional wisdom that has guided their international expansion.
- Partner Demotions: Sherman & Sterling is looking into demoting some of their equity partners. This could be a sign of things to come for other elite firms.
- Legal Project Managers:This relatively new role is gaining greater acceptance and, in some cases, greater preside within big law firms. If the role of legal project manager is fully embraced it could become an essential part of the future of legal services.
Nicholas Bruch is a Senior Analyst at ALM Legal Intelligence. His experience includes advising law firms and law departments in developing and developed markets on issues related to strategy, business development, market intelligence, and operations. He can be reached at NBruch@ALM.com.