Despite resurgent strain on the U.S. economy in recent weeks thanks in part to global economic troubles, Pennsylvania law firms saw at least a glimmer of hope in the last year as they fared much better on all financial fronts, even with costs increasing. The trick could have been increasing rates, which was far and away the most cited tactic for maintaining profitability, according to PaLAW’s 16th annual Managing Partners Survey.

But in a slow-growth economy, whether financial metrics will continue to improve in the face of hard-to-find revenue streams and little left to cut remains to be seen.

The number of firms that saw increases between the prior two fiscal years in gross revenue, revenue per lawyer (RPL), net profits, and particularly profits per equity partner (PPP), shot up from last year.

Of the respondents, 70 percent saw jumps in gross revenue between their last two fiscal years. That was compared to just 46.2 percent who could say the same last year. Similar figures were seen with RPL, a metric that rose year-over-year at 70 percent of responding firms. Only 44.4 percent said the same thing last year.

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When it came to net profits, nearly 76 percent of responding firms saw increases, compared to 55.6 percent who said last year they had seen increases in that figure. The largest improvement was seen in the PPP area, in which 72.4 percent of respondents saw increases year-over-year, compared to the 37 percent who said so the prior year. And the nearly 30 percent of respondents last year who said they saw decreases in PPP dwindled to just 3.4 percent this year.

The larger number of firms that saw jumps in profits as compared to those that saw rises in revenue is consistent with what the largest firms in Pennsylvania experienced in 2010. As Zack Needles reports in his analysis of firm financials beginning on page 96, most large firms saw significant rises in PPP that weren’t often matched by equal jumps in revenue. Even a few firms that saw revenue decline saw sizeable increases in PPP, thanks to what they said was consistent cost management.

But as Altman Weil consultant Ward Bower points out in his article on law firm growth strategies beginning on page 94, there is little room for more cost cutting without dramatically restructuring a law firm’s business model.

According to the Managing Partners Survey, costs have been on the rise over the last two fiscal years. When asked in 2010 if costs increased, decreased or stayed the same when comparing the firm’s two most recent fiscal years, the respondents were equally split with each category getting 33 percent of the responses.

In 2011, however, those figures changed. The number of firms that saw an increase in costs rose from that 33 percent to 55.2 percent. Those that saw a decrease dropped to 20.7 percent while 24.1 percent of respondents saw costs remain flat in the last two years.

KEEPING PROFITS UP

The list of tactics firms implemented to reduce costs and maintain profitability over the past few years is long, but these arrows are being pulled from the quiver much less frequently in many instances. The number of respondents who said they reduced equity partners, laid off attorneys or staff, reduced hiring, reduced marketing costs, deferred associates or cut associate compensation dropped significantly between 2010 and 2011.

For example, only 4.3 percent of respondents said this year that they reduced lateral hiring to maintain profitability. That was compared to 34.8 percent who did so last year. While nearly 48 percent of respondents in 2010 said they reduced entry-level hiring, only 13 percent said so in 2011.

More than 39 percent of 2010′s respondents had cut marketing costs, whereas only 4.3 percent did so in 2011. While no one cut associate salaries in 2011 in order to maintain profitability, 21.7 percent of 2010′s respondents had.

There were just two areas firms looked to noticeably more in 2011 than in 2010 in order to maintain profitability – switching their practice area focus to higher-demand areas and, everyone’s favorite, raising billing rates.

In 2010, 26.1 percent of respondents switched to higher-demand practice areas compared to the 39.1 percent who did so in 2011.

Raising billing rates became much more popular in 2010 after many firms were forced to freeze or reduce rates in the few years prior. That popularity grew even more in 2011, with the 65.2 percent of 2010 respondents who rose rates in 2010 jumping to 73.9 percent who did so this year.

PARTNERS ON CHOPPING BLOCK NEXT?

Maintaining profitability often came at the expense of staff or associates who were often either fired or saw their compensation cut during the recession. Consultants have suggested that firms need to turn to the partner ranks to have any continued profitability management in the coming years as revenue remains stagnant. The Managing Partners Survey shows there is some evidence firms are starting to heed that advice, albeit in small increments.

Firms looked slightly more often to the reduction of partner compensation as a method of maintaining profitability, with that figure rising from 4.3 percent in 2010 to 8.7 percent this year.

While partner layoffs don’t seem to be in the works in any significant numbers, de-equitizations do. Between June 2010 and June 2011, 23.3 percent of firms said they de-equitized partners. That was up from 12 percent who did so the prior year. And more firms plan on continuing that trend in the coming year. When asked if de-equitizations were planned for the time period between June 2011 and June 2012, 13.8 percent of respondents said they were, up from 8 percent last year. The percentage of partners to be de-equitized at those firms who plan to ranges from 3 percent to 8 percent.

By all accounts, layoffs at most levels are done, with well more than 90 percent of respondents saying they did not this year and have no plans in the coming year to lay off associates. Between 87 percent and 93 percent said the same for staff. While 15.4 percent of respondents last year said they deferred associates, no one said so this year. And while 18.2 percent decreased associate salaries in 2010, none did so this year. In fact, 34.6 percent increased salaries this year compared to the 13.6 percent who did so in 2010.

That figure is consistent with reports of a number of Pennsylvania firms raising salaries for incoming first-year associates. Blank Rome, Buchanan Ingersoll & Rooney, Reed Smith, Stradley Ronon Stevens & Young and Schnader Harrison Segal & Lewis all increased salaries for their new attorneys, though they weren’t accompanied by a fanfare of press releases that historically heralded such changes in years past.

Whether they increased or kept salaries the same, firms seem happier with the current compensation model and have few plans to change it.

When asked about first-year associate salaries, 54.8 percent of respondents said first-years were fairly compensated. That is a jump from the 37.5 percent who responded the same in 2010. Those that feel they are somewhat overpaid fell from 58.3 percent in 2010 to 41.9 percent in 2011.

In 2010, 28 percent of firms were considering changing compensation models for either partners, non-partners or both. In 2011, fewer than 10 percent of respondents are looking to monkey with anyone’s compensation structure.

Along with salary increases, first-year associates are also getting hired at higher rates. Of the respondents, 36.7 percent said they hired more first-year associates this year than in 2010. That figure rose from 18.5 percent who said the same last year. Conversely, only 23.3 percent of respondents said this year that they hired no first-year associates, compared to 55.6 percent who hired none in 2010.

LAW FIRM GROWTH

Along with financial improvements came headcount growth, though not enough in Pennsylvania at least to make much of an impact on this year’s ranking of the 100 Largest Law Firms in Pennsylvania.

Reed Smith held onto the number one spot despite reporting 12 fewer attorneys across its Pennsylvania offices. Morgan Lewis & Bockius and Pepper Hamilton swapped second and third place from last year thanks to a change in headcount of only a few attorneys at each firm. Morgan Lewis moved up to second with four more lawyers, putting it at 303 attorneys in Pennsylvania. Pepper Hamilton had five fewer lawyers in the state this year, dropping it to third place with 297 attorneys.

Once again, the top five was rounded out by Buchanan Ingersoll & Rooney and Marshall Dennehey Warner Coleman & Goggin. The rankings are based on the number of full-time attorneys across all Pennsylvania offices.

When looking beyond just the top five firms, the overall responses to this year’s Managing Partners Survey showed significantly fewer firms stayed the same size in the last year and many more grew by 10 percent or less.

In 2010, 40.7 percent of respondents said headcount remained flat in the prior year, whereas only 16.1 percent said the same this year. More than 58 percent of respondents grew slightly and 16.1 percent shrunk slightly. No firms shrunk more than 10 percent and 9.7 percent of firms grew by more than 10 percent.

As for growth in the coming year, 16.1 percent of firms said they plan on growing significantly, or by more than 10 percent. That was up from 3.8 percent who said the same last year. The bulk of firms, or 64.5 percent, plan to grow slightly.

One clear growth area for firms was in the non-partner track or staff associate category. More than 45 percent of respondents had that tier at their firms, up from 29.6 percent last year. It doesn’t seem that growth trend will continue into next year, however. More than 53 percent of respondents plan to keep the tier the same size, while 20 percent will look to shrink the number of staff associates they have.

Fewer Pennsylvania firms merged in the last year than had in the previous year. And fewer seem interested in merging in the coming year. Those findings buck national trends that show law firm merger activity increasing. It may be a function of the respondents to the survey considering a number of small Pennsylvania firms have been involved in mergers in the last year or so.

Only 16.1 percent of respondents said they merged in the last year, compared to 25.9 who said the same in 2010. Thirty percent of firms are not interested in a merger in the coming year, up from 22 percent who were opposed last year. More than 53 percent of respondents said they were open to merger opportunities in the coming year and 16.7 percent said they were actively seeking them.

OTHER NOTABLES

Firms may be taking a hint from the American Bar Association’s recommendation to do away with mandatory retirement policies. That or they are looking to keep books of business no matter what the age of the partner holding that book. According to the survey, only 25.8 percent of respondents had mandatory retirement policies, down from 44 percent who did last year.

Client surveys are being used more frequently, though probably not yet at the levels consultants would suggest firms employ. When asked if they regularly used client satisfaction surveys, 35.5 percent of respondents said they did. That is up from the 18.5 percent who said the same in 2010.

Slightly fewer firms have a diversity initiative, with 70 percent saying in 2011 that they have one and 81.5 percent responding the same in 2010. The number of firms that said they received RFPs asking about the firm’s minority and gender numbers declined by a similar margin.

THE RESPONDENTS

The survey is sent out to managing partners at more than 100 law firms across the state. There were 32 respondents this year, with 29 percent of them hailing from firms with more than 125 attorneys. The second largest response group, at 24.1 percent, was from firms of between 26 and 50 lawyers.

More than 63 percent of respondents were from Philadelphia firms, 16.7 percent were from Pittsburgh and the rest were from locations across the state, including Blue Bell, York and Allentown.

More than 58 percent of responding firms were full service, 22.6 percent had limited practice areas and 19.4 percent were boutiques.

Contact Gina Passarella at 215-557-2494 or at gpassarella@alm.com. Follow her on Twitter @GPassarellaTLI.