Pennsylvania law firms need to address the glut of partners in their ranks before rising expenses eat away at the revenue gains they are making, recent surveys by two large banks indicated.
In looking at financial results for the first nine months of the year, Mary Ashenbrenner of Wells Fargo’s legal specialty group in Philadelphia cautioned the region’s law firms to aggressively manage expenses as well as the productivity of its most senior lawyers.
The Wells Fargo survey, which compared where firms stood after the first nine months of 2013 compared to the same time period in 2012, had some bright spots for Pennsylvania-area firms.
Aside from Southern California firms and those firms with profits per equity partner greater than $2 million, Pennsylvania fared better than anywhere else in the country when it came to growing top line revenue.
Ashenbrenner said gross revenue was up 3.1 percent in the region compared to a 1.4 percent rise nationally. Revenue increases were not thanks to a growth in demand, which Ashenbrenner said is expected to be down for some time to come. Rather, firms are raising rates—at the rate of 2.6 percent in the Pennsylvania area and 3.4 percent nationally, she said.
A similar survey by Citi Private Bank Law Firm Group also found that Pennsylvania was one of the best markets in the country when it came to increasing revenue, though John Wilmouth, a senior client adviser with Citi, said it had more to do with an increase in hours per lawyer than it did with rates rising. The Wells Fargo survey found hours per lawyer in Pennsylvania were down, while the Citi survey found the hours were up. Either way, both surveys found expense gains were outpacing revenue gains in the region.
The strength of Pennsylvania’s revenue numbers is a testament to the “value play” the region represents, Ashenbrenner said. She said the area’s firms are viewed as providing quality work for reasonable prices. Pennsylvania firms are also more likely to engage in alternative fee arrangements—at a rate of 14 percent compared to 10 percent of firms nationally that implement AFAs, she said.
According to Ashenbrenner, the high-profit firms had strong revenue growth in the past 12 months because of some large M&A deals and litigation. For “bet-the-farm” work, Ashenbrenner said, clients are going to the high-profit law firms, but otherwise clients are seeing the value of Pennsylvania firms.
But in order to turn that revenue into profits, Pennsylvania firms are going to have to take a serious look at their partner numbers, she said.
“Firms continue to be reluctant or hard-pressed to deal with overcapacity,” Ashenbrenner said. “And it’s at the senior levels.” Expenses in Pennsylvania rose 4.2 percent during the time period tracked by the Wells Fargo survey. That is compared to a 1 percent rise in expenses nationally. Much of that increase in Pennsylvania has to do with the cost of attorney headcount, Ashenbrenner said.
“While firms continue to cull the non-timekeeper categories, total attorneys in Pennsylvania are up 2.9 percent and were flat nationally,” she said.
Senior partners, both in Pennsylvania and nationally, still log an average of 1,500 billable hours a year, compared to the 1,700-to-1,800-hour range seen prior to 2009, Ashenbrenner said, noting current productivity levels are “very concerning.” It’s that lack of productivity that is suppressing firms’ profitability, she said.
“It’s as simple as this: Firms with busy partners are the ones enjoying the most success,” Ashenbrenner said.
Productivity and inventory are up for Pennsylvania firms, and they rose at rates higher than the national average, but the hours per attorney have fallen, according to the Wells Fargo survey results.
The total hours logged by firms rose 1.6 percent in Pennsylvania while they dropped 1.1 percent nationally. Inventory rose 4.7 percent for Pennsylvania firms and 3.6 percent for firms nationally. But the drop in individual attorney hours logged shows a productivity problem that will eventually catch up with firms if they don’t better manage expenses, including headcount, Ashenbrenner said.
“Firms that have kept a keen eye on expense management and productivity are pulling away from the pack,” Ashenbrenner said. “Those firms that didn’t take precise action and pivot quickly are really falling behind.”
But Ashenbrenner noted that stratification among firms is less severe in the Pennsylvania region than it is nationally.
A number of large-scale law firm mergers have been seen in recent months and Ashenbrenner said merger discussions are certainly on the rise. The firms that are falling behind will be more eager to merge in the coming year, but she again noted that stratification isn’t as apparent in Pennsylvania, which may make mergers less of a factor in the market.
In 2012, expense gains were also outpacing revenue gains by the end of the third quarter, but the fourth quarter brought a boon in transactional work that helped overcome that deficit. Ashenbrenner said there is nothing expected in the fourth quarter of 2013 that will help ease the pressure on profitability.
Wilmouth said the focus needs to be on increasing revenue as much as possible. While Citi is seeing the gap close between revenue and expenses, he said firms still have that hurdle to jump in terms of making up for the revenue they saw in the fourth quarter of 2012. The good news, he said, is that firms seem to have built up inventory as they headed into the fourth quarter of 2013. Wilmouth said Pennsylvania firms had the second-largest increase in inventory of all the markets Citi surveyed.
Pennsylvania firm leaders were optimistic when it came to year-end revenue projections. Ashenbrenner said 82 percent of the 12 Pennsylvania-area respondents in the Wells Fargo survey expected to meet or exceed budgeted revenue for 2013, compared to 70 percent of firm leaders nationally who felt the same. That optimism was similarly expressed to The Legal in a recent canvas of Pennsylvania law firm leaders who all said they expected to increase revenue in 2013 despite not seeing a fourth-quarter boon in revenue.