Citi Report: Firms Saw Modest Growth in 2013

, The Am Law Daily

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There is good news for the Am Law 50 and mixed news for the broader industry in the 2013 results. Though the industry's 2013 profits per equity partner (PPEP) growth of 3.5 percent fell short of 2012's 4.3 percent increase, it’s a solid result, given the challenging demand environment we saw last year. Am Law 1–50 firms outperformed other segments in net income and PPEP growth and improved on their 2012 results. Firms with a large international presence outperformed the more U.S.–centric firms, with global firms, in particular, seeing the highest growth in profitability. The better news is that relative to the prior year, demand momentum picked up as 2013 progressed, and given positive economic indicators, we project that 2014 will be a stronger year for the legal industry than 2013.



These results are based on a sample of 180 firms (43 Am Law 50 firms, 37 other Am Law 100 firms, 46 Second Hundred firms and 54 additional firms). Eleven of these firms fit our definition of “global” (greater than 25 percent of lawyers based outside the United States). Nineteen are defined as “international” (less than 25 percent and more than 10 percent of lawyers based outside the United States). Citi Private Bank provides financial services to more than 600 U.S. and U.K. law firms and more than 35,000 individual lawyers. Each quarter, the Law Firm Group confidentially surveys firms in The Am Law 100 and Second Hundred, along with smaller firms. In addition, we conduct a more detailed annual survey and other studies throughout the year. These reports, together with extensive discussions with law firm management conducted on an ongoing basis, provide a comprehensive overview of financial trends in the industry and insight into where it is headed.



Revenue increased modestly at 2.5 percent, driven mostly by 3.7 percent rate increases. The collection cycle was marginally shorter than in 2012, and demand was down 0.4 percent. This negative demand result masks the positive demand momentum we observed as 2013 progressed. As we wrote earlier in the year, demand was down 3.3 percent during the first quarter, moderating to a decline of 0.7 percent for the first half, and a 0.6 percent decline for the first nine months. Recalling how strong the fourth quarter of 2012 had been, we were concerned that the industry would be challenged to achieve growth during the fourth quarter of 2013 from that strong base. So to see the demand decline actually moderate further from the nine-month cumulative result of -0.6 percent to -0.4 percent for the full year is a good thing. 


While revenue growth was modest, the industry benefited from careful management of expenses, with a growth rate of only 2 percent. Operating expenses were up just 1.8 percent, the lowest increase we have seen in three years. Compensation expenses rose just 2.4 percent, partially driven by a 0.4 percent increase in lawyer head count.


That modest growth in lawyer head count, in an environment where demand remained in decline, led to a worsening in the level of excess capacity we have observed in recent years, evident in deeper declines in productivity. It’s this persistent excess capacity that we believe is a key driver of the pricing pressure we hear law firms talk about, and that we see reflected in realization numbers.



Equity partner head count declined 0.3 percent, continuing the trend of careful equity partner head count management we have seen in recent years. Though firms continue to promote star performers into equity partner ranks, we know from our clients that firms have become a lot more focused on managing performance levels of equity partners.



Beyond the industry averages, we noted that firms with a greater international presence outperformed other segments. Global firms in particular saw the highest revenue growth, and were the only segment to see demand and productivity growth (though in absolute productivity levels, global firms continue to trail other segments).


With only a modest increase in expenses, global firms outperformed other segments in growth in net income, PPEP and contribution per lawyer (revenue per lawyer minus expense per lawyer). This segment also ended 2013 with the highest inventory growth of all segments, which should help this segment get off to a fast start in 2014. The more U.S.–centric firms, on the other hand, saw declining demand, deepening excess capacity and declining margins. These results were a reversal of prior years, in which global firms in particular had a tougher time.



Am Law 50 firms materially outperformed other segments. They led all segments in revenue growth and saw the lowest increase in expenses. In fact, they were the only segment to see revenue growth outpace expense growth, driving material net income growth and 5.6 percent PPEP growth. With a marginal decline in demand, revenue growth was due to rate increases and a shortened collection cycle. And as head count increased, Am Law 50 firms continued to see excess capacity worsen, as did other segments. The margin pressure experienced by other segments was most acute for the Am Law Second Hundred, where slightly negative demand and the highest growth in head count led to deeper excess capacity and declines in net income, contribution per lawyer and PPEP.

Looking forward, we believe that the demand environment will continue to improve. However, as we wrote in our recent Citi Hildebrandt Client Advisory, we believe that while the cyclical drivers of law firm demand are improving, we are operating in a more modest demand environment. With new competitors in the legal industry and changed law firm client purchasing behavior, law firms will have to examine their best growth opportunities in light of this changed environment and seek ways to deliver legal services more efficiently, to prosper.

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