Strong demand and productivity continue to propel the legal industry to new highs, but crushing expenses during the final part of last year have created some drag on the outlook for Big Law in 2022.
Overhead and talent costs increased noticeably in the final quarter of 2021, according to the most recent Peer Monitor Index report from Thomson Reuters, and those costs are expected to continue increasing as office returns become more concrete and law firms continue to pay more for in-demand associates.
The report, published Monday, found an 8.4% increase in direct expenses in the fourth quarter of 2021 relative to Q4 of 2020, driven primarily by increases in head count and average associate pay. In particular, the industry saw 11.4% growth in average associate compensation, reflecting increasing pay costs.
The report also noted a 5.8% increase in overhead, citing large jumps in technology, office and marketing expenses.
“Increases in office expenditures are particularly noteworthy because many firms have yet to implement full return-to-office plans, indicating that this category is likely not done growing. The same can be said for marketing & business development expenses because sources of these expenses, such as conferences and client visits, have only just begun to ramp back up,” the report stated.
Total overhead expenses on a per-lawyer basis were still 2.4% below where they were in the last quarter of 2019, the report added.
The specific overhead increases highlighted in the report were marketing and business development (15.2%); office expenses (7.9%) and technology (5.8%).
As they have in other recent reports, the analysts sounded a note of caution about the continued pace of associate salary increases, noting they haven’t yet stemmed the tide of associate turnover.
“In the short term, this may be a necessary arrangement, but eventually something must give,” the report stated.
In an interview, Bill Josten, strategic manager of enterprise content for Thomson Reuters, said the direct-expenses increase was expected, though the 8.4% figure was still “pretty aggressive.” He noted it doesn’t account for the latest round of salary bumps, made in January, and that it’s a trend that “likely will continue.”
He said the increases in direct expenses and overhead were the two biggest factors weighing down the report’s PMI number—a composite score of legal market performance. The number tallied by the analysts was 58, down nine spots from the previous quarter. Those two numbers came on the heels of an all-time high score of 84 in the second quarter last year.
Still, there was good news in the report, too. It found rate growth of about 3.6%, productivity growth of about 0.6% and demand growth of 4.2% over the previous year. Josten said that last number was particularly striking.
“If you go back and look at most of the decade, demand was somewhere between plus or minus 1%. If we saw 0.9 or 1% increases or decreases, if it was anything in excess of 1%, that was pretty noteworthy,” he said. “To see it on a year-over-year basis at 4% is pretty remarkable. Especially when you consider that the fourth quarter didn’t really have the low baseline that the rest of 2021 did. So, that was kind of an outstanding figure.”
The report noted that the demand increase was driven “almost exclusively” by transactional work in areas such as real estate, corporate, M&A and taxes. Those groups saw demand increases last quarter of 11.3%, 7.7%, 4% and 2.8%, respectively. The report also noted those groups are making up an increasingly large portion of law firms’ work.
“By 2021’s close, these practices accounted for 37% of the total hours tracked, a proportional increase of 2.6 percentage points in just one year’s time, and 5 points since 2015,” the report stated.
Meanwhile, litigation (2.5%), labor and employment (1.9%) and intellectual property also saw demand increases over Q4 of 2020. Bankruptcy work was down 8.7%.