Salaries and expenses: can law firms turn the tide on rising costs?

This year’s analysis of the financial statements of the top 50 law firm LLPs or companies is based on information in law firms’ accounts to March or April 2021. These show above inflation increases even before the post-pandemic war for talent had heated up. For some years, there has been a question over whether these increases are sustainable. Today, that question is more pressing than ever.

The overall rise in total lawyer and support costs for this year is largely in line with last year, at just over 4.8% for top 50 firms, despite the actual headcount number falling slightly. However, it is worth noting that this comes at a time when there were relatively few external people pressures. Lawyers weren’t moving from firm to firm and there was no broader wage pressure. This is re-emerging in a huge way since the pandemic.

Will clients pay?

Perhaps the most important question is whether these increasing staff costs can be passed onto clients. Law firms can absorb rising staff costs if revenues go up by an equivalent amount and they maintain their gross margin. With payroll costs increasing by 4.8% they weren’t far off as fee income grew by 4.2%, meaning only a small reduction in gross margin.

What is stark is that during the first full year of the pandemic the operating margin of the top 50 firms increased from 29.1% to 32.1%. With gross margin declining this has all come from savings across other operational areas. Firms have saved money on expenses such as marketing, travel and entertainment during the lockdowns. There is of course a danger that margins start to weaken as these other expenses come back on stream.

Is pay the only lure?

There is another, more philosophical, question about lawyer pay. Firms continue to focus on salary as a tool to attract the next generation of lawyers. However, there is a real question over whether this still attracts the best and brightest. Millennials have different workplace priorities, caring deeply about the ‘purpose’ of their firm, alongside elements such as diversity, inclusion and environmental impact.

As such, offering more and more money may get people through the door, but it may not build the loyalty and commitment that law firms want. Instead, law firms could consider whether they are offering sufficient flexibility, whether their workplaces are diverse and whether they are offering enriching, intellectually challenging work. Those associates that are lured by the highest possible salary can always be drawn away by a higher offer.

Law firms may, ultimately, need to find a different way to approach recruitment and retention, particularly at a time when the economic environment looks increasingly challenging. Paying lawyers higher and higher salaries is not reversable from a business point of view and may not achieve its longer term objective of attracting in the best talent or serve to encourage loyalty.