Header graphic for print
In Search of Perfect Client Service Why lawyers don't seem to get it

Econ 101: If you increase expenses more than you increase revenue, profits will be lower

Posted in Commentary, Leadership and Management

You just can’t make this stuff up.  A recent ABA Journal article, Some law firm leaders question associate pay hikes amid tepid year, caught my eye. The Peer Monitor report stated:

Firms were squeezed by a perfect storm of slumping demand and rising headcount.

The ABA Journal article reports:

The economic forces have led some law firm leaders to question widespread associate salary hikes that raised starting pay to $180,000, according to Gretta Rusanow, head of advisory services at Citi Private Bank.

But here’s the money quote:

The associate pay hike is creating pressure for law firms that raised salaries for competitive, rather than performance, reasons, Rusanow writes in the Am Law Daily. “In our conversations with firm leaders,” she wrote “many express bafflement as to why so many firms adopted the increases when their productivity and profitability results couldn’t support them.

Firms may not have control over demand (arguable), but they have control over headcount and compensation.  It is pretty fundamental (perhaps day 1 of Econ 101) that if you raise expenses–like headcount and compensation–without a like increase in revenue, profits will decrease.  Were law firm leaders assuming growth in demand despite all the data that suggested?

I fully expect the reaction to this loss of profit will be to further increase rates to try to drive revenue.  (Now picture law firm managing partners with their heads buried in the sand over the caption “Addressing those pesky realization issues.”)