After a tough start to its 2023 Financial Year, Australian law firms now are seeing some movement out of the shadows and into the sunlight
The 2023 Financial Year (FY 2023) got off to a shaky start and many Australian law firms are still feeling the impact of the downturn. However, some signals that we’re seeing at the midyear point suggest a path for firms out of the doldrum that could lead them to positive results despite the tough beginning to the year.
In the latest Australian Legal Market Midyear Update, published by the Thomson Reuters Institute, we see how firms continue to see lower levels of legal demand compared to the midpoint last year; yet the pace of this contraction in legal demand has slowed throughout FY 2023. While this is good news for many law firms, struggles still remain, such as the ongoing growth in expenses. However, a deeper dive into the midyear data shows that there are reasons for some cautious optimism.
Demand decline & rate growth
As the Midyear Update shows, demand for legal services began the year in negative territory, when compared against the highwater marks of FY 2022. Even though Q2 of FY 2023 saw less of a demand contraction, the midyear measurement still showed an overall decrease compared to last year, which is still concerning.
This is happening at the same time as firms see strong growth in agreed-upon rates throughout the midpoint of FY 2023. While agreed-upon rates remained in record territory for many Australian law firms, the net effect of this rate performance combined with the continued demand downturn saw firms experience essentially flat growth in fees worked for the first half of the financial year. (Fees worked reflects the year-over-year percentage change in the product of rates multiplied by billable hours in the relevant time period.)
This overall flat performance in YTD fees worked is concerning, especially as Australian law firms find themselves under increasing inflationary pressure in which low revenue growth effectively results in a net loss of buying power. Added to this mix is that many Australian law firms also saw a decrease in their billing realization rates, which saw all lawyers experiencing a declining percentage of their work being billed to clients as compared to the previous fiscal year.
Finally, growing expenses remain a constant threat to many law firms’ balance sheets. Compared to the beginning of the pandemic era in Q3 FY 2020, Australian law firms on average have seen their direct expenses — lawyer compensation — grow more than 20%. Indirect expenses — essentially everything else, from office rent to office supplies — declined in the early days of the pandemic due to work-from-home initiatives, but now have returned to pre-pandemic levels.
Signs of a potential rebound?
While all this may indicate a tough road through the second half of FY 2023 for many Australian law firms, the Midyear Update did contain some hopeful indicators. For example, expense growth — which hung like a heavy weight around the neck of many firms — appeared to show that it was slowing by midyear. Further, there are also strong signs that legal demand may be on a slight upswing.
On a further positive note, slightly more buyers of legal services in Australia report that they anticipate spending more over the next six months, with 31% of buyers saying they expect their legal spend to increase in that time frame. This was just slightly higher than the percentage of legal buyers who said they expect to their legal spend to decrease in the next six months. While just a slight net positive, many more buyers of legal services in the specific practice areas of regulatory, labor & employment, and disputes services said they expect their legal spend in these areas to increase as compared to those that said they expect it to decrease.
Interestingly, these spending expectations may reflect what we’re seeing in the broader economy, both in Australia and around the world. For example, increasing inflation, for all its negative impacts, can also influence larger workforce trends, leading to an increased need for legal counsel on labor & employment matters. Increased efforts by the government to stiffen regulations, too could easily result in an increased need for outside counsel.
As the Midyear Update illustrates, the remainder of the fiscal year will be a delicate balancing act for many Australian law firms as firm leaders need to keep a keen eye on levels of legal demand and rate growth, while managing their expenses (especially headcount).
While Australian law firms may be in a slightly more favorable position than many firm leaders might have thought after the dismal first quarter of FY2023, achieving success through the remainder of the year will depend on how fast, flexible, and informed their strategic decision-making will be as they continue to manage ongoing and new risks in today’s legal market.
You can download the latest Australian Legal Market Midyear Update here.