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Legal Practice Management

Q1 LFFI Analysis: Will rising law firm rates push clients away?

William Josten  Senior Manager, Enterprise Content - Legal, Thomson Reuters Institute

· 6 minute read

William Josten  Senior Manager, Enterprise Content - Legal, Thomson Reuters Institute

· 6 minute read

As the rates that law firms can charge clients for legal services continue to rise, will there come a tipping point at which clients simply balk at the higher price tag?

Law firms’ worked rates — those rates agreed to by clients to engage new work — rose at a dramatic pace in the first quarter, according to the Thomson Reuters Institute’s Law Firm Financial Index for Q1 2023. Further, we previously offered additional details on the rates picture, exploring rates by work type and timekeeper group, and even looking a bit at what collection levels of those newly raised rates look like.

However, one key area remains to be explored — specifically, how are clients reacting to these large jumps in hourly rates?

It should be noted from the outset that the fact that rate growth is higher in 2023 than last year surprises basically no one. Nearly every observer of the legal industry knew that the pace of rate growth would accelerate this year, and the only question was, by how much. We now have an indication of that answer, and it’s an appreciable amount.

Gauging client pushback

Many legal market commentators have also been speculating that clients will likely start pushing back more aggressively on rates. This is a nuanced proposition as there are several different ways clients may do this. Let’s explore some of the possibilities.

First, clients may be inclined to ask for larger discounts off published standard rates. In truth, this may or may not be happening, but it’s not particularly germane. Standard rates are the advertised top rates from a law firm, similar to the rack rate on a hotel room — it’s a number they publish, but almost no one actually pays it. The point of trying to increase the discount on standard rates would be to attempt to exert some influence over the actual rates being charged by law firms. Whether clients are requesting larger discounts or not, the fact remains that worked rates still went up by quite a bit. Even if clients are pushing back on standard rates, they are not doing so to a large enough degree to place much of a damper on the growth of agreed-upon rates.

Nearly every observer of the legal industry knew that the pace of rate growth would accelerate this year, and the only question was, by how much. We now have an indication of that answer, and it’s an appreciable amount.

Second, clients may be expressing price sensitivities to their law firms throughout the course of their matters, encouraging firms to increase the amount of the potential fee the firm writes down before the client receives an invoice. There is some evidence that law firms are, in fact, increasing the amount of potential fees they proactively write-down prior to invoicing, which is contributing to the reported decline in realization. Whether this is the result of actual or simply perceived pushback from clients is an open question. It seems more likely that any increase in write-downs is due to perceptions of possible client objections by law firm lawyers rather than anything proactive on the part of clients.

Third, clients may be seeking larger discounts on their invoices, once received. If this were the case, we would see a widening gap between what we call billing realization (the percentage of the agreed rate that’s billed to the client) and collected realization (the percentage of the agreed rate that’s collected from the client). If the gap between these two figures widens, it’s an indication that clients paid a smaller percentage of their invoice. While there is some evidence that the gap between billing and collected realization widened for the quarter, it is difficult to tell at this point if this is the start of a trend or just part of the regular realization cycle.

Finding the value proposition

While there may be additional actions clients could take in reaction to rising rates, there is one that merits particular attention: Clients might just vote with their feet.

An unhappy client has a plethora of potential law firms and alternative legal services providers from which to choose, particularly if the main issue of contention is cost.

At a series of roundtable discussions in which I’ve participated with general counsel this year, I often have heard of concern over the increasing costs of outside counsel at a time when in-house law departments are facing an uptick in their overall matter volumes along with pressure to curtail their budgets — clearly, a difficult conundrum.

For many of these GCs, one option that comes immediately to mind is to shift to lower-cost law firms for some of the legal work needed. This phenomenon of demand mobility is something we explored in our Report on the State of the Legal Market earlier this year, as well as our State of the Corporate Law Department, released in March. Indeed, clients are not shy about discussing their feelings on this among their peers. They will freely discuss not only the fact that they’re doing it, but what types of matters they’re shopping around, how they’re identifying potential new law firms, and even which specific law firms to whom they are giving additional work.

At a time when half of legal service buyers report switching at least some portion of their panel of outside law firms, we are in a time of nearly unprecedented volatility in terms of legal demand shifts. That’s not to say that all work is at risk or that every higher-cost law firm should be worried, however. Another observation I have heard frequently from GCs is that for some firms, cost is no problem because of the value the firm delivers.

Of course, value is a bit of an amorphous term in that its meaning is very much in the eye of the beholder, i.e., the client. But there is some commonality of definition: quality, efficient legal advice that meets the client’s need — without exceeding a reasonable scope — and which recognizes the client’s broader business objectives.

For those law firms that deliver value well, clients will often tell me something along the lines of, “I have no problem with what they charge me, because they’re worth it.”

Such a characterization would be a worthwhile goal for every law firm. Truly understanding what the client values and delivering against that value proposition requires a lot of discussion with and understanding of the client, their goals, and their business. But for those firms that can do it well, it is, perhaps, one of the best ways to ensure the long-term strength of the relationship with the client.

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