Key performance measures

Upon first glance the Dynamic-Static storyline appears as one would expect. From the beginning of 2019 through 2021, Dynamic law firms achieved at least a 0.9 percentage point advantage over Static firms in every key performance measure category. Powered in part by their dominance in corporate work compared to the litigation-heavy Static firms, Dynamic law firms achieved 2.5% demand growth on a CAGR. These results are incredibly solid given that the typical firm in the population sample averaged 0.3% yearly demand growth in the last decade.[3] Static firms, for comparison, saw 1.8% contraction over this time period in average demand, resulting in a 4.3 percentage point Dynamic Net Advantage,[4] with positive growth in fees worked[5] only because of rate increases.

Profitability and profit per equity partner

These results would suggest that when we drill down into the profitability performance of these firms, we should see results similar to those when we first drew the distinction between Dynamic and Static law firms in past reports. This, however, is not what we find. From 2017 to 2019, Dynamic law firms had a massive advantage in revenue per lawyer, total profit, and profit per equity partner growth compared to Static firms. However, from 2019 to 2021 this advantage for Dynamic firms evaporated. By the end of 2021, Static firms were almost equal to or even surpassing Dynamic firms in terms of growth in RPL and average profit margin. Most importantly, Static firms grew their PPEP nearly a full percentage point faster than Dynamic firms.

That is not to suggest, however, that Dynamic firms do not still hold an advantage over their Static counterparts in terms of actual equity partner payouts. Indeed, as a result of long-term profitability advantages, Dynamic firms still held an average advantage of $580,000 in PPEP compared to the average Static firm in 2021, as well as a profit margin of 44.5% compared to Static firms’ 40.8%. And the PPEP growth rate among Dynamic firms of 14% is still extraordinarily healthy. In fact, these Dynamic firms are technically growing as fast if not faster than when we originally selected them, an impressive feat given the difficulty of achieving high growth on top of high growth.

Still, the surprise success of Static firms deserves further examination. The improvement in their standings is best illustrated by re-ranking our firms based on their profitability performance over the past three years. While in this report’s analysis we are still following the same sample of firms from our last few reports, we did redo our Dynamic/Static framework based on the 2019-2021 CAGR to see how many firms remained in their respective classes. Of our Static firms, 60% of those firms would now no longer be classified as Static if we were to use these redrawn rankings. This may beg the question: why did we retain our previous methodology? The fundamental ways in which Dynamic and Static firms achieved their PPEP growth demonstrate vital strategic and tactical differences that merit further exploration in their own right. Re-ranking firms based on their 2021 results would hide these important distinctions.

[3] This number references a 10-year average from 2010 to 2019 from Figure 1 of the 2022 State of the Legal Market report.
[4] Dynamic Net Advantage refers to the percentage point difference between the growth rates of Dynamic firms and Static firms.
[5] Fees worked is a metric used as an analogue for accruals-basis revenue. It measures the change in the product of average hours multiplied by average rates between selected time periods.

Sharing the spoils

The key to the comparison between Dynamic and Static law firms is how the firms in each group are distributing their financial gains to their lawyers. On the classic Hollywood pirate ship, after a successful voyage the crew are all given their share of the spoils. While there can be no doubt that 2021 was a profitable year, what our two firm types did with the resulting wealth they generated differs greatly.

Dynamic firms greatly increased their lawyer compensation, especially to associates. Based on 2019 to 2021 CAGR, these firms increased their associate compensation by 7.7%, a Dynamic Net Advantage of 2.6 percentage points over Static firms. This figure, however, fails to capture the rapid rise in compensation Dynamic firms have been enacting. Indeed, if we were to continue with the Hollywood pirate motif, it looks like the firm’s partners are throwing vast quantities of jewels at their junior lawyers. Through the full year 2021, these Dynamic firms increased their associate compensation per associate Full Time Equivalent (FTE) by 13.5% and ended Q4 2021 paying their average associate 18.3% more than their Static firm counterparts.

Static firms, conversely, have been far slower to grow their associate compensation. These firms have grown their compensation slower than the all-firms average and in the depths of the talent war, increased their associate compensation per associate FTE by only a comparatively modest 8.6% during 2021.

Raising the ranks

Dynamic and Static firms also stand in stark contrast regarding how they are structuring their leadership and hierarchy moving forward. Static firms are actively reducing the promotion rate of equity partners in their firms while increasing the replenishment rate of non-equity partners far faster than the industry average. Because of this, an increasing share of Static firms’ partnership receive a fixed salary, while those who receive a full cut of the profits are fewer. This has been key to how Static firms are increasing their profit per equity partner faster than Dynamic firms – by working to slow the growth of non-partner expenses and by decreasing the total number of share-earning partners. In other words, Static firms’ PPEP growth is due to their cutting the pie into a decreasing number of slices, rather than increasing the size of the pie. This is a similar tactic employed by the East India Company of our Hollywood allegory, in which the profits of the journey would primarily go to the smaller group of officers and the owners of the ship, rather than the crew.

When combined with increasing associate compensation, Dynamic firms’ strategy of higher-than-average equity partner promotion more resembles the way a corsair ship operated in the 17th and 18th centuries. On such vessels, the crew’s pay was far more heavily weighted on the success of the voyage, as the spoils were distributed to the crew rather than members receiving a smaller fixed salary. Like with law firms, this distribution was not necessarily equal, as the captain, quartermaster, and surgeon received extra shares for their services; yet in comparison to the pay arrangements typically seen in the day, including those of the East India Company, this structure was far more egalitarian. By bringing equity partners on-board at a significantly higher rate, Dynamic firms are more heavily aligning their compensation with firm performance than is done at the average law firm, while sending a greater portion of the wealth to their lower ranking lawyers.

Investing in the ship vs. the crew

The difference between the Dynamic and Static firms’ approach to talent cultivation goes beyond just salary and replenishment. Both groups of firms are increasing their overhead spending in specific categories, which implies that strategic investments rather than price pressures are behind the moves.

For example, both Dynamic and Static firms are significantly increasing their investment in technology. On a CAGR basis, Dynamic and Static firms increased their technology investment per FTE by 2.2% and 5.2% respectively. In fact, based on their highly accelerated pace of technology investment, Static firms are now spending nearly the same amount on technology per lawyer FTE as are Dynamic firms. And both populations outspend the average law firm in terms of tech expenditures.

When it comes to knowledge management and library services spending, Dynamic firms continue to spend $1,000 more per lawyer than the average firm. Static firms also played catchup here as well, growing 4.0% on the CAGR and actually exceeded Dynamic firms in per FTE knowledge management and library services spending. This is, however, one of the last places where Dynamic and Static firms converge on investment strategy.

Dynamic firms have thrown themselves fully into the bidding war for talent, spending 5.8% more on recruiting expenses than before the pandemic and increasing their support staff compensation at double the rate of Static firms. More broadly, Dynamic firms continue to build on their expenditure advantage in terms of overall per lawyer FTE expenses. On the other side, Static law firms’ recruiting expenses remain below 2019 levels and their professional staff benefits spending has grown at only half the rate of Dynamic firms despite the ongoing war for talent.

Instead, Static firms appear to be more focused on investing in the firm and its infrastructure. While Dynamic firms’ occupancy expenses are down 2% relative to pre-pandemic levels, Static firms are spending 3.2% more on their office spaces, possibly indicating a desire to push for a faster return to office.

That said, any firm pushing for a speedy return to office needs to exercise caution to respect the newfound levels of independence and autonomy to which lawyers have become accustomed. First, pushing for a speedy return to office risks infringing on these desirable ways of working, pushing their lawyers to explore moves to other firms where these benefits remain. In this way, a return-to-office strategy intended, at least in part, to help build a sense of loyalty and camaraderie by bringing colleagues into closer proximity could well backfire. For Static firms, who are already experiencing higher rates of associate turnover, this could serve to increase talent pressure in a time when such challenges are already fraught.

All in all, while Static firms substantially increased their spending in the “fixed” assets of the firm, they’ve fallen behind in investing towards the “crew,” an area in which Dynamic firms are investing heavily, in addition to their “ship”.

Abandoning ship

While it’s difficult to draw a strict correlation between the expense strategies and the key performance metrics of these firms, we do find the following particularly noteworthy given the trends in spending.

From 2019 to 2021 on a CAGR, Dynamic firms increased their lawyer FTE headcounts by 1.6%, a 2.3 percentage point Dynamic Net Advantage.[6] Static firms, conversely, saw their headcount shrink. When we dive deeper into the turnover data, the trend is reinforced. Dynamic firms experienced turnover levels consistent with the rest of the market, although notably in 2021 they had significantly lower equity partner turnover. Static law firms, on the other hand, had noticeably higher turnover for both associates and equity partners. It’s notable that, despite the comparable percentage increases in PPEP of Static firms, they are experiencing higher turnover than Dynamic firms and the all-firms average, by a significant margin.

[6] See Figure 3.

During a meeting discussing the development of the Macintosh computer, Steve Jobs charged his employees with adopting a more daring, pirate-like approach to their business. In the halcyon days of Silicon Valley, it was a deliberate strategy to buck the conservative, hierarchical corporate structure of traditional technology companies and push the boundaries. This counter-cultural mindset enabled companies like Apple to take on established giants such as IBM, eventually coming out on top. Dynamic law firms are doing something similar. These firms have managed to cultivate a competitive culture that embraces change and non-structured collaborations. And for these Dynamic firms, this mindset is appearing to pay dividends.

We analyzed the results of the two Stellar Performance surveys[7] from 2021 to determine if there were any characteristics that stood out in regard to those firms represented in our Dynamic firms’ population. Through this analysis, we found multiple avenues in which Dynamic law firms’ culture was seen as distinctly different from the rest of the pack.

First, lawyers at Dynamic firms rated their collaborative culture higher than did their counterparts from other firms, especially in terms of the support lawyers received from fee-earning colleagues. In fact, Dynamic firm lawyers were twice as likely to cite the collaborative culture as one of their favorite aspects of their current firm. While lawyers in general saw the need for structured communication to better facilitate effective remote working, lawyers at Dynamic firms were more likely to also recognize the need for a collaborative, non-hierarchical, and empathetic approach. Standout lawyers at these firms increasingly recognized the importance of constant communication, delegating work, participating in social events, and using communication tools other than email.

Second, lawyers at Dynamic firms appeared more willing to embrace change. They’re less likely to have used hourly rates on most recent matters, and they are more likely to be confident in talking about their firms’ offerings of environmental, social, and corporate governance (ESG) services and are more proactively doing so with their clients. This is because Dynamic firm lawyers are more likely to place importance on their own firm’s ESG proposition and more likely to be satisfied with its direction, according to the surveys.

When it comes to technology, stand-out lawyers at Dynamic firms are more likely to self-classify as an early adopter or innovator of technology and more apt to recognize agility and adaptability as an increasingly important skill that lawyers should possess.

The Law Firm’s Reward

This more collaborative, innovative culture within Dynamic firms crosses over with another startling factor: Productivity.

The productivity level of Dynamic firms’ associates and equity partners held 3.5% and 3.4% above the all-firms average in 2021. This was a significant accomplishment given that these are the major categories in which Dynamic firms are looking to grow. In contrast, Static firms are continually becoming less productive over time, with their disadvantage even compared to the all-firms average productivity growing from 2019 to 2021, across all three major lawyer types.

This becomes clearer by focusing more closely on the productivity of partners. Given the way that Static firms have thinned their equity partner ranks, it would be a fair assumption to think that the remaining partners would be more productive. After all, it's typically assumed that partners who work more hours are more secure in their positions. Instead, Static firms saw their equity partners produce an average of 3.8% fewer hours annually than an equity partner at an average law firm in 2021, a three-year high. At the same time, non-equity partner productivity similarly lagged well behind average annual productivity.

Equity partners at Dynamic firms, by contrast, posted a 3.4% advantage in annual hours relative to the average firm in 2021, their largest advantage in three years. Dynamic firm equity partners are outperforming their Static counterparts, and the gap is only increasing. In 2019, Dynamic firms had a Dynamic Net Advantage of 3.6 percentage points over Static firms. In 2021, that advantage has grown to 7.2 percentage points. This same relationship persists for non-equity partners as well, with Dynamic firms maintaining far higher productivity than their Static counterparts.

[7] Stellar Performance is a series of reports conducted by Thomson Reuters to investigate what characteristics those lawyers identified by their clients as true standouts have. Based on interviews with thousands of Thomson Reuters Stand-out Lawyers, the survey works to identify key aspects that allows law firms and their lawyers to stand out from the pack.

Dynamic firms may well have had an advantage going into the pandemic simply because they were already well positioned to take advantage of the flood of transactional work that has kept the large law industry afloat since 2020. Fully 38.8% of all Dynamic law firm hours in 2021 were generated by transactional practices, which is composed of corporate-general, mergers and acquisitions (M&A), real estate, and tax. These categories have been the primary drivers of legal demand growth for most of the period since the onset of the pandemic. Static firms have historically been far less leveraged in this transactional category, and instead are far more focused on litigation practices, an area that has struggled to find growth for many years.

This being said, Static firms now seem to recognize that they are overly dependent on a practice that has seen little to no growth over the last decade and are actively working to grow their transactional practices. Many Static firms have shifted their practice focus, changing their proportions to favor transactional work at the same pace as Dynamic firms in order to better take advantage of this surge in transactional work.

Interestingly, even with less of a focus on litigation as a practice, Dynamic firms seem to be outpacing Static firms in terms of growing this otherwise largely stagnant practice area. On a 2019-2021 CAGR, Dynamic firms grew their litigation practices 2.3%, while Static firms only managed to claw back to 2019 levels by the end of 2021.

Which brings up some interesting questions: What if Static firms had the same practice proportion as Dynamic law firms when entering the pandemic? What if Dynamic firms had the same focus and proportion of litigation practice demand as did Static firms? Would Dynamic firms still have come out in a similarly advantageous position at the end of 2021?

To determine this, we “swapped” the practice proportions of fees worked and demand for all practices between the two populations, then reran their growth metrics as a hypothetical exercise. We found that, even under these conditions, Dynamic firms still significantly outperformed their Static counterparts in terms of demand growth and fees worked with a Dynamic Net Advantage of 1.4 percentage points and 1.8 percentage points respectively. Even with the wind of transactional practices poised to expand at the backs of Static firms and a significant headwind of contracting litigation demand before Dynamic firms, the latter outperformed the former in this hypothetical exercise. In short, while a heavier focus on transactional practices may have contributed to Dynamic firms’ success, there was far more at play than simply a fortuitous mix of practices.

Rates provide further evidence of Dynamic firms’ strength, as well as evidence that Static firms’ strong financial results for 2021 may cover deeper, unresolved weaknesses. As you can see below, in each of the last three years, Dynamic firms achieved a higher level of overall worked rate growth than both Static firms and the all-firms average. In 2021, Dynamic firms managed worked rate growth at a pace 1.2 percentage points beyond that seen in the all-firms average, the largest difference in growth rates seen in the last three years. When we break down these rates to the title level for Dynamic firms, this advantage exists for both the major categories of associates and partners with partners especially outperforming the all-firms average.

For their own part, Static firms managed to exceed the all-timekeeper all-firms average for worked rate grown on a 2019-2021 CAGR, as we discussed previously. However, looking behind the averages, a story emerges that demonstrates why Static firms may not be able to maintain this same pace of rate growth and risk falling behind the average firm again. On a by-year level, we see that static firms remain close to or fall slightly behind the pace of the all-firms average in each of the last three years.

Diving into worked rate growth by lawyer type, we find that Static firms remain well below the pace established by the all-firms average and are falling further behind. While the all-firm rate growth for associates averaged around 3.4% growth in Q4 2021 compared to the year-earlier period, Static firms missed the mark at 3.2%. This is worrying as Static firms have held somewhat of an advantage in this category since early 2020, but now have started to fall behind. More worryingly, worked rate growth for partners was even more disparate, with a 0.9 percentage point difference between Static firms and the all-firms average in Q4 2021. This suggests that the success of Static firms in keeping pace with the market average had more to do with the proportions of hours worked in 2021 – with a larger proportion of hours being worked by higher-rate partners, driving up the average worked rate – than it did with these firms actually achieving faster rate growth. In other words, despite the impressions given from the 2019-2021 CAGR, these firms continue to lag behind in rate growth.

Collecting the Bounty

From the beginning of the Dynamic/Static series, Static firms have enjoyed an advantage in terms of realization, constantly surpassing the realization rates which Dynamic firms have achieved. This holds true through 2021 as well. Notably, Static firms have achieved billing realization against worked rates of above 96.9% in Q4 2021, dramatically higher than the market average of 94.0%. Even in comparison to the Midsize law firm category, which has the highest realization of all of the segments, Static firms outperform. Indeed, one may conclude that they overperform.

In light of the fact that these Static firms typically raise their rates at a slower pace than the average firm, one could conclude that these firms are leaving money on the table. While higher rate growth would potentially decrease realization, worked rate growth of 4% to 5% would likely eclipse the losses a drop in realization might incur.

Indeed, history has indicated across several sets of analyses we’ve conducted that the percentage of a worked rate that is collected is tied more closely to the percentage of that rate which is actually billed to the client (billing realization) than it is to worked rate growth. It is quite common to see realization hold steady even as worked rates gradually increase. This indicates that successful realization improvement is far more tied to effective internal billing and collection practices within the firm, especially if those practices are geared to optimize billing realization. In fact, the correlation of billing to collected realization can be seen in Figure 16 where each of the three sets of realization figures, Dynamic, Static, and All Firms, track their billing and collected realization figures in relatively close parallel.

Static firms may be overly cautious in raising their rates, perhaps out of fear that their clients would decline invoices or even take their business to other firms. Even still, Static firms would be well-advised to carefully consider their rate-growth strategies given the new pressure that increasing inflation is placing on all law firms.

Interestingly, when it comes to realization, Dynamic firms show a rare point of weakness. They are notably behind the all-firms average in both billing and collection versus worked rates. Part of this may be explained by their more-aggressive-than-average rate increases, a tradeoff these firms may indeed find worthwhile. Either way, Dynamic firms are showing steady improvement in their realization, sharing the same upward trend as the market average. So long as Dynamic firms maintain this upward progression in conjunction with their increased rates, they seem well positioned to weather any period of ongoing inflationary concerns.

Dynamic law firms exited 2021 stronger than they entered 2020. Average daily demand (ADD) per FTE grew by 1.2% compared to 2019, nearing 6.0 billable hours worked per FTE per day. This is significant, given that the all-firms average is still -0.2% below 2019 levels. Despite a global pandemic and the macroeconomic turmoil that followed in its wake, Dynamic law firms are performing significantly better than their peers.

With the ongoing competition for associates, Dynamic firms also seem to be finding the talent that they need to meet demand, growing both their overall size and significantly outperforming their competition in terms of equity partner replenishment. Moreover, they appear to be having a far easier time retaining this talent than their Static firm counterparts.

Unfortunately, Static firms do not share in this bright outlook. These firms are still below their 2019 ADD per FTE levels and are falling further behind. In 2019, Static firms averaged 0.1 fewer daily billable hours per FTE than the average firm and 0.22 fewer than Dynamic firms. In 2021, the Dynamic Net Advantage of Dynamic firms expanded to 0.37 ADD per FTE, with Static firms falling further behind the average firm then they were before the pandemic. For a metric such as ADD per FTE, where tenths of an hour can mean millions of dollars in revenue when compounded over a year, this difference illustrates the slippery slope that Static firms now find themselves sliding down.

Whether one’s firm is Dynamic, Static, or neither, good times cannot last forever. Eventually, the tides must shift. Transactional practice demand which has kept the large law market prosperous throughout this last global crisis must likewise eventually fade. Dynamic firms, given their seemingly more loyal and productive crews, solid market positioning, and dynamic cultures appear well prepared for when such tides turn. Static firms, by contrast, may well find themselves unable to maintain the talent they need. Static firms have outpaced Dynamic firms in PPEP growth in recent times, but they have done this primarily by restricting the ranks of their partnership, while at the same time running the risk of falling behind the market on other key factors such as associate pay, retention, and hiring. If transactional demand fades, these Static firms may find themselves with few sources of growth to fall back upon.

Further, while Static firms have thinned the equity partner ranks, they have significantly increased the salary obligation they now owe to non-equity partners, an obligation that will remain no matter the tides. It is true that Static firms have made great strides in the last few years, including making positive investments in such key areas as technology. However, even while they have worked to reposition themselves to take better advantage of a major shift in legal demand, they may have missed the final piece of the puzzle that’s needed to achieve sustainable success.

As such, while the general market is prosperous, we would not be surprised if the diverging line between these populations of Dynamic and Static law firms reasserts itself when a market downturn inevitably arrives.

Dynamic firms have displayed a belief that change is a positive force and it should happen during the best of times, not just when market shifts demand adaptation. With talent likely to be the key challenge of 2022, Dynamic law firms are making decisions now to better position themselves as a top destination for the best talent. Today, Dynamic firms seem far more willing to open the doors to the highest ranks and pay those in the lower ranks a grander sum.

However, one should be cautious in believing the relative success that these firms are seeing in retention comes solely from the increased payouts these firms are giving to their lawyers. In the 2022 Report on the State of the Legal Market,[8] we referred to the research of American psychologist Frederick Herzberg and his study of wages and contentment. Herzberg showed how paying someone less than they believed they were worth had a significantly detrimental effect on retention. Yet, even if an employer were to pay an employee more than the employee felt they were worth, this did not, in itself, create a higher sense of job satisfaction. In other words, paying lawyers more will not necessarily be sufficient to improve the chances they will stay at the firm.

While it is true that Dynamic law firms paid their lawyers more than other firms and have accelerated raises at a far high rate, these firms also saw far greater profits over the last year. With the coffers full, Dynamic law firms have paid out this additional compensation so that their lawyers are unlikely to feel underpaid. After all, one’s estimation of “worth” in terms of compensation is often highly correlated to the wealth their labor generates. As the wellbeing of the firm improves, the firm’s lawyers were likely to expand their expectations alongside, so Dynamic firms sailed ahead of the problem to cut it off. Critically, though, these firms are also looking at strategies that go far beyond mere compensation, looking to place themselves on the cutting edge by changing and adapting to a greater extent than most of the firms which they compete.

In an economic environment in which attracting and retaining talent is a major challenge for the entire legal industry, Dynamic firms seem to have taken the advice of Steve Jobs, who said: “It’s more fun to be a pirate than to join the navy.”

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[8] See 2022 Report on the State of the Legal Market at https://www.thomsonreuters.com/en-us/posts/legal/state-of-the-legal-market-2022/