The Law Firm Financial Index (LFFI) issues a warning signal for the legal sector in the second quarter of 2022

In the second quarter, the Thomson Reuters Law Firm Financial Index (LFFI) fell for the fourth consecutive quarter, injecting a warning about the direction that law firms’ performance could take

For the fourth straight quarter, the Law Firm Financial Index (LFFI) headed lower, highlighting the longest slide and lowest score in the history of the index. Given this second quarter figure, it would be easy to diagnose the legal industry with a case of general infirmity. Fortunately, a closer look reveals a more nuanced perspective and offers reason for optimism tempered with caution.

Main takeaways in T2:

          • Growth in transactional practices slowed and was not offset by the recovery in non-transactional practices in the second quarter.

          • Slowing demand growth allowed increased spending to lower the LFFI score.

          • Rates, realization and technology investments all showed strong signs of future growth.

The second quarter score, which fell to 36, was weighed heavily by increased spending, particularly in year-over-year overhead growth. Unsurprisingly, a return to office work has pushed these numbers even higher, compared to the baseline set for the second quarter of 2021. Another contributing factor may also be inflation, as all overhead categories have increased. Similarly, direct spending continued to grow, albeit at a slower pace, as associate compensation growth slowed somewhat.

Unfortunately, demand growth in the second quarter was unable to outpace spending as it had in previous quarters. Previously, transactional practices – general corporate, mergers and acquisitions (M&A), real estate and tax – had driven demand growth and offset demand contraction for non-transactional practices. This quarter has seen demand for transactional practice slow and as a result overall demand has declined.

The Law Firm Financial Index is a rebranded version of the Peer Monitor Index (PMI), which Thomson Reuters has published quarterly since 2006. Although the fundamental methodology for determining the index’s score remains unchanged, the new name reflects an effort to incorporate additional information to give more context to the index score. Like the old PMI, the LFFI is a composite score, representing the quarter-to-quarter change in the drivers of law firm profitability, which includes rates, demand, productivity and expenses. Positive factors that drive the company’s profitability will produce a higher score.

Growth areas shine

Despite the poor indicators described above, the industry as a whole does not show signs of structural instability. Worked rate growth was solid and rate realization improved. Another area that continued to shine was technology spending, which grew at its fastest pace in nearly a decade. Given that computer hardware and services are normally a deflationary market, this is particularly indicative of the well-being of the legal industry. This acceleration in investment suggests that companies are keeping their long-term health in mind rather than nursing the bruises from struggling revenue growth in the second quarter.

More than ever, companies have the opportunity to find a sustainable middle ground for profitability. For a period of almost two years before the first quarter of 2022, many law firms saw their profits per lawyer increase; now, however, that demand has slowed and quarter-over-quarter profitability growth has reversed.

This quarter’s LFFI score serves as a warning to companies that if certain areas move in a positive direction, companies risk ending the year in a weaker position than last year. Now that 2022 is five months away, these warning signs should be viewed with extreme interest.

You can download the full Q2 2022 Law Firm Financial Index report below.