Recession, what recession? It may not have landed yet, but there is one on the way. Nearly a decade has passed since the Great Recession in the US, which lasted from December 2007, when the $8trn housing bubble burst, to June 2009.
Ever since the financial crisis that accompanied it, the world has benefited from another artificial bubble created by QE – better known as quantitative easing, which has suppressed long-term interest rates and provided essential financial resources to the economy.
In December 2018, The European Central Bank (ECB) announced that it was finally ending its €2.6trn bond-buying programme that was set up to resolve the eurozone crisis. The ECB’s programme was foreshadowed by the Fed which launched its own QE programme back in 2008 to mitigate the effects of the financial crisis following the collapse of Lehman Brothers. This also involved buying trillions of dollars of government bonds and mortgage-backed securities: between 2008 and 2015, the Fed’s balance sheet swelled from $900bn to $4.5trn. The impetus for both the Fed and the ECB was to use QE as a mechanism to avoid any repeat of the factors that led to the Great Depression of the 1930s.
All that is now history. Starting in July 2009, US economic expansion is set to become the longest on record this summer, surpassing the expansion that followed the 1990-91 recession. In the aftermath of the successive crises of 2008-13, international law firms have prospered. Growth rates in revenue and profitability have routinely been in double figures since 2016, fuelled by corporate activity, M&A and a glut of regulatory work. But like any business, law firms may be looking at the year ahead with some trepidation as the potential for another recession looms.
We might now enjoy low energy prices, and in most countries, low unemployment and low interest rates, but the odds of recession are getting higher. On any analysis of the economic cycle, it is long overdue. The only question is not if, but when it will strike. According to JPMorgan Chase, the probability of a US recession within one year is 28 per cent, rising to 60 per cent within two years, and eighty per cent within three years. Of course, the EU27 may get there first as much of the rest of the world economy outside the US has already has begun to slow down.
So are law firms ready for the challenge?
A common view is that the legal industry is more recession proof than most: instead of big ticket deals, attention turns to litigation, insolvency, bankruptcy, Chapter 7 and Chapter 11, workouts, administration, restructuring, refinancing, and so on. Larger firms with diverse practice areas and geography are seen as better able to weather the impact of a recession. However, memories are short, even for lawyers. They forget the contraction in partner numbers, the hiring freezes, the closing of offices and the law firms that went under during the last recession.
The reality is that law firms are recession resistant, just not recession proof. Of course, some firms have fared much better than others. But the events of 2007-9 had a universal impact as a perfect storm produced a simultaneous downturn in finance, transactional and litigation work with insufficient work elsewhere to compensate. Although the next recession may not be as severe as the last, it could yet have a disproportionate impact on the legal sector.
The provision of legal services has moved on apace in the past decade. Big companies now spread their workload across multiple firms, using cost-saving strategies wherever possible thanks to an army of procurement professionals and the cut price offerings of alternative legal service providers (ALSPs). What worked in the last recession as risk mitigation and cost reduction strategies may not therefore work in the next one: increasing fee rates, shedding staff and thinning out equity partner ranks, known euphemistically as de-equitising. Raising prices will simply shift demand towards cheaper firms and ALSPs. Redundancies and de-equitising partners are similarly problematic because there are far less partners available to cut since most law firms are now much leaner than when Lehman went under.
So how can they combat the impact of the next recession?
Counterintuitively, the answer may lie in Keynesian economics: fiscal stimulus – an injection of spending that leads to increased business activity and through the multiplier effect, greater demand. In practice, this means giving clients fewer discounts and pre-bill write-downs, while increasing spending on business development and technology investment. The received wisdom of the last decade has been to respond to client demand for better value by cutting prices and reducing expenses. But the most successful firms, such as Latham & Watkins and Kirkland & Ellis, have not done that. As the first two law firms to cross the $3bn revenue line, part of the reason for their success lies in a sustained commitment to invest.
It is a lesson that may apply in the next recession for law firms of every size: change and adapt rather than stand still. At the same time, add to the value of services to justify existing prices rather than cut prices to try and match their perceived value. Beyond off-loading high-volume, repetitive tasks from lawyers’ time, enhancing their capabilities is key: enabling them to deliver greater value in tasks where their expertise is essential.
Investing in technology therefore really does matter: a wealth of legal tech products now enable lawyers to make better-informed decisions using data through predictive analytics and legal research. The law firm relationship with ALSPs is also pivotal since they now encompass a multiplicity of tasks: project management, administrative services, drafting and revising documents, increasingly using automation and AI-powered tools. An opportunity exists for firms to incorporate even more technology into their business by using ALSPs without compromising data security.
Ultimately, each client’s assessment of quality and value in the legal services delivered by their law firms determines their price. When faced by economic adversity, firms that are tempted by innate caution to hunker down and choose not to invest sufficiently in technology, or who reject the benefits of ALSPs, may have a much harder time of it in the next recession.
How each law firm comes out of that recession will be a true test, not just of its collective character, but of how well it has served its clients in hard times and managed to keep them on board, as well as winning new business. In focusing on profitable practice areas, business development needs more investment, not less. Marketing is often the first casualty in a recession, which can be an expensive mistake. But above all, sound management means keeping client relationships strong in a fiercely competitive environment by expanding existing relationships and by developing opportunities for new ones.
No recession lasts. The best law firms will exit from the next recession stronger than when they entered it – but only if they plan ahead.
Dominic Carman, journalist, writer and legal commentator.