In the previous article of this series, we expressed profit margin (defined as operating income divided by revenue)  in terms of revenue per lawyer (RPL) and cost per lawyer (CPL). We noted that 2018 profit margin at 40.03% was at the highest level in 30 years; and had been climbing steadily upwards from 2009. We examine here whether this upward trend can continue into next year? In other words, could Am Law 100 profit margin increase further from 2018 to 2019? And can 2019 exceed the record margin of 40.14% set in the very first year of the Am Law 100 publication in 1987?

Projecting 2019 Profit Margins

To estimate the 2019 profit margin, we  need three data points: (1) the 2018 profit margin; (2) 2018 to 2019 annual percentage increase in RPL; and (3) 2018 to 2019 annual percentage increase in CPL. The first data point is readily available, but we need to be creative in order to find the latter two. Fortunately, we can look to numerical surveys of law firms conducted by two leading banks which captures such data directly. For the first nine months of calendar 2018 against a similar nine month period in calendar 2017, the two surveys lead us to an average annual RPL growth rate of 4.65% and an average annual CPL growth rate of 4.30% (Log Into Legal Compass To View the Am Law 100).

Studying this further, we can make two critical observations. First, we see RPL growth rate from 2018 to 2019 of 4.65% is higher than the corresponding RPL growth rate from 2017 to 2018 of 3.07%. Similarly, CPL growth rate from 2018 to 2019 of 4.30% is higher than the corresponding CPL growth rate from 2017 to 2018 of 2.73%. Why has growth rate in both parameters increased recently? An increase in demand from 2018 to 2019, coupled with high standard rate increases are driving revenues; while increased headcount, additional compensation expenses and investments in marketing and technology are pushing up costs. Both revenues and costs are being tempered by increases in headcount, thus leading to relatively lower growth rates in the per lawyer metrics, RPL and CPL. Second, we see RPL growth rate % is 0.35% higher than the CPL growth rate %. This is a positive rate differential and should lead to an anticipated increase in profit margin from 2018 to 2019.

We can now project 2019 profit margin using our earlier formula. We use the 2018 Am Law 100 average RPL of $936,666, the 2018 Am Law 100 average CPL of $561,748; and the above growth rates, assuming that the annual calendar year levels are the same as the 9-month survey results:

Thus, 2019 profit margin is projected to be 40.23%, which would be 0.20% higher than the 2018 profit margin of 40.03%. Indeed, 2019 projections turn out be 0.09% higher than the record level of 40.14% set in 1987. While 0.09% is a small figure, it is still significant. Indeed, 2019 could represent a new profit margin record in the 33 year history of the Am Law 100 survey.

Comparing Projections to Am Law Early Results

Can we numerically test our 2019 projection? We are fortunate to have The American Lawyer's early reporting on 2019 financial performance for some law firms. As of March 13, 2019, we have data on 42 firms in the 2018 Am Law 100; whose combined 2018 revenues and operating income total to almost 45% of the corresponding numbers for 2018 (see $41.1/$91.4 in Table 1). Owing to this significant percentage, we can assume this 42 firm sample is representative of final 2019 Am Law 100 results.

For these 42 firms, we see annual growth in RPL of 5.4% exceeds the 4.65% indicated by bank surveys; and similarly, the growth in CPL of 5.0% exceeds the 4.30% indicated by bank surveys. Further, the differential between growth in RPL and CPL is 0.40%, which is very much like the 0.35% differential obtained from bank surveys. Since RPL growth rate exceed CPL growth rate, we would anticipate profit margin to increase from 2018 to 2019.

Indeed, for these 42 firms, 2019 profit margin of 39.12% is higher than the 2018 profit margin of 38.87% by 0.25%. Our mathematically calculated projection was an increase of 0.20%, a remarkably close, if not somewhat conservative result. We are pleased to note good validation from actual firm data for our projection.

Summary

We had projected profit margins would increase from 40.03% in 2018 by 0.20% to 40.23% in 2019 to set a new Am Law record. The early results for 42 firms, comprising nearly half of the 2018 Am Law 100 proves our projected increase of 0.20% is close to the sample result of 0.25%. However, it is important to note that this analysis is a projection of future results based on historically available but partial information. The real world is replete with one-off events, noisy data, compositional changes and other non-forecastable changes. Thus, 2019 Am Law 100 actual results may well be different from these mathematical derivations.

Madhav Srinivasan is the Chief Financial Officer at Hunton Andrews Kurth LLP, leading the global finance and pricing competencies. Madhav is an ALM Intelligence Fellow and also an adjunct faculty at Columbia Law School in New York and University of Texas at Austin School of Law.

More information on the ALM Intelligence Fellows Program can be found here