What would it really take for an Am Law 100 firm to have a prolonged period of decline? Clearly more than a pandemic, political instability or social unrest, which combined in the last 18 months to produce a very difficult time for many but a profitable time indeed for many elite law firms. 

Countercyclical and diversified practices, a large enough footprint to weather geographical downshifts in certain markets and strong talent pipelining insulate the most profitable law firms from a variety of external factors that can impact their business, which will be detailed below. 

But when a firm, whether for strong short-term gain or a lack of managerial foresight, lets the above erode or be forgotten, a cancer grows internally regardless of external factors.

That internal rot, unless dealt with, can manifest in a down year or even a prolonged period of decline for even the most profitable firms. 

Eggs and Baskets

External and internal forces, while in some ways separate, are often linked. How firms react to external forces and manage them plays a large part in how effective they are in staving off lean years. 

"What is interesting to me about recent law firm financials is that in 2020, with the politically and socially unstable environment and a pandemic, you still saw firms with profit margins of 19% or more," said Precious Owodunni, president and CEO of Mountaintop Consulting. "It just shows how well insulated the big firms are to large scale hiccups."

But while many firms are insulated to a degree, how they manage these "large hiccups" contributes perhaps more to bottom line profitability than the hiccup itself.

Janet Stanton, principal at legal consulting firm Adam Smith Esq., cited the example of Silicon Valley firms in the early 2000s as an example. 

"Some firms made what turned out to be very bad business decisions," she said of how firms reacted to the Dot-com bubble. "Some of those firms took payment in stock, for example. They made bad financial bets, and some of them went under."

Owodunni agreed with that assessment, saying that while an external factor like a bubble may hinder some growth, how the firm responds is just as important.

"There are big-picture factors, of course, but a lot of what will impact profit over time are the decisions made by the firm in how they deal with those big picture issues," she said. 

Cannibalism

Another element that threatens firms from within is their ability to attract and retain the right people. And keep that talent from other firms. 

"The talent market hasn't been tighter in decades," said Kent Zimmermann of Zeughauser Group. "There is a small group of firms that is benefiting from rapidly compounding size and profitability. And within that group there are firms, if they set their minds to it, they could poach most people across most firms."

Zimmermann went on to say that in the not-too-distant future, this scenario could play out in full, potentially decimating the talent pipeline not just for lateral hires but for associates as well. 

"There is a point on the horizon not that far away when a small group of firms will have the option of compensating associates at a level that most can't match," he said. "The best associates are the future and the best partners want the best associates to work on their matters. On a partner compensation level that has already happened. There is a small group of firms that pay stars at a level that most firms can't match. The segmentation is a live issue happening right now. It is not a 'one day' thing. It is already happening with partners." 

External Disruption

Even if a firm is able to hedge its bets on financial decisions and maintain control over its talent pool, there are of course external factors that can impact firms as well.

At some point, the music will stop and the lights will come on to the economy to some extent, analysts and firm leaders have said. Exactly when that will happen, and how fast, could largely be shaped by external forces. Indeed, firms' current run of success is significantly linked with macroeconomics.

Between high stock prices, low interest rates and government stimulus flooding the economy, there's plenty of demand for legal work right now, with mergers and acquisitions and private equity deals as prime examples.

Analysts and firm leaders believe there's still money on the sidelines, and firms continue bulking up on talent in transactions, many under the assumption that kind of deal work will have a long tail and continue to spin off into other areas, like litigation.

"I think when the funds get deployed, when loans start getting called, when interest rates start going up and inflation creeps in a little bit more, then you could see things slow down," said Paul Schmidt, chair of Baker & Hostetler. "I think that the question is, will that be gradual or will that be sudden?"

Unfortunately, there are precedents for the easy-come, easy-go theory. Look no further than the lead up to the Dot-com bubble of the late 1990s, the routine ups and downs in the energy market, and of course, and the lead up to the Great Recession, to find times when business couldn't be better. Then they came to a screeching halt.

"Many of the tech firms that were the hot places to work 20 years ago didn't survive the tech bust. They were so heavily concentrated in that industry and that one geography that they weren't able to sustain themselves," said Owodunni. "We saw the same thing in Texas over the last 10 years as firms that were very heavily into energy either did not do well and had to close down, or had to merge on less favorable terms with larger platforms to be able to withstand the booms and busts of the energy market."

But many of the firms that are capitalizing on transactions right now are well-diversified. 

Certainly the largest and most profitable firms have a mix of practices, including countercyclical ones like insurance, restructuring or even cybersecurity, that could keep them firing even if the demand environment significantly changes. It might take an enormous shock, akin to the Great Recession, to really challenge those firms' growth.

"If there was a global financial crisis, that would slow some firms down, as it did in 2008, the last time we went through that," Zimmermann said. "Even such catastrophic events are difficult to foresee."

But Zimmermann noted that while no one expects the wind to be taken out of private equity sails in the near, or really, the long-term, history suggests the world might be due for another economic downswing.

"If you look at 100 years of economic data, there are cycles that happen every 10 to 15 years, and we are a long way into an upcycle that has sustained," he said.

While noting the significance of something like a downswing in M&A work, Randy Kiser, a scholar of the legal profession and analyst for DecisionSet, said separate threats for firms in the near future could come from the talent pool. If firms don't have enough young talent in leadership, or talent in general, they could start to stagnate.

"What happens if you can't recruit or retain enough attorneys to do this work?" he said. "At this point, it looks like that is a growing threat to the law firm business model. As long as you're selling time, you have to be very careful about retaining the people who are delivering that profitability."

Schmidt, of Baker & Hostetler, noted law firms' fortunes can also rise and fall depending on who is running the government. Just as law firms expected a bump in white-collar enforcement when President Joe Biden won the election last fall, sweeping policy changes can push and pull them in different directions.

"You've got a lot of stuff going on on the Hill right now," he said. "There's a $3.4 trillion infrastructure package on the one hand, which will ultimately push more money into the economy, so that can change things. On the other hand, you've got tax policy implicated in that, which makes transactions more expensive, and that could have an impact."

Ultimately, Schmidt added, whether you're one of the top-performing firms with a big mix of evergreen practices, or a smaller firm that's leaning into one or a few areas, the economic and political environment lately has lifted most of the legal industry.

"Therefore, I think you'd expect if there is a slowdown, it's likely to impact the industry as a whole," he said. "I think the tide is rising and lifting all boats. There might be some waves there lifting some others, and maybe there are some crests, but frankly most of the boats are rising as this tide has been rising, and will probably experience—if not the same levels—experience some level of contraction when it recedes."