Law firms saw their performance slow down slightly towards the end of 2024, allowing for a solid finish but highlighting greater challenges ahead in 2025
The financial health of law firms experienced a slight cooling in the fourth quarter of 2024, as indicated by the Thomson Reuters® Institute Law Firm Financial Index (LFFI), which fell 7 points to a still-impressive score of 64.
Interestingly, law firms were quick to invest in several internal areas late in 2024, with significant resources going to technology and knowledge management. Of course, this sent expenses up, with overhead expenses rising 6.9% and direct expenses climbing 6.2% as well, after firms paid bonuses to their associates and staff.
Key takeaways in Q4
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- The LFFI score dropped to 64, reflecting a slight deceleration in firm performance.
- Expenses surged in Q4 due to sizeable bonuses and renewed investments, particularly in knowledge management and technology.
- Despite the spending spree, law firms managed to achieve double-digit profit growth.
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The balance of demand and expenses
Demand growth showed a slight decline from Q3’s record-high performance, with notable structural advantages puffing up the final figure. Counter-cyclical practices, which had seen record growth over the past two years, experienced a significant slowdown in Q4, the new LFFI report shows. Conversely, transactional practices saw rapid growth, potentially influenced by the US presidential election. The result was a passing of the torch so to speak, in which transactional growth achieved a growth rate higher than that of counter-cyclical practices.
While this was always a long-heralded possibility, weakness in other areas led to growing concern for 2025’s demand growth potential, even if Q4’s overall demand growth only slightly deteriorated from Q3.
This increase in transactional demand kept the Index relatively high, however, one of the major forces that pulled it down was productivity, which in the face of further hiring in Q4, dropped back to near-parity to Q4 2023. Typically, firms usually have seen a not-insignificant decline in productivity every year since the global financial crisis that began in 2007. However, the fact that firms saw actual productivity growth earlier in 2024 buoyed the Q4 Index result. Now, it seems that firms are again seeing productivity (at least as measured as hours-per-lawyer) becoming a drag on their performance, rather than the boon it briefly had been.
Not surprisingly, law firms’ spending adjusted for inflation skyrocketed at the end of Q4 as firms locked down talent and brought more technology online. This surge in spending, while denting the Index’s score, did not overly perturb the bottom line, as firms still saw profit growth in the double digits. Still, the spending boost remained substantial. Year-end bonuses for firms brough rolling 12-month average expenses growth to some of its highest levels in more than a year and notably increased their pace of acceleration. Indeed, it’s difficult to shift such metrics so drastically in a single quarter, clearly illustrating the scale of firms’ interior investments.
Looking ahead to 2025
The forecast for 2025 suggests a more static demand environment in the first half of the year, with an eventual uptick by year-end. This will not only remove one of the key drivers’ of 2024’s performance (demand growth) but also further increase the performance drag of productivity declines. As such, law firms will need to rely on rates and realization to improve revenue-per-lawyer performance In 2025, which will likely return firms to more traditional Index levels.
Of course, a myriad of events could alter this trajectory in 2025, from transactional demand accelerating further in the new year as clients adjust to an increasingly chaotic world to generative AI seeing its first full year of making an impact in the aggregate. Overall, the Q4 2024 LFFI report outlines an industry that, despite facing challenges, remains on a solid path to continued financial health.
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