The survey said?

Now in its 15th year, the PricewaterhouseCooper’s Annual Law Firms’ survey reveals that 2006 has been an exceptional year for many law firms, with average fees per partner and average profits per partner increasing year on year.

PricewaterhouseCoopers’ 15th Annual Law Firms’ survey continues to indicate that virtually all of the UK’s Top 25 law firms have recorded strong growth in profits, as total fee income has increased and restrictions on equity partner numbers maintained.

The strong growth in law firm profitability has been well documented over the last year. In prior years, growth was largely achieved through close control of partner numbers and the cost base. This year’s growth in profitability has been achieved through maintaining a tight rein on equity partner numbers, combined with a strong growth in total fee income.

A benign and favourable economic environment has enabled firms to increase their fee income, with over 65 per cent of the Top 25 firms growing fee income in excess of ten per cent and some achieving more than 20 per cent growth.

However, despite the growth in fees and average profit per partner, profit margins remain under pressure due to continuing low levels of staff utilisation (relative to last year and target), continued salary pressures and high levels of qualified staff turnover.

“The survey results show that 2006 has been an exceptional year for many law firms and a key driver of the high level of growth in profits per partner has been the continued restriction on equity partner numbers,” said Alistair Rose, leader of the professional partnership advisory group at PricewaterhouseCoopers. “More than half of the Top 25 reduced the number of their equity partners, an indicator of a real focus on maintaining growth in profits per partner at the expense of broadening the partnership. Interestingly, however, among the top 10 law firms, just over half increased their partner numbers this year, reversing the trend of the last couple of years.

“Given the profitability growth reported by firms, it is surprising that levels of chargeable hours, per member of staff, have fallen by an average of three per cent for the Top 25. Again, firms are failing to achieve target utilisation. At the same time, staff turnover levels are also still high, averaging up to 20 per cent for some Top 25 firms. There are clearly work-life balance issues involved here, combined with the increasing restrictions on equity partnership as an achievable career goal.”

On the subject of salary increases, the survey indicates that the most significant have been targeted at the three-to-five years’ post-qualified experience (pqe). There is also evidence of greater use of flexible benefits and flexible working arrangements. However, firms are still struggling to introduce specific, targeted bonus arrangements and this is an area where management teams need to focus given the costly attrition rates many are experiencing.

Risk management remains a key area of focus for firms, according to the survey. Greater emphasis on this, combined with a healthy professional indemnity (PI) market, has seen PI insurance costs fall for many firms this year. However, there still remains a reluctance to routinely limit liability on client engagements, with just over a third of the Top 25 seeking to do this. The larger the firm the more likely ‘client resistance’ is cited as being the reason for not seeking limitation of liability.

The survey highlights the level of spend and trends in key business support functions. A key change this year has been that firms are spending more on their IT infrastructure.

This is also an area, along with travel and payroll that firms are actively considering for outsourcing. More than half of the Top 10 said this was an area of focus for the coming year as they look to control their costs and secure competitive advantage.

International expansion has again featured in 2006 with over half the Top 25 reporting increases in their overseas revenues of more than 15 per cent. This is, however, lower than previous years as firms seek to consolidate their overseas operations. Not surprisingly, the largest firms have the most established overseas operations with six of the Top 10 now generating more than 30 per cent of their income from those sources. China is attracting most attention with 74 per cent of the Top 25 having at least one wholly-owned office there; this compares with just 33 per cent in 2004.

Looking forward, firms are again budgeting for a strong performance in 2006/7, with more than 80 per cent of firms in each size category assuming increased profits per partner and increased numbers of fee earners.

The strong financial performance, per partner, is also seen as not being necessarily sustainable as a greater number of firms in the Top 25 are predicting they will increase their partner numbers. However, the Top 10 are remaining more conservative in this area, with just 50 per cent expecting to increase their equity partner numbers, but 83 per cent predicting increases in their fixed share partners.

2006 has been an exceptional year for many law firms, with average fees per partner and average profits per partner increasing year on year. The survey highlights how the results have been influenced by the tight control over partner numbers. For the Top 25 firms, average fee income has grown over the last three years by 48 per cent but average partner numbers have grown by 11 per cent. Managing partners will need to consider whether this model is sustainable, especially given the pressures on staff utilisation and retention rates.

PricewaterhouseCoopers surveyed a wide range of law firms of diverse size and location, including 84% of the top 25 firms and 57% of the top 100 firms.

Copies of the survey can be ordered online at http://www.pwc.com/uk/lfs.