Even so, law firms seem basically optimistic that the nation will avoid a costly economic decline. “Multiple banks have said they don’t believe there’ll be a recession in 2023, so the current economic situation might be just a bit of a stall,” says Eric Wangler, President of the North America Division of BigHand.
A number of market forces are competing to dominate the current economy. Just how they play out will decide how the year goes. Serving to depress business activity are rising inflation, higher interest rates, a softening housing market, continuing supply chain disruptions, declining capital investments, and escalating costs for wages and energy. On the other hand, helping bolster activity are the strong level of current orders and a continuing need for additional workers in a surprisingly robust labor market.
What could tip the balance? A resurgence of the pandemic in China, a worsening situation caused by the Russian invasion of Ukraine, or another energy supply shock that would hit consumer pocketbooks. The labor market will also need to cool down at a pace that avoids sparking economic turmoil, and the Federal Reserve will need to successfully tame inflation without allowing interest rates to damage business and consumer activity.
“The U.S. economy is vulnerable to anything that might go wrong,” says Bernard Yaros Jr., Assistant Director and Economist at Moody’s Analytics.
INDUSTRY SLOWDOWN
Given all these competing forces, Moody’s Analytics sets the odds of a recession in 2023 at 50-50. Indeed, the current peek-a-boo nature of recessionary trends has encouraged some at the consulting firm to refer to the current economy as a “slow-cession”— an economic trajectory that is decelerating but not necessarily destined for an actual decline for any appreciable length of time.
While all that may be true, the legal industry is certainly feeling the pain in terms of slowing revenues.
“Our Law Firm Financial Index numbers show a decline of 0.6% for 2022 as a whole, and a decline of 4% for the fourth quarter,” says William Josten, Manager for Enterprise Legal Content at the Thomson Reuters Institute. While those numbers look ominous at first glance, Josten urges that they be put in context. The 2022 decline was against a very strong 2021 that was in fact a rebound from the pandemic-depressed 2020. “We went into 2022 knowing we were working off a year of artificially high baselines,” he says. “We knew there would be a falloff in terms of demand growth.”
Furthermore, Josten says that last year’s demand contraction of 0.6% was actually within the historic norm. “If you go back and look at most of the decade following the Great Financial Crisis, we were typically at plus or minus 1% demand.”
The need to contextualize extends to the bottom line. “Compared with the fourth quarter of 2021, firm profitability has fallen off quite a bit,” says Josten. “But compared to a pre-pandemic baseline, profitability is still up more than 12%.”
”The current peek-a-boo nature of recessionary trends has encouraged some at the consulting firm to refer to the current economy as a ‘slow-cession’— an economic trajectory that is decelerating but not necessary destined for an actual decline for any appreciable length of time.”
TAKING ACTION
Slow-cession or no-cession, law firms are hedging their bets by taking prudent moves to strengthen their financial position. That means putting renewed scrutiny on expenses such as overhead, marketing and technology, without crippling the firm’s ability to operate efficiently when the economy rebounds.
Staff reductions are modest, perhaps because of a fear that quality prospects will be scarce on the ground when firms need to hire them later. “There’s been some targeted headcount reductions primarily in the top 100 big [merger and acquisition] firms,” said Wangler. “But they are not as drastic as what went on in 2008 and 2009, nor are they likely to be assuming there is not a complete meltdown in the economy.”
Two other areas of concern are billing discipline and rate growth. “We saw a trend in 2022 where essentially everybody saw declining realization against their rates,” says Josten. Firms need to monitor their write-down numbers while making critical and delicate decisions about price hikes in a market where clients may not be in the mood for higher rates.
Prudence is the current watchword. Recessions tend to gain force quickly once they begin, as commercial enterprises shift from chasing demand to cutting costs. History shows that organizations taking swift remedial action rebound faster once hard times recede.
