Continued double-digit expense growth remains a long-term challenge.
Thomson Reuters (NYSE/TSX: TRI), a global content and technology company, today released its 2023 Australia: State of the Legal Market Report.
During financial year (FY) 2023, law firms in
'The 2023 financial year was a remarkable comeback story for Australian law firms, who managed to overcome a difficult first half and achieve positive growth in demand, ending the year near the profitability levels of last year,' said
Rise of counter-cyclical practices
Counter-cyclical practices - dispute resolution, insurance coverage, insurance defence, workplace relations, and insolvency & restructuring - were vital to firms' comeback in FY 2023. These practices, which account for one-third of all hours logged, provided the bulk of demand growth in FY 2023, improving by 3.9% vs. FY 2022, and achieved 8.5% growth in the second half of FY 2023.
While transactional practices - general corporate, mergers & acquisitions, banking & finance, real estate, and tax - declined by 0.6% on a year-over-year basis, the Australian legal market outperformed other global markets in the second half of FY 2023, with law firms in
Cost expansion affects profitability
Rising costs, both direct and indirect expenses, remain a concern and outstripped revenue growth. Total expenses for the average law firm grew by 11.6% in the past 12 months.
Firms' direct expenses grew an average of 11.4% in FY 2023, continuing double-digit growth from FY 2022 (13.4%). This rise is likely due to headcount increases and already-hired talent becoming more expensive. Unlike global counterparts, law firms in
Indirect expenses for firms' support functions and infrastructure grew by an average of 14.3% this year, with all major indirect categories experiencing inflation-driven cost increases. Marketing & business development and knowledge management saw the largest jumps year-on-year, with technology, office and recruiting expenses also significantly increasing.
The report found that lawyers are becoming more expensive and less productive, as indicated by both hours-worked-per-lawyer and profit-per-lawyer perspectives. The decline in productivity suggests that firms have not yet recovered from the utilisation decline in FY 2022, and headcount increases outpacing demand growth.
With expenses growing faster than demand growth, Australian law firms saw the average profits per equity partner (PPEP) contract for the first time since FY 2016. PPEP declined 3.1% over the past twelve months. This decline is an improvement compared to the 9.3% decline in PEPP during Q2 FY 2023 on a rolling 12-month average due to weaker demand, rising expenses and strong baselines. The latest 12-month figure indicates that firms are trending in the right direction.
Additionally, rising costs led to an average decline in profit margin of 3.3 percentage points compared to FY 2022. Recovery seems possible as recent indicators of stronger demand and slowing expenses are working in firms' favour.
Discontent in the ranks
Australian lawyers appear dissatisfied with critical aspects of their firms compared to their global peers and less positive in the net promoter score, giving their firm +56% compared to the global average of +68%. Australian standout lawyers also pose a much higher flight risk than global lawyers, with 65% responding they were 'somewhat unlikely/highly unlikely' to leave their current firm vs. 80% globally. Discontent among lawyers suggests the potential for pushback if firms decide to make too aggressive moves that lawyers disagree with.
The 2023 Australia: State of the Legal Market Report outlines three possible scenarios or alternative futures law firms for how the nascent technology may affect the industry:
Download the 2023 Australia: State of the Legal Market Report here.
Over the course of FY 2023, the financial metrics in this report were collected from Thomson Reuters Financial Insights data, which is based on the accounting systems from 20 participating law firms operating in
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