When looking at the Peer Monitor Index, we don’t tend to pay much attention to expenses. Metrics like demand and rates tend to command more eyeballs, and therefore, more analysis.
But the recently released Peer Monitor Index report for Q4 2016 is an exception. Rates performed well; in fact, better than they had the previous year, rising 2.9% compared to 2016’s 2.7%. But even improved rates would not have been enough to hold the PMI steady at its current level without some assistance.
Which is why we’re looking at expenses. For the first three quarters of 2016, expenses had risen at a pace not seen in years. But that changed in Q4. Direct expenses grew only 2.9% for the quarter. At the same time, indirect expenses grew at their slowest pace of the year, climbing only 2.8%.
On the whole, it appears that law firms are trying to keep a tight cap on expenses. Though not surprising, this will be an interesting feat to accomplish, particularly since 2016 was the year many larger law firms decided that their Associate class needed about a 20% pay bump.
Law firms have held relatively steady on their expenses for most of this decade, with a few exceptions, much of 2016 being among them. What is perhaps most interesting about expense performance in 2016, though, is how firms are allocating their expenditures.
Spending in areas like technology, recruiting and marketing/business development has continued to expand. This should almost certainly be looked at as a positive thing, as clients are constantly hounding law firms to find new and more efficient ways to deliver legal services, which would be impossible without investment in new and better technology. Moreover, the marketing and business development functions at the firm can help highlight these investments in the light most favorable to the firm as a means of winning new business.
As previously mentioned, demand performance in 2016 was lackluster at best. Not much new business came into the large- and midsize law firm space, so those firms that were able to grow their demand likely did it by acquiring market share from competitors. When developing business depends on solid differentiation from competitors offering similar services, a strong marketing effort is therefore essential.
Equally worthy of note are areas where law firms scaled back their expenses. After years of increasing office expenses due to rising rents in expensive high-rises and office build-outs to suit more “open concept” office layouts, office expenses finally saw some decline in growth rates in Q4. Libraries and outside services also saw expense growth scale back at the end of last year, likely a sign of shifting budget priorities as law firms look to move more dollars into tech and marketing.
While slower expense growth was enough to hold the PMI steady for Q4, that factor alone will not be enough to keep it there for long. If law firms’ efforts to increase demand and productivity don’t pay off, it seems quite likely that 2017 may see the Peer Monitor Index decline.