Australian law firms set for a competitive 2015

Australian law firms are positioning for strong growth backed by rising profitability and improved cash flows, creating a highly competitive legal market in 2015 despite a challenging business cycle, a study by leading national accounting firm Crowe Horwath and the Australasian Legal Practice Management Association (ALPMA) has found.

The ALPMA/Crowe Horwath Financial Performance Benchmarking Study of Australian Law Firms shows that while average revenue per partner fell for most firms in 2014, the successful pursuit of leaner operations significantly increased gross profitability.

According to the study, the average profitability of law firms increased to 15.1% in 2014 compared to 10.1% in 2013, while gross profitability is up to 58.2%, compared to 55.5% in 2013.

The study’s Financial Resilience Index, which measures how efficient the generation of revenue is from the capital employed by the firm, also increased to 2.69, compared to 2.23 last year, showing an increase in financial resilience of more than 20%.

Crowe Horwath Partner – Professional Practice Advisory, Andrew Chen, who lead the research, said that whilst firms acknowledged the business cycle remained challenging, this year’s study had revealed a more optimistic and competitive focus for the industry.

“Australian law firms have endured a tough playing field since the Global Financial Crisis, but this year’s study suggests the industry may be reaching a turning point, with growth firmly on the agenda.

“Firms that participated in this year’s study intend to increase revenue in 2015 by an average of 10.3%, with larger firms aspiring to grow over 20%.

“Unlike previous years, when firms looked inwards and concentrated on cost cutting right across the board, firms are becoming more targeted in their cost reduction strategies,” Mr Chen added.

ALPMA president Andrew Barnes said the study revealed that Australian law firms are also opening their purse strings to invest in areas of business they believe will facilitate growth.

“Firms are starting to shift their focus from cost savings to revenue growth – there’s really only so far you can cut costs before you start hitting bone.

“Firms are planning a greater investment in marketing and business development activities and focusing on lateral recruitment. This is likely to drive a very competitive market in 2015.”

Mr Barnes added that those firms who succeed will be those who can execute their strategies, maintain a lean cost base and, importantly, retain key staff.

“Firms that have not been building their business development and marketing capability and managing staff engagement over the last 18 months or so will be behind the eight-ball from the outset.”

For the first time this year, the survey also sought to measure the basis of client billing amongst respondent firms, with the majority of firms’ revenue (70%) still based on the billable hour as their predominant billing measure.

“What is noteworthy is that 30% of respondents advised that they use a method other than billable hours, such as fixed or value pricing. I expect this number will increase over time as clients continue to demand value from their legal spend and firms reinvent the way they practice or mimic the way their competitors do,” Andrew Barnes said.

Mr Chen said there was still some way to go before firms attained greater certainty regarding their financial position.

“It’s encouraging to see the overall financial resilience of the law firms continuing to rise, with firms now moving onto addressing the revenue growth challenge.

“Those that maintain a prudent approach to managing costs but also invest in developing their businesses will be best-placed to navigate this competitive market place and achieve greater clarity around their financial position.”

Key findings from the Crowe Horwath/ALPMA Financial Performance Benchmarking Study include:

  • Firms’ gross profitability increased to 58.2%, compared to 55.5% last year.
  • Firms’ average profitability increased to 15.1%, representing a significant improvement from 10.1% recorded in 2013, 9.4% in 2012 and 8.6% in 2011. Firms with more than $20m in revenue were most profitable, averaging close to 19%. Average profit per partner increased by 2.1%
  • Average revenue per partner fell 5.69% among all firms to an average of $1,203,100, except for those in the $5m-$10m range, where it increased to an average $1,294,654
  • Average overhead costs (excluding rent) reduced to 36.1% as a percpentage of revenue, compared to 40.1% in 2013
  • Overall, firms are more financially resilient, with the Financial Resilience Index rising 20.63% to 2.69. The index measures how efficient the generation of revenue is from the capital employed by firms
  • Each firm expressed a desire to increase revenue by an average of 10.3% this year, with larger firms aspiring to revenue growth of just over 20%
  • Average lock-up days (time taken to complete matters, invoice and collect fees from the client) reduced from 147 days last to 141 days. This indicates an improvement in internal processes for collecting cash and is a positive for firms’ cash flow.
  • ALPMA/Crowe Horwath Financial Performance Benchmarking Study of Australian Law Firms uses Crowe Horwath’s proprietary benchmarking tool, Open Measures, to compare participating Australian law firms and provide deep insight to guide strategic decision-making at participating firms. This is the fifth consecutive year the study has been undertaken to assess the financial health of legal practices and help firms benchmark their performance to their peers. A total of 99 firms participated in this year’s study.