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Are Profit Margin And Recessions Still In Sync?

March 28, 2023

By Madhav Srinivasan, Hunton Andrews Kurth LLP

The profit margin of the Am Law 100 law firms has moved contemporaneously with US economic recessions for four such recessions from 1987 to 2022. In each recession, profit margin first declines, and subsequently recovers. In the 2020 recession, a typical multi-year sequence was compressed within one year. Profit margin did increase from 2020 to 2021. It is expected to fall from 2021 to 2022, but without an official US recession. How does this impact their three-decade long relationship? Two key events in 2023, whose occurrence will be known as the year progresses, can provide deeper insight.


Shape of the Profit Margin Curve

The profit margin of the Am Law 100 law firms, defined as the annual The American Lawyer survey’s net operating income divided by revenue on a percentage basis, has been in the 35% to 45% range from 1986 to 2021, despite a 18-fold increase in the combined revenue from $7 billion to $127 billion. While relatively stable at a macro level, when the profit margin curve is graphed, there appear to be three distinct shapes: a “U” shape from calendar 1986 to 1999; a “V” shape from 1999 to 2006; and a “Check” shape from 2006 to calendar 2021 (see figure 1). The curve has distinct peaks and troughs, which turn out be contemporaneous with US economic recessions and declines in the S&P500 stock market index. There have been four such recessions from 1987 to 2022: in 1990-1991, in 2001, in 2007-2009 and the COVID-19 recession within 2020. In each recession, profit margin first declines, and subsequently recovers. In the “U” and “V” shapes, profit margin dropped during the recession and later recovered – but not to pre-recession levels. In the “Check” shape, profit margin similarly drops, but recovery has been longer, driving profit margin to record levels.


Source: The American Lawyer annual survey 1986-2021

Profit Margin derives From RPL and CPL

To better understand the underlying mechanics of profit margin, we can look to two frequently used and operational metrics: Revenue per Lawyer (RPL) and Cost per Lawyer (CPL). Mathematically, Profit Margin = 1 – (CPL/ RPL). Profit margin is thus positively correlated to RPL and negatively to CPL. When revenues increase at a higher rate than costs, profit margin increases. Conversely profit margin falls when costs increase at a higher rate than revenues. From one year to the next, profit margin rises when the annual change % in RPL exceeds the annual change % in CPL. It falls when the reverse happens, with annual change % in CPL exceeding the annual change % in RPL.

Placing this in the context of recessions, at their onset, economically depressive forces lead to reduced legal demand, which brings down RPL. CPL stays rather constant as the cost structure remains flat, thus profit margin drops. As the recession persists, costs are controlled, pushing down CPL, which offsets further drops in profit margin. As recession fades, accreting demand leads to higher RPL. Upward costs pressures typically follow, causing CPL to rise, though at a slower rate. With RPL rising faster than CPL, profit margin increases.

A Curious 2020

From 2019 to 2020, Am Law 100 RPL increased 4.8% while CPL increased 0.4%, thus profit margin increased by 2.5% from 40.2% to 42.7%. The National Bureau of Economic Research did indicate a quick US recession from February 2020 to April 2020. How did profit margin increase in the same yeas as a US recession? To answer, we need to look within calendar 2020. COVID-19 suddenly impacted the world in March 2020. The first quarter of 2020 was rather flat for law firms. In the subsequent second and third quarters demand slowed but operating costs also sharply decreased owing to zero travel & client events and low office operating expenses. In the fourth quarter demand rose sharply due to intense capital market activity. Costs also increased but at a slower pace. On a monthly basis, profit margin fell from January 2020 to April 2020, then reversed course and increased sequentially each month, leading up to that 2.5% annual rise for the full year. The contemporaneous movement of profit margin with US recessions did hold - except that a typical multi-year sequence was compressed within one year. Indeed 2020 was a curious year, with a check-shaped profit margin curve embedded within its twelve months.

Record Margin in 2021

2021 saw strong transactional and capital markets demand, low operating costs due to COVID restrictions but substantial increases in lawyer compensation driven by the war for talent. From 2020 to 2021, Am Law 100 RPL increased 12.5% and CPL also moved by a high 9.1%. With the increase in RPL exceeding that of CPL, profit margin moved up 1.8% from 42.7% in 2020 to a historical record level of 44.5% in 2021.

A Decline in 2022?

2022 saw difficult macroeconomic conditions, including a large 4% increase in the Federal Funds rate, a 18% drop in the S&P500 index, a decrease in legal industry demand coupled with continued increases in law firms’ cost base. The full 2022 Am Law 100 results are not yet available, but we can try to estimate profit margin by using other legal industry sources. The average of three different data sources indicate RPL decreased by 1.5% and CPL increased by 4.0% from 2021 to 2022.

Using the below formula, with known 2021 values for RPL and CPL and the average % changes in RPL and CPL from 2021 to 2022, the estimated 2022 Am Law 100 profit margin is 41.3%, a 3.2% decrease from the 2021 profit margin of 44.5%. Early reports from Am Law 100 firms in March 2023 are also indicating a general decrease in profit margin. The final figure will be of course be available with the publication of full Am Law 100 results in May 2023.

        PM2022 = 1 – (CPL2021) * ( 1 + Annual Change %CPL 2021 to 2022)
                              (RPL2021) * ( 1 + Annual Change %RPL2021 to 2022)

On the economic front, US GDP growth rate was negative 1.6% in the first quarter of 2022, followed by a negative 0.6% in the second quarter of 2022. While the traditional recession definition would be two such consecutive quarters of negative GDP growth, the National Bureau of Economic Research did not declare an official US recession in 2022.


Profit margin declined from 2021 to 2022, but there was no official US recession. Does this impact their three-decade long relationship? This depends on the occurrence of two events in 2023.

First is the possibility of a 2023 US recession, which a large number of economists and investors are now anticipating based on recent stress in the US regional and European financial systems, moderating-but-still-high inflation and the continued inverted yield curve. This is turning out to be perhaps “the most widely anticipated of all recessions.”

Second is whether there would be a further decline in law firm profit margin from 2022 to 2023. Initial data for January 2023 and February 2023 are indicative of a small drop, but the final year-end figure will be driven by the intricate interplay of legal industry demand and costs, impact of rate increases, eventual lawyer productivity and headcount.

If only the first or both occur, the relationship does hold, although with a timing difference. If only the second or neither occurs, the empirical simultaneity would need to be revisited. The picture will get clearer later in 2023 with additional economic and legal industry data.


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