Should law firms be more concerned about the deteriorating economy? Rachel Rothwell examines the issues


Last week, leading management consultants warned that law firms are being too complacent about this year's bleak economic forecast. Too many solicitors are assuming the economy will pick up by Easter, they said, and are confident that they have enough deals on their books until then.



It could be that firms' assumptions will prove correct - after all, the purveyors of doom predicting a drop in mergers and acquisitions (M&A) seem to surface every January. But there are also signs that 2008 really could be a difficult year for the economy. Bank of England governor Mervyn King certainly seemed to think so in a speech made at the end of January. He said economic activity was set to slow down, 'possibly quite sharply', and warned that the year ahead poses 'economic challenges for all of us, more so than at any time since the bank was given its independence in 1997'.



So why are law firms so sanguine about the year ahead? One reason is the period of grace they enjoy before whatever is going on in the main economy starts to affect their profits. With plenty of deals and billable hours on the go at the moment, firms will not generally feel the pinch of a slowdown until six to nine months after it occurs in the business world.



Law firms are also often said to be counter-cyclical. Less work for M&A partners may mean more for the corporate recovery team, as businesses start to go under. Economic strife also spells more commercial litigation, though less so here than across the Atlantic.



But it may prove foolhardy to rely too strongly on these counter-cyclical elements, if there really is a serious economic downturn. Corporate firms could find themselves hit not just by a lack of deals, but also by price squeezes in other areas of advice, as corporate clients come under pressure to reduce their legal spend. When times are tough, in-house legal teams are more inclined to keep work close to their chest and prove the value of the in-house legal practice.



If lessons are to be learned from previous downturns, it is that smaller and medium-sized firms have the most to be concerned about. When recession struck in the 1990s, they were the biggest losers. As M&A activity drops, magic circle and other large firms will make the most of their premium brands to aggressively sell themselves to clients. With fewer mega deals, the big beasts will go for smaller prey and begin taking food from the mouths of mid-tier firms, by acting on lower-value deals. Particularly vulnerable are smaller firms paying top price for premises and staff in London and other cities. As their business model depends on keeping their lawyers fully occupied, any slowdown will affect them disproportionately.



If business begins to wane, smart firms will be on the lookout for early telltale clues. One important measure will be the utilisation rates of junior staff. As deals dry up, partners tend to hoard work for themselves to ensure their billable hours do not dip - while lower level fee-earners are left twiddling their thumbs. A drop in the number of new files being opened is another good indicator of a slowdown. It also makes sense to talk to clients and find out whether the specific deals they were planning are still likely to go ahead.

If the signs look ominous, firms will need to take action to minimise their exposure. Bolstering any counter-cyclical departments is one obvious solution - corporate lawyers may want to shore up on their insolvency knowledge, while the employment team can start offering advice on redundancy programmes. A slowdown could even offer some interesting opportunities for canny firms. As practices begin to shed staff, it could be a good time to recruit select individuals the firm has been coveting - at lower cost than usual.





But management consultants warn against slashing staff numbers in an over-simplistic way. In the past, the typical law firm reaction to a slowdown was to start shedding those who were easiest to get rid of; junior staff and those who were last to join. A better solution may be to take a critical eye across the board and ensure that a proper appraisal system is in place to deal with underperforming partners, as well as more junior lawyers. An economic slowdown can be a powerful incentive to tackle any underlying problems.



If the firm's M&A gravy train does begin to grind to a halt, it may also make sense to take a good hard look at partner drawings. Better to slice with a razor now than to take the axe to them later.