Measures of profitability

Traditionally 30% net profit percentage has been regarded as a good level of profit in a solicitors practice (the remainder breaks down as 40% salary, 30% overheads).1 However, a 2008 Law Society survey of 108 law firms found a lower profitability percentage of around 24%2.

In 2009 an NAO survey of criminal legal aid firms found that on average profit margins ran at 18.4% representing a 1.9% decrease on the previous year, and 3.2% decrease on two years ago. The proportion of firms making 20% or more profit had also fallen from 46% in 2006/07 to 37% in 2008/09. Around one in six firms reported no profit from criminal legal aid3.

To allow comparisons between firms a measure of profit per equity partner is frequently used. ”Competition between law firms has led to Profit Per Equity Partner (PPE) becoming the single most important statistic in evaluating law firms performance leading to the adoption of risky strategies in recruiting and eliminating partners, diversifying into new practice areas largely with the goal of improving the PPE. This also impacted on recruitment as a large number of associates per partner would increase the profits per partner, as the firm pays much less to these associates than it bills the clients. Accordingly, the size of corporate law firms kept increasing to hundreds and even thousands of lawyers4.” Profit of top 100 UK law firms was £4.07 bn in 2009 / 2010, though with fee income down the expectation is this was driven by reducing the number of fee earners5.

PPE is also partly driven by conventions around notional salary calculations.


Drivers of profitability

1. UTILISATION

A key driver of profitability in any business is efficient utilisation of resources. Since the resource of a law firm is its employees time, the challenge is to maximise the number of chargeable hours achieved for each fee earner, and minimise the amount of non chargeable time, such as time spent looking for new clients.

So in this context utilisation refers to the ability of a fee earner to convert time into income through achieving the maximum possible level of utilisation, and bill enough hours to meet their chargeable hours target. This target will be designed to cover costs (salaries and overheads) and deliver a level of profit above these costs. By way of illustration another survey6 found that criminal lawyers were unable to charge for some of the hours they actually work. While a typical working week amounted to 48.1 hours, only 35.6 of these are chargeable/value added. This gives a utilisation ratio of around one hour twenty minutes worked for every one hour billed. For solicitors legal practices an annual target of 1,100 billed hours used to be the industry standard.

A survey of legal aid solicitors legal practices found different levels of utilisation across firms: “Close to 10% of firms typically achieve fewer than 800 hours. This equates to approximately 3.5 chargeable hours achieved per day, which compares with over 5 chargeable hours achieved per day for firms achieving 1200 hours in total and 8.5 hours per day for those achieving 2000 hours in total7.” Another survey found that, “private practitioners on full-time contracts worked a median average of 45 hours a week and typically billed for 1,440 a year (27.6 hours a week, median). Those on part-time contracts worked a median average of 26 hours a week and typically billed for 871 (16.75 hours a week). On average, therefore, part-time workers billed for 64% of their working hours compared to 61% for full-time workers8.” Larger firms appear to have higher target hours and therefore higher rates of utilisation, with one source showing that 55 ‘City’ and ‘Large national’ law firms have average chargeable hours targets of 1,4629.

In terms of chargeable hours achieved, a 2010 survey of 59 of the top 100 firms10 found a wide range of chargeable hours achieved across these firms. These surveys show a general trend of rates of utilisation peaking in 2007 and 2008 and falling back to 2006 levels in 2009 and 2010. For the Top 10 firms utilisation appears to have returned to pre recession levels. For firms outside the Top 100 there was no increase in utilisation during 2007 and 2008, and the general trend is for lower levels of utilisation over time.

Issues around utilisation are also relevant for barristers,  especially as a referral profession, and all legal businesses.

2. GEARING

In this context gearing refers to the number of fee earners per partner. This is a key indicator because when firms are profitable they are more likely to increase fee earners rather than promote fee earners to partnership. Conversely when faced with financial challenges, it is reported to be easier to lay off fee earners than it is to remove partners. Consequently it is a reliable measure of growth.

Gearing enables firms to achieve lower hourly costs and therefore potentially greater profitability11. Complex legal work should be characterised by low gearing and high charge out rates , while simple work should have lower charge out rates and higher gearing, since it is more easily delegated. Utilising SRA turnover data12 and making assumptions around how partners, solicitor, and fee earner counts interact, we can gain insight into actual levels of gearing. Unsurprisingly turnover increases as size increases, as does gearing and categories of work undertaken.

Sole2 to 45 to 1011 to 25More than 25All firms
Average Gearing - Fee Earners per Partner
2.4
2.83.23.43.63.2
Average number of categories undertaken3.44.96.67.47.14.5

The Law Societies annual statistical reports provide a timeline of changes in gearing. However this covers only admitted staff (i.e. solicitors) as data on non solicitor fee earners is not collected, although since 2010 SRA do collect this. This data shows very small increases in admitted staff gearing over time, with the largest proportional changes occurring for Sole Practitioners. This also shows a general trend of higher rates of gearing in larger firms. For example in 2010, there were 1.7 solicitors for every principle in Sole Practitioners grouping, compared to 3.4 solicitors for every principal in firms with 81+ partners13.

Level of turnover at solicitor legal practices

The RIR found no information on the level of profitability of non solicitor law firms, and limited information on profitability of barristers chambers.

For solicitors legal practices the charts below show the breakdown of turnover by category of work and the range of turnover in 201014. This data suggests a total annual turnover of £17,9bn for the 88% of solicitor firms in this data set. 31% (£5.1bn) of turnover generated comes from Finance and Business work compared to 13% (£2.3bn) from Conveyancing and £1bn from Will writing and Probate.

 

There is significant published information on the largest 1% of solicitor firms because of a range of time series data collected and reported on by a variety of private companies, for example PWC , The Lawyer, and Chambers & Partners. For example The Lawyers annual UK 200 reports show how the largest firms have performed over the past three years. Looking at the top 25 by turnover shows that each of the 4 highest ranked firms have almost double the turnover of the 5th firm. Generally there has been a fall in turnover over the three years, though some firms have increased turnover between 2010-2011. Turnover is only 0.02% lower in 2011 than in 2009 for this group of firms. Over this period whilst some firms have reduced the number of lawyers employed and as a group the top 25 firms in 2011 employ only 2.4% (600) less lawyers than they did in 2009.

While this does provide an insight into the changes experienced by the largest 1% of solicitors firms, this leaves significant gaps in knowledge about the changes in turnover experience by the remaining 99% of solicitors firms.

Partly because of the size of these firms, there is far greater information on suppliers who tend to offer legal services to more sophisticated consumers such as large businesses, and less on those that tend to offer legal services to individual consumers.

Using the 2010 SRA turnover data, LSB analysis of the number of categories by size suggests the number of categories undertaken increases as the size of the firm increases, with size measured by number of partners.

The tables below show the number of solicitors legal practices and the proportion of these who undertake work in each category, the largest category of turnover by size of firm, and the proportion of firms who derive more than half their turnover from each category. In terms of turnover by size, the proportional income across each category, by size of legal practice, shows that:

  • Smaller firms are more reliant on conveyancing for fee income, with 14% of sole practitioner firms getting more than 50% of their income from this category. This is similar for Crime.
  • Larger firms generate a greater proportion of their income from Finance & Business, and Accident or Injury, but are more diversified as a group.
Proportion of firms with turnover in each categoryNumberConveyancingWill writing & ProbateFamilyAccident or InjuryHousing, Landlord and Tenant disputesEmploymentCriminalImmigrationWelfare Benefit issuesDebt problemsFinance & BusinessOtherIntellectual Property
Sole3,97346%44%36%18%30%29%20%16%2%15%24%52%4%
2 to 43,86471%63%58%36%45%43%30%16%3%26%34%64%4%
5 to 1084682%78%72%60%58%66%35%8%4%41%62%82%9%
11 to 2529384%80%71%65%57%85%31%9%4%50%85%93%23%
More than 2518085%68%48%45%54%87%24%13%7%39%95%94%55%
Sole2 to 45 to 1011 to 25More than 25Sole2 to 45 to 1011 to 25More than 25
Conveyancing26%28%26%26%15%14%13%6%7%3%
Will writing & Probate9%10%10%9%6%5%3%2%1%1%
Family12%13%12%8%6%8%7%4%3%1%
Accident or Injury7%10%15%18%17%5%8%11%12%11%
Housing, Landlord and Tenant disputes2%1%0%0%0%1%1%0%0%0%
Employment5%2%2%1%1%4%2%1%1%0%
Criminal12%15%16%7%4%10%12%11%5%3%
Immigration9%5%1%2%0%7%4%1%1%0%
Welfare Benefit issues0%0%0%0%0%0%0%0%0%0%
Debt problems1%1%1%2%1%1%1%0%1%0%
Finance & Business8%6%7%14%32%6%4%5%6%21%
Other11%10%11%14%21%8%5%6%8%9%
Intellectual Property1%1%1%0%1%1%1%1%0%1%

Analysis of the combinations of categories of work, including legal aid, shows a huge range of different combinations of categories of work undertaken, with over 1,200 different combinations based on SRA entity turnover data.

LSB analysis shows that the top 20 different combinations of categories of work in which turnover is reported account for 33% of the 9,156 firms. All remaining combinations individually represent less than 1% of all these firms. The largest individual different category combination is firms who only undertake Crime work – accounting for 5.6% of all firms. Of these the majority undertake some legal aid work – representing 5.1% of all firms.

The next largest individual category combination is firms who only undertake Family work, with around half of these firms undertaking some legal aid work.

The first genuine combination of categories of work is for firms that report turnover in 9
categories: Conveyancing, Wills & probate, Family, Accident or Injury, Housing, Employment, Debt, Finance & Business, and Other. This accounts for 2.3% (211) firms.

The historic level of specialism is underlined by the large proportion for firms that only undertake work in one category – a total of 18% for all firms. There is no correlation between number of categories and level of turnover, allowing for firm size.

These combinations of categories of work only account for 15% of total turnover, as shown in the chart below. This shows large numbers of firms offering the same services for relatively small amount of turnover.

The 5th highest combination of categories in terms of turnover is for firms that report turnover in 9 categories: Conveyancing, Wills & probate, Family, Accident or Injury, Housing, Employment, Debt, Finance & Business, and Other.

The top 4 largest combinations of categories of work by turnover are show in the table below. These account for 23.6% of total turnover, but only 0.6% of firms. These are all non legal aid firms, but not all large firms in terms of number of partners.

Largest combinations of categories of work by turnoverSole2 to 45 to 1011 to 25More than 25TotalProportion of all turnover
Conveyancing, Will writing & Probate, Employment, Finance & Business, Other, Intellectual Property-4-27138.7%
Conveyancing, Employment, Finance & Business, Other, Intellectual Property15-36157.2%
Conveyancing, Housing, Employment, Finance & Business, Other, Intellectual Property22315134.2%
Conveyancing, Will writing & Probate, Housing, Employment, Finance & Business, Other, Intellectual Property1317123.5%

Barristers’ earnings

In 2010, it was reported that: “Based on present rates of pay a typical criminal barrister of 4-5 years‘ call appearing in a range of criminal court trials would earn circa £50-60,000 p.a. This is a gross figure from which VAT, Chambers expenses, travel, IT, books, etc, must be deducted. For a young practitioner, this can easily amount to 30% and more. The net effect is that a young barrister after (a minimum of) five years of training will earn as a pre-tax (take-home) income of approximately £35-42,000 per annum…..The median comparable salary of barristers practising in family law was circa £66,000 per annum. A quarter of family practitioners had a comparable salary of £44,000 per annum. These figures include no provision for sick leave, annual leave, or employer‘s pension contributions. The median number of hours worked was 46 per week, with a quarter working more than 56 hours per week.

Further a 2008 survey found that “A quarter of family barristers earn less than £44,085 a year from the bar, and a quarter more than £93,392. At the extremes, 5% of family barristers earn less than £15,000 and 5% more than £179,202.” Drawing on the information from this survey we can summarise hourly rates achieved by Family barristers:

Hourly Rates for family Barristers
All types of work£70
Privately funded family£113
Local authority family£69
Legal aid family£57

The Lawyer annual UK 200 survey shows the top 30 Barristers chambers in terms of turnover. This group represents 9% of all chambers. As a group the data shows them growing in both turnover and revenue per barrister between 2008/9 and 2010/11.