PEER MONITOR INDEX

PMI Drops in Third Quarter

Expenses Climb While Law Firm Market Demand Softens
TheHILDEBRANDTINSTITUTESPEERMONITORINDEX(PMI) 1fell 6 points to 56 in the third quarter breaking a string of three consecutive upward quarters. While rates strengthened slightly, demand growth weakened. Most significantly, the rise in expensescontinuestoaccelerate.Inthethirdquarter,increases in expenses ran well ahead of slowing revenue growth, sharply curtailingprofitability. Growth in demand 2 for legal services was positive, but slowed to 0.8 percent, its weakest reading so far this year. Rates firmed slightly,up3.5percentcomparedwiththesameperiodayearago. But the worrisome trend in expenses that PMI has been tracking continuestoworsen.Bothheadcountandoverheadexpensesrose totheirhighestlevelsoftheyear. Inshort,themarketcontinuestogrowalbeitatalethargicpace. But expenses will need to be brought under control if demand doesnotpickup.Achievingtoplinegrowthandbalancedexpense controlswillbethekeythemesforfirmsforthebalanceof2011 andinto2012.

Q3 2011 EXECUTIVE REPORT - ISSUED 10.28.11

PEER MONITOR ECONOMIC INDEX (PMI)

80 75 70 65 60 55 50 45 40 35 30
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3

Q3 PMI Score: 56
Credit Crisis

2006

2007

2008

2009

2010

2011

ThePMIrepresentstherelativerateofchangeamongthemajorfactorsinfluencinglawfirm performance.Thesefactorsaretrackedindividuallyinthegraphbelow.

Demand by Practice Areas

Litigation demand was up 1.5 percent, a slight slowing from previousquarters.IPlitigationcontinuestobeastrongperformer, up 5 percent. IP litigation work has been consistently strong throughout2011.Strengthinlitigationpracticeshasbeenamajor driveroftheimprovementseeninthemarketoverthepastyear, asitrepresentsaboutonethirdoftotalindustrydemand. Growth in transactional practices slowed, however, probably reflectingcautionandvolatilityinthefinancialmarketsduringthe quarter.GeneralcorporateworkandM&Aweredown2percent, whilecapitalmarketswasdown4percent. Laborandemploymentworkwasup1.5percent.Realestatework wasflat.Taxworkwasdown5percent,itsfirstdeclineinovera year. Bankruptcy was down a steep 6 percent, continuing to declinefromthepeakseentwoyearsago.

PMI KEY FACTORS

Q311Q310Q309
Demand Productivity Rates DirectExpenses OverheadExpenses

0.8% 1.4% 3.5% 5.1% 3.2%

0.9% 5.8% 0.4% 4.8% 2.1% 4.1%

7.5% 4.4% 1.4% 2.5%

128404812162024

CurrentReading(Q32011) 3YearRange

ChangefromQ32011

UpFlatDown

Performance by Market Segments

Firm performance varied somewhat across market segments. Demandgrowthwasup0.6percentforAmLaw100firms.Atthe same time, headcount growth was restrained in those firms, boostingproductivity,whichremainspositiveyeartodate. The strongest demand growth was among Am Law Second Hundred firms, up 1.9 percent. However, a sizeable rise in headcount resulted in lower productivity for the quarter. So far thisyear,productivityisflatforthismarketsegment.
1 ThePMIisacompositeindexscore,representingthequarteroverquarterchangein drivers of law firm profitability, including rates, demand, productivity and expenses. Positivefactorsdrivingfirmprofitabilitywillproduceahigherscore.Ascoreexceeding 65generallyindicatesahealthyoperatingenvironment. 2 Demandisdefinedasthegrowthinbillablehours.

DEMAND GROWTH BY PRACTICE: ALL SEGMENTS

10

Period over Period Growth

5

Growth Rate (%)

-5
Proportion of Overall Market

-10

5%
IP-Lit

9% 9%
L&E L&E

6%
Real Estate

33%
Litigation

12%
General Corp

3%
M&A

6%
Capital Markets

3%
Tax

3%
Bankruptcy

Q311vQ310

Demandatmidsizefirmsdropped1.1percent.Whileyeartodate demand remains positive for Am Law 100 and Second Hundred firms, it is now flat for midsize firms. Combined with higher headcount,productivitydroppedinthethirdquarterforthelatter segment, which helped pull yeartodate productivity further into negativeterritory. As it has been for much of 2011, Los Angeles was again the strongestmajorU.S.marketinthethirdquarter,upmorethan5 percent. Chicago was up 2 percent. New York was down 2 percent, due largely to weakness in transactional practices. Washington, D.C. was also down 2 percent. Demand in London wasup2percent.

Productivity

Productivity,measuredinhoursperlawyer,wasdown1.4percent thefirstsignificantdropintwoyears.Whiledemandgrowthwas positive for the quarter, it was far outpaced by the increases in headcount,thusloweringproductivity. Lawyer FTEs declined throughout most of 20092010 as firms aggressively shed capacity to cope with the economic downturn. Headcount was then largely flat through the first half of 2011, and accelerated markedly around midyear. The productivity growth rate has been slowing for five consecutive quarters, and has now turned negative,asfirmshavebeenaddingcapacityinexcessofavailablework. Ifthesehiringpatternscontinue,andifdemanddoesnotincrease tokeeppace,firmswilllikelyfacefurtherdeclinesinproductivity,as wellasincreasingpressuresonprofitability.

Rates
Rate growth showed improvement, up 3.5 percent from a year ago.Fortheoverallmarket,thisisthestrongestrateperformance inoverayear. However, the improvement in worked or negotiated rates was somewhatoffsetbyadeclineinrealizedrates.Afterabriefuptick earlier this year, realized rates have resumed the longterm downward trend that has been in place since 2008, and reached anotheralltimelowinthethirdquarter. Asimilarstoryisunfoldingincollections.Followingaslightriseearlier thisyear,netcollectedrealizationsfelltoanewalltimelowof85.4 percent. However,indiscussingrates,thePMIaveragesdonottellthewhole story. Rate performance continues tovarywidely. Many firms are achievingbetterthanaveragerategrowththisyear,whileotherfirms arenotfaringaswellinthefaceofclientpressures,andareseeingflat orevenslightlynegativerategrowth. IntheSpecialSectionofthisreport,wediscussthedivergencesweare seeing in the market, not only for rates, but in other areas of firm performanceaswell.

2011-2012 Outlook
For the past year, PMI has been anticipating the return of growth in expenses. Following widespread cost reductions in 2009 and 2010 (reflecting primarily significant reductions in headcount), expense growthturnedpositiveearlythisyear.As2011haswornon,costshave steadilyacceleratedtothepointwheretheyarenoweasilyoutpacing bothdemandandrategrowth,thusimpactingprofitability. Until recently, firms had generally been doing a good job of balancing their headcount against slowly growing demand. But firms have stepped up their hiring in recent months in a modest returntotraditionalseasonalhiringpatterns. Whilefirmshavebeenhiring,however,demandhasslowedastheyear hasprogressed,wideningthegapbetweenlawfirmcapacityandavailable work.Whetherthistrendcontinueswilldependontheperformanceof thebroadereconomyandwhetherweseecontinuedrecoveryinlitigation andtransactionalwork. Perhapsthebiggerquestionisthechallengepresentedfor2012. With expenses growing, and the economy facing continuing headwinds, achievingmeaningfultoplinegrowthwillbecrucialforsuccessoverthe coming year. Growth may be elusive, but firms with a strong strategic focuswillbebetterpositionedtocapturemarketshare. FormoreinformationonthePMI,andhowPeerMonitorcanhelpyour firmsuccessfullymanagethroughtodayseconomy,pleasecontactMark Mediceat4122032155(mark.medice@thomsonreuters.com) orvisitpeermonitor.thomsonreuters.com.

Expenses

Costsbothdirectandoverheadrosesignificantlyinthethird quarter.Directexpensesjumped5.1%,whileoverheadexpenses wereup3.2%.Bothincreaseswerethehighestseeninmorethan twoyears.Expensegrowthdramaticallycutintofirmprofitability in the third quarter, accounting for the major portion of the declineinthePMI. Theexpensepicturehasshiftedmarkedlythisyear.Atthistimelast year,directexpenseswerefallingatarateof7.7percent.Expenses havesharplyreversedcourseandarenowrising,movingupnearly 13percentagepointsinonly12months. Attorney hiring rose in the third quarter headcount was up 2.4 percent,ahighfortheyear.Theattorneyreplenishmentratiohas risento1.3fortheoverallattorneypopulationitshighestlevelin more than three years, as new hires are now easily exceeding retirements,layoffsandotherdepartures. During the economic downturn, firms instituted widespread layoffs and sharply curtailed new hiring. Some positions were eliminated throughattritionandretrenchment,andstartingdatesfornewhires were frequently deferred. Because of the backlog of deferrals and hiring in anticipation of growing demand, the rate of new attorney hiringhasnowbeenclimbingforfourconsecutivequarters. A similar picture is unfolding in overhead expenses. A year ago, overhead expenses were falling at a rate of nearly one percent. Since then, the indirect expense growth rate has turned positive, movingupfourpercentagepointsinthelast12months,reflecting the inability to continue putting off certain investments in technologyandotherstrategicareas.
3 Includesbothdirectexpenses(salaries,fringebenefitsandprofessionalfeesassociatedwith billabletimekeepers)andoverheadexpenses(allothernondirectexpenses,includingstaff compensation,marketing,technology,occupancy,officeexpensesandresearch). 4 Attorney replenishment is the ratio of new attorneys to the firm divided by those departing.Aresultgreaterthan1indicatesgrowingcapacity,whilearesultlessthan1 signalsacontraction. 5 Productivity is defined as hours per attorney and represents the ratio of capacity to marketdemand.

SpecialFocus:Is2011TheBestYear?
Howhasbusinessbeensothisyear? Onewouldthinkthatwasarelativelysimplequestion.Butthisyear,asking a managing partner that question yields answers anywhere from Great itsthebestweveseeninthelastseveralyears,andwerepositionedwellfor thefuture,allthewaytoweresomehownotgeneratingmuchtractionin themarketplace. PMI is showing a growing divergence among firms in performance. While somefirmsareshowingconsistent3to8percentdemandgrowthratesyear todate (or even higher), other firms are contracting and showing near doubledigitdeclinesindemand. What appears to separate many firms in these performance groupings is a willingness to adopt a strategic outlook that drives value for clients (reduced costofservice)whilealsodrivingvalueforthefirm(profitability).Itincludes, among several factors, a willingness to invest significant partner hours in projects that reexamine firm structures, client relationship management, compensationmodels,billingpractices,businessdevelopmentandmore. Clear patterns are emerging as to which firms are adopting a future oriented business cycle approach. In an environment of slow economic growth,increasingcompetitionformarketshare,andrisingclientpressures forlowercostsandgreaterdemonstratedvalueforservicesprovided,new modelsforsuccessarerapidlytakingshape. For further discussion on how advanced market analytics can help drive successfulfirmstrategies,contactyourPeerMonitorconsultant.

PEER MONITOR INDEX

2011 Thomson Reuters