Law firm profitability has continued to slide this year as demand wanes and expenses rebound as firms emerge from pandemic operating conditions, according to a new Thomson Reuters report.

Law firm profitability declined for a fourth straight quarter in the second quarter of this year, with the Thomson Reuters Law Firm Financial Index ‘flashing warning signs’ for the near term outlook if current trends continue unabated. The four-quarter losing streak is the longest slide in the index’s history and comes after two years of record profitability for firms.

Demand for law firm services fell 0.5% in the second quarter compared to a year ago, with litigation work falling by 2.2% and M&A work dropping by 4.9% (real estate was the outlier, with demand increasing 2.5%). Compared to pre-pandemic levels, however, transactional practice demand is 5.7% higher, while non-transactional practice demand has contracted by 3.3%.

At the same time, expenses surged at double-digit rates as inflation, talent wars and implementing hybrid working arrangements increased operating costs. Overhead expenses rose 13.5% as firm’s ramped up spending on recruitment and business development that had been cut during the pandemic. Recruitment spend was 97.2% higher than the second quarter of 2021, while marketing and business development spend was 74.3% higher. Meantime, technology spend grew at the fastest pace in eight years, with law firms spending 10.5% more on average.

Direct expenses rose 12.4% in the second quarter, even though increases in associate compensation – a key driver of direct expense growth – showed signs of slowing.

Mike Abbott, head of the Thomson Reuters Institute, said: “Last year’s tailwinds have inevitably turned into headwinds. In 2021, we saw a sharp rebound in demand along with dramatically reduced overhead expenses. The story of 2022 is more about the rebound in expenses as firms adjust to the current economic environment and wrestle with issues such as how to manage return-to-office or hybrid work.”

That combination of lower demand and higher expenses saw profit-per-lawyer fall 3.6% in the second quarter compared to a 12-month rolling average from the end of Q1 2021. Profit-per-lawyer has now declined for two quarters in a row.