Inflation is at a 30 Year High. What that Means for Your Law Firm.

Inflation is at a 30 year High.
What that means for Your Law firm.

November 12, 2021

The most recent inflation numbers in the US are showing that as a result of accommodative monetary policy (low interest rates), and extraordinary fiscal policy (government stimulus programs) in response to the pandemic, inflation has climbed over 6% for the first time since 1991.  Inflation affects how every company does business and also affects the family budgets of every family in the nation.

Understanding Inflation

The causes and effects of inflation are complex, but in the simplest terms inflation is the rate of increase of prices over time.  As inflation increases, everything becomes more expensive.  Said another way, it is a decrease in the value of a dollar.  When the federal reserve creates money to keep interest rates down, the total money supply increases.  With the increase in the number of dollars, each dollar is worth less, so it takes more dollars to purchase things.  Inflation can be extremely deleterious to an economy, since it erodes the buying power of every member and business in a society.

Inflation can have a cascading effect that reaches every corner of the economy.  Raw materials and energy become more expensive, raising the cost of doing businesses.  As the cost of business increases, those increases are passed on to consumers in the form of higher prices.  As workers feel the pinch, they demand higher wages from their employers, which further increases overhead and forces more price increases.

Inflation also has a psychological effect on consumers.  Since consumers expect that things will be more expensive tomorrow than they are today, consumers tend to hoard certain items, or accelerate the timing of major purchases to get them at today’s lower price.  This causes an artificial spike in demand, which drives prices even higher and exacerbates inflation further.

How Inflation Will Affect Your Law Firm

As inflation continues, the overhead in your firm will increase.  You will begin to see higher prices for rent, office supplies, phone and internet service, advertising, parking, gasoline and a host of other items that are necessary to run your firm.  As these expenses increase, they will eat into your profit margin and income unless there is a corresponding increase in revenue.  As a business owner, inflation has potential to hit you twice.  If your profit from the business goes down due to a higher cost of overhead, you lose once, and then your diminished income buys less when you take it home.

Inflation’s Effect on the Cost of Personnel

In most law firms, the largest cost item is the cost of labor.  The mistake that some lawyers make when inflation begins to increase their overhead is to try to save money by not giving their employees raises.  This can lead to disastrous results. 

You must keep in mind that your employees are feeling the pinch of inflation on their expenses at home as well.  If you do not give them pay increases that at least equal the increase in the cost of living, they will be more likely to look for another job.  This turnover will be exacerbated by the fact that we are in the midst of a labor shortage nationally, and that shortage is also being felt in the legal profession.  Due to this shortage, to fill their positions, other employers will be aggressive in offering potential employees more money than they are making now .  So, not only are you more likely to lose a valued employee if you don’t keep pace with inflation, you may have a very difficult time finding a replacement.  Even if your employees don’t leave, the erosion of their buying power will result in a reduction of morale in your firm.

Therefore, it is essential that you give your employees increases that, at minimum, match the rate of inflation.  Any performance or seniority increase should be added on top of the inflation increase. So, if inflation is 6% and you want to give the employee a 2% performance increase, you must increase his/her salary by 8%. This can be considered a defensive maneuver, because it is necessary to defend against losing good people, which would leave you short-handed during a labor shortage. Given the fact that you are almost forced to increase the cost of labor, that will further erode your profit as overhead increases across the board.  To meet this challenge, you must increase revenue.

Increasing Revenue During High Inflation

There are two ways to increase revenue to avoid profit erosion during periods of higher inflation.  The first and most important response is to raise your rates by at least the rate of inflation.  So, if you are charging $350 per hour and inflation is at 6%, you need to increase your rate by 6%, which would be $21.  Since inflation will likely continue after you raise your rate, you should increase it by somewhat more than the rate of inflation, and in this case consider an increase of $25 to $30 in anticipation of increases in the cost of overhead for the following year.

Lawyers are frequently reluctant to raise their rates, because they fear that their clients will leave them or not retain them.  While changing rates can cause price sensitivity among some clients, this is less likely during inflationary times, because everyone begins to expect higher prices once the realities of inflation begin to set in.  The impact of such increases is therefore muted.

If you work on contingency, you must factor inflation into your demands and negotiate harder to increase your total recoveries.  This will help both you and your client keep pace with inflation.

The second thing that is critical during times of high inflation is to become more aggressive in your marketing.  Increasing the number of inquiries through effective marketing has two benefits.  First, it will increase the number of potential clients whose matters you consider, which allows you to be more selective and also compensates for some clients who will not retain you due to price sensitivity.  And secondly, the more clients and matters you have, the more revenue you will generate to help you offset the additional cost of overhead.

Summary of Inflation Strategies for Law Firms

To best protect your firm’s profit margin during times of high inflation, three key strategies should be employed:

  1. Make sure you give your employees salary increases that will at the very least equal the rate of inflation each year to avoid turnover.
  2. Increase your rates by slightly more than the rate of inflation each year to compensate for the increase in overhead
  3. Increase your marketing to bring in more inquiries and clients to add to top line revenue..