Sharing the burden

Though headline financials for law firms have looked stable in recent years, there are signs that the underlying financial model in the sector is less healthy than it was. Profit margins in law firms have come under increasing pressure, and, in our experience, a typical law firm has been losing 1–2% on average in gross margin in each of the last two years. This profit margin squeeze is a result of a number of factors, including high inflation in some core overheads and the high costs of IT investment. For many, such costs have been subsidised in part by the return of client account interest income to the law firm business model, a long-lost companion since pre-2008.

Law firms in 2025 now face the challenge of dealing with this underlying reduction in core margin while at the same time contributing further to the Treasury through April’s increase in employers’ national insurance (NI) rates. This article looks at what firms are doing to tackle both issues.

How will firms manage the increase in employers’ NI?

For the many law firms we have spoken to, their approach to the employers’ NI rise is a mixture of measures – often a combination of overseas outsourcing, restrained retention, fee / rate inflation and repressed employee remuneration.

Overseas outsourcing

It has become common for firms to look for alternative resourcing options in recent years due to recruitment difficulties and developments in online communications. Many firms already use offshore support functions; onboarding, anti-money laundering procedures and court bundle production are some of the areas firms seek support for, along with letter and email production and general client communication management. Firms that have already invested in these areas, as well as a wider group of firms who previously considered going down this route, are increasingly looking to use offshore facilities or outsourcing options more generally.

The relative commercial benefits of such arrangements can be debated, but the driver for increased focus in this area is in part to combat the costs of employment in the UK.

Restrained retention

There is evidence across a range of law firms that a strategy is emerging to curb recruitment for trainees and those in support functions. These are generally the groups of employees where the impact of the increase in employers’ NI costs will be felt most significantly. 

While the top 150 firms may not implement this strategy, certainly outside this group there is a notable pull away from investment in the younger generation due to the relative rise in the costs of employing them. This has longer-term implications for the development of talent in the legal sector and ultimately could lead to future inflation in the price of legal services in the UK.

Fee / rate inflation

There is evidence that inflation in law firm prices has lagged behind general inflation in recent years, at least in some parts of the legal market. In practice, this has been possible in many firms because of the return of interest income to the law firm model – effectively subsidising consumers.

Many firms have indicated to us that the employers’ NI rise will simply mean hourly rates – and ultimately the pricing of legal services – will need to increase to absorb these additional costs. Ultimately, therefore, the NI rise becomes an inflationary pressure within the economy. Around half of the law firms we have spoken to on this subject indicated that price rises will be an element of their strategy in managing the increased employers’ NI.

Repressed employee remuneration

The final common response from law firms relates to the impact on future employee pay rises. For the legal sector, these rises commonly occur in the early summer. However, many are reporting that because of the employers’ NI increases, pay rises in their firms will be curbed in 2025 and beyond, to below general inflation, to recoup some of these costs.

While law firms are naturally coy about making statements of this nature, it’s clear from the budgets already being prepared for 2025/26 that this approach will be adopted by a sizeable portion of them.

How are firms planning to improve margins?

The Law Society’s Financial Benchmarking Survey 2025 (which examines law firm data from the 2024 financial year) illustrates the extent to which dependence on interest income has crept back into the law firm model. The report signposts significant growth in median profit per equity partner (PEP) – 21% in one year. However, it also notes that, in 2024, interest income represented 21% of PEP for the median firm; by comparison, in 2022, this would have been broadly 0%. Adjusting the reported 2024 PEP growth figure, if growth in interest was removed, the PEP is only 1%.

So, over this period, even though PEP has increased in law firms, the quality of profits (because of dependence on interest income) has notably declined. During this same period, interest income has allowed firms to become distracted – losing focus on pricing and productive capacity.

Because of this, firms are now turning to time capture, scoping, client communication, pricing, matter management and spare capacity to improve margins.

Time capture

There is evidence across the sector that time-recording / chargeable hours are reducing. The reasons for this are debatable, but some suggestions are that:

• Home working is less effective than it was post-pandemic.
• Regulatory and employee burdens absorb too much time.
• Value-based pricing removes the priority placed on time capture.
• Activity levels are lower and fee earners are simply less occupied than in recent years.

Many firms, however, are starting to realise that time capture is not about pricing but rather understanding costs, and, until firms accurately know what their people are doing, it’s hard to make plans to manage the firm effectively from a profit perspective.

Various strategies are being implemented to address this issue, including:

• time-recording training for (new and existing) employees
• increased controls around time-recording
• establishing time-recording policies
• improvements to time-recording software and practice management systems
• revisiting how chargeable hours targets are ‘negotiated’ with fee earners.

Scoping and client communication

It’s clear from our own work with law firms that a vast amount of profit and margin is given away through inadequate scoping of the work being undertaken. Clarity about what the firm will do and what the client will do is a crucial part of managing both client relationships and profit margins.

This sounds like a simple statement, but it’s a detailed and complicated area for firms to manage well – for example, scoping should cover what the firm is not going to do, and what the costs will be if the scope is widened. Examples of what may be out of scope are important, as is the issue of the expected timeframe for a matter. Being clear on what the client will do, what third parties will do and by what dates are all important ingredients that affect the margins for a law firm.

When we train firms on time-recording and scoping, we recommend that fee earners should expect to spend at least 10% of the total time on a matter scoping the work. Of course, this is not just something you do at the start of a matter – it needs to be ongoing, and client communication on the subject is key. Great scoping at the start with no communication until the end – followed by a bill for out-of-scope work – is at best ineffective and at worst damages a law firm’s reputation.

Pricing

Again, pricing is at the heart of margin management in law firms. However, no matter how innovative the approach to pricing, without basic knowledge of the costs from accurate time capture, the pricing strategy is likely to be a ‘best guess’.

Law firms continue to invest heavily in this area and we regularly see financial benefits from training, but it does need to be coupled with strong controls and fee-earner understanding of the importance of time capture and costing. In many respects, the greatest benefit of pricing training is not only giving fee earners the confidence to discuss fees with their clients, but also in them understanding the importance of doing so from the client’s viewpoint. Pricing training provides fee earners with the skill set to better deal with scoping at the start and throughout a matter.

Matter management

Managing the legal matter – rather than ‘doing the work’ or ‘giving advice’ – is at the heart of ensuring good profit margins in law firms.

This is a big subject, but common examples of these behaviours include:

• assigning the appropriate people – in terms of cost, skills and experience – to the work
• applying controls around quality and client care
• using the firm’s existing intellectual property – for example, recycling skills and documents
• prioritising communication with the client
• ensuring that scoping is a continual event
• prioritising client relationship management.

While one would assume law firms always focus on matter management, the reality is that many have become less effective in this area since home working became widespread.

Spare capacity

In parts of the legal sector, there is evidence that firms are carrying spare capacity in some teams. While the cost and difficulty of recruiting teams is an easy reason to put off difficult decisions concerning people, in our experience those that take decisive action earlier tend to end up with a more profitable and sustainable firm for all stakeholders.

Closing thoughts

So, will the employers’ NI rise help improve the government’s finances? If one simply looks at the legal sector and its response, the logical answer is no. In reality, the cost of the NI rise will ultimately be shared by consumers, employees and law firms – and perhaps its most damaging aspect is the long-term implications it has for reduced investment in future talent. It seems entirely probable that, over time, the financial benefits for the Treasury that were anticipated from the employers’ NI increase will simply not arise.

However, the issue of declining margins in law firms goes deeper than the NI increases. The last few years have seen firms rely on interest income rather than address their pricing and productivity issues, leaving them with considerable work to do to restore financial health and disciplines in 2025 and beyond.