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It is time to re-think the new normal…but please don’t touch the remuneration!

06 Aug 10:00 by The Private Practice Team

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Even if the coronavirus (COVID-19) pandemic appears to be slowing down, at present, it will generally have a major impact on salary developments in the coming years. The corona crisis has shaken the working world and it is already clear that many companies are experiencing dramatic losses. These losses will then also have an impact on personnel budgets, meaning that salaries will not be spared the dire consequences of the pandemic.

Initial macroeconomic studies in Germany assume that salaries will only increase by around 1.5% this year compared to 2019. The forecast for 2021 predicts an increase of 0.3%. By comparison: for the past ten years, the average rate of growth in salaries has been around 2.5% p.a..

Turning to national and international commercial law firms, the picture is very different. We saw an extreme salary rally before the financial crisis and again over recent years which means that salaries have been pushed to unprecedented heights. When an invoice has been presented, and with a simple calculation, anyone can work out how high the personnel costs are for employed lawyers in international law firms.

There is currently much discussion about what should be re-thought and/or lived. However, few contributed to the subject of remuneration which in itself, is not surprising when it is a subject that directly affects your pocket. There are occasional reports that entry-level salaries of graduates have been reduced and we hear about salary and bonus cuts being made but also note that only about 2% of associates in Germany are reported to be impacted by this.

We see some law firms, like Allen & Overy and Clifford Chance taking the lead on significantly redefining remuneration bands for their lawyers. Given the scale of the legal sector's economic challenges, the only surprise is that this has taken so long.

So, employees’ costs in a top law firm are significant and these fixed costs are still expected to impact as demand declines. In addition, it is generally accepted that the compensation of junior lawyers is artificially increasing which is surprising given the growing protest by General Counsel that rookie lawyers’ compensation is too high.

However, the transparency of a closed system for associates and pressure from competitors means that courageous law firms’ leaders, willing to challenge the market, are sought. For example, law firms are cautious when it comes to manipulating compensation bands even in challenging economic times despite many medium-sized companies and US companies already implementing temporary or more short-term salary cuts. Freshfields Bruckhaus Deringer, for example, tried to reset its remuneration compass after the banking crisis.

Dot.com and financial crises have shown that salary rallies have a lagging impact. At the very moment a market is turning, there are high employee costs, something we have seen playing out during the COVID-19 pandemic.  Even last year, when we were expecting economic developments, additional salary increases were implemented.

A job cut - except in certain support areas - is anything but opportune. Substantial redundancies in law firms often cause more problems than they're worth - low morale and a lack of resources available when the service demand returns. To eliminate pain and anguish, job cuts are worth avoiding, essentially also for managing partners.

Flexible working and payment systems are usually already in place in large law firms but if not yet tech-ready, law firms should be prepared for this, even if the legal industry is still one of the least affected by COVID-19.

However, the question to pose is whether these measures are sufficient. Reducing salaries has been shown to have a modest impact. In Q4 it will be seen whether more drastic measures are necessary because if law firms want to maintain their salary structure, jobs will be lost as a consequence.

To conclude, should law firms seize this opportunity (carpe diem) and completely override the lockstep system which has traditionally shown itself to be remarkably resilient to change and adaptation? What do you think? Let us know here.