Background
The UK Office for National Statistics (ONS) produces a quarterly Services Producer Price Index (SPPI).
This contains useful data on pricing of legal services and broader inflation impacting businesses.
This briefing is based upon the October 2024 release and is of relevance to law firm partners and management involved in the pricing of legal services to understand the general pricing trends for UK B2B law firms.
Key Messages from April's Briefing
In July, we saw clear signs of cooling in the Aggregate Services index, with this trending towards 3%.
This suggested that law firms would see some easing of inflationary pressures within their own cost base in the coming months.
In contrast, we saw Legal Services inflation marching on to around 8%, perhaps indicating that partners could be more bullish in their pricing conversations with clients in the second half of the year.
What's Changed in October?
As with previous quarters, Legal Services inflation is lumpy, this time heading down from the 8% noted in July to 5.5% in October.
This contrasts with the smoother path for Aggregate Services which came in at 3.3% in the quarter to October 2024, compared to the quarter to October 2023.
Whilst this paints a similar picture to that in July - of Legal Services inflation notable exceeding the input inflation law firms are experiencing (as indicated by the Aggregate Services index), that lumpiness (or volatility) does make forecasting future index readings difficult.
Chart 1: Legal Services Inflation is higher and more volatile than Aggregate Services
Pricing Outlook
Despite the noise around clients pushing back on law firm rate increases (and I'll confess my surprise here), based on the ONS data, firms are achieving rate increases comfortably in excess of the more general B2B inflation indicated by the Aggregate Services index.
That said, in the January ONS data release, we'll see the indexes for the full calendar year published. I'm expecting Legal Services inflation to have at least plateaued, if not cooled, from the 7.4% registered in for the full year in 2023.
Whilst the volatility in recent readings unhelpfully indicates a range of scenarios that could play out through Q4 to the end of the calendar year for Legal Services inflation, it is likely that the rate of inflation in Legal Services will that exceed that of Aggregate Services, perhaps the former in an, admittedly wide, range of 4.5% - 6% for the quarter, with the latter at around 3%.
Next Steps
With firms starting to enter budget cycles for the typical April financial year, the volatility in the index is unhelpful. Firm's would be well-advised to model through a range of scenarios before Christmas, to then firm up rate increase assumptions following January data release.
Clearly firms working to the calendar year will have to work on a more expedited cycle, without the benefit of the January release.
Staff costs typically comprise ~50% of a UK law firm's fee income and so firms are going to feel yesterday's announcement of a 1.2 percentage point increase in employers' national insurance contributions effective from 1 April 2025.
All else being equal, firms are going to lose around half a percentage point on operating margin as a consequence of this.
Whereas, typically, larger firms may be able to carry on with a policy of pushing through rate increases to cover this, smaller firms have not bitten that bullet to the same extent over the past few years and increasingly being left behind in the market (and leaving money on the table!)
Set against that context, for the coming financial year it is important to separate out (a) the budget from (b) the staff pay awards, and (c) pricing strategy.
It is increasingly important, and increasingly difficult, for firms to look at their pricing strategy if they have not already done so.
Methodology
Legal Services Price inflation data is taken from Table 3(g) of the latest Services Producer Price Index (SPPI) for Legal Services. The Aggregate Services data is taken from Table 1.
The underlying methodology is described in the ONS User Guidance and Methodology.
In summary, it’s comprised of ~500 prices drawn from a stratified random sample from the Inter-Departmental Business Register. This represents law firm submissions of realised rates on actual hours worked, weighted for the seniority of fee earner delivering the service.
The majority (>60%) of legal services in the dataset are classified as Business and Commercial.
This dataset is relevant to B2B legal services providers, but less so for (a) B2C providers and (b) providers to small businesses below VAT and PAYE registration thresholds, as these groups are not represented in the dataset.
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