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Law firms entered the second half of 2026 with strong demand, higher billing rates and improving profits. But the figures behind that growth point to a harder question for firm leaders: Can revenue continue to outpace a rapidly rising cost base?
The Thomson Reuters Institute’s Law Firm Financial Index improved sharply in the second quarter. Demand remained strong enough that, if the pace continues through December, 2026 could become the strongest year for legal demand since 2021. Worked rates also continued to rise.
The financial picture remains healthy. Yet expenses are increasing at a pace that could put margins under pressure if demand or pricing growth weakens.
Direct expenses, including compensation and staffing costs, rose 8.3% in the second quarter. Overhead increased 7.7%. Both recorded their highest growth rates since 2024. Technology and knowledge management spending rose 11.6% overall and 8.7% per lawyer.
This means profitability increasingly depends on several parts of the business working together. Demand must remain healthy. Clients must continue to accept higher rates. Firms must also make sure that spending on people and technology produces enough additional revenue to justify the cost.
Higher rates are doing more of the financial work
Pricing has become one of the main sources of law firm revenue growth.
Worked rates increased 7.1% in the second quarter of 2026, according to Thomson Reuters. That level of growth would have been unusual before the recent run of large annual increases. It is now an important part of the financial model at many firms.
This follows several years in which law firms have increased rates well above inflation. The Thomson Reuters 2026 Law Firm Rates Report found that worked rates rose 7.4% in 2025, compared with inflation of 2.8%.
That gap has helped firms absorb rising salaries, technology costs and other operating expenses.
There are limits to this approach. Clients may accept large increases when demand is high and legal budgets are growing. Continued increases can become harder to defend when corporate legal departments face pressure to control spending.
Pricing discipline is therefore becoming more important. Firms with strong client relationships, specialist practices and a clear record of delivering value may have more room to increase rates. Others could face greater pressure to offer alternative fee arrangements or limit annual increases.
The main issue is how dependent firms have become on continued pricing growth. If rate increases slow, firms will need stronger productivity or tighter cost control to maintain the same level of profit growth.
Law firms are changing who delivers the work
Staffing patterns are also supporting profitability.
Associate demand rose 4.3% during the second quarter, while demand for non-equity partners increased 6%. Equity partner demand fell 1.2%.
The shift matters because associates and non-equity partners can generate strong margins for firms. More work can be completed below the equity partner level, allowing equity partners to focus on client relationships, business development and higher-value matters.
The ratio of hours worked by non-equity partners compared with equity partners has reached its highest level since late 2018. Thomson Reuters has also reported that broader law firm leverage reached a 17-year high in 2026.
Greater leverage can support profitability because firms earn revenue from a larger group of lawyers below the equity tier. But the model also raises costs.
Associates and non-equity partners require competitive pay, training, technology and administrative support. Firms therefore need enough work to keep those lawyers productive.
If demand weakens while headcount and salaries remain high, the same structure that supports margins in a strong market can become a financial burden.
Staffing decisions made during periods of high demand can therefore affect profitability for years. Firms need to balance the benefits of adding capacity with the risk of carrying too much cost if market conditions change.
Rising costs could widen the gap between firms
The second-quarter figures also show that financial performance is becoming less uniform across the legal market.
Productivity improved at Am Law 100 and Second Hundred firms during the quarter, while it continued to decline among midsize firms. Thomson Reuters said the productivity gap between these groups had reached its widest level since late 2022.
Scale may be becoming more important.
Larger firms can spread technology, knowledge management and other overhead costs across a wider revenue base. They may also have greater pricing power in specialist areas where clients have fewer alternatives.
Midsize firms often compete in a more price-sensitive part of the market. That can make it harder to pass higher salaries and technology costs on to clients at the same rate as larger competitors.
Technology spending adds another issue. Firms are increasing investment in AI, research systems, workflow tools and the people needed to manage them. These investments may improve efficiency, but they also create recurring software, integration and support costs.
Measuring the financial return from technology spending is therefore becoming a management issue, not simply an IT decision.
Strong market conditions currently give firms room to carry those costs. Demand is healthy, rates are rising and profitability remains strong across much of the industry.
The greater test will come if one of those conditions changes.
If rate growth slows while labor and technology expenses continue to rise, firms will need stronger productivity gains to protect margins. If demand also weakens, the difference between firms with disciplined cost structures and those that rely heavily on revenue growth could become much clearer.
For law firm leaders, the strongest second-quarter numbers may be less important than the changes taking place beneath them. Pricing, staffing and technology investment are all supporting growth, but each also adds pressure to the cost base.
The firms in the strongest position will be those that can convert higher revenue into lasting gains in productivity and profit while keeping expenses under control.
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