75% of UK 200 “to disappear” within five years, Arden claims

Arden Partners believes that as many as 75 per cent of the current UK 200 firms may disappear over the next five years as the “highly fragmented” market consolidates.

The claim is made in a new report by stockbroker Arden which focuses on investment-related issues and opportunities in the UK legal market. It claims that mid-market firms are under particular pressure, with the sector remaining “highly fragmented”.

Arden, which used data from this year’s The Lawyer UK 200 series, pointed to the fact that there are 106 firms in the top 200 with revenues of less than £22m. This, claimed Arden, was a significant group that would be challenged to achieve scale or develop efficiency.

Arden also estimated that there is in excess of £200m of unrealised profit from the duplication of support services at these sub-scale firms.

“Over the next five years significant consolidation is expected and the top 200 law firms may well be reduced by 75 per cent in number,” claimed one of the report’s authors, Arden business support services head John Llewellyn-Lloyd. “This will be especially noteworthy in the mid-market regional space where a number of firms are already positioning to be prime beneficiaries of the upheaval.”

The focus of research, which also includes an assessment of the impact of Generation Y lawyers and ABS structures, was on the impact of the changing market primarily on the mid market.

It is this segment where Arden envisages change will be most keenly felt as the legal sector adapts to the pressure for efficiency and national scale that is being demanded and that the plethora of local, small-scale firms are unable to meet without significant investment or expansion.

Drawing parallels with the accounting profession, Arden added that this significant consolidation among firms with revenue greater than £20m could result in 70 firms disappearing and more than £3bn of revenue changing control.

Arden also claims that the sector is at a “tipping point” with significant levels of external investment driving consolidation and funding new disruptive entrants. 
It added that with more than £510m now invested into the sector by external investors, and investments by these investors now controlling revenues in excess of £1.11bn, sufficient investment has now been made to acquire a top 10 law firm.

Of particular note is the fact that clients are driving change as they pressure for a more efficient resource allocation that allows “more for less”, said Arden.

“The growth of legal panels and competitive tendering for work has put significant pressure on fees especially for more standardised and volume-driven work further developing the appeal of the legal market to outside investors as revenue streams become reliable and repeatable, a characteristic that appeals particularly to private equity backers,” Arden added.

The drive for new operating structures is further reinforced by lawyers of Generation Y, claimed Arden, who are increasingly seeking reward over a shorter time horizon as the draw of partnership diminishes.

“As such corporate structures enabling share-based remuneration have increasing appeal by sharing profits to high-achieving employees in lieu of a partnership track,” said the stockbroker.

The legal sector remains highly fragmented as external investors have historically had extremely limited opportunities to invest in the sector. As a result, partners have had no incentive to disrupt the status quo that has provided them with long-term annuity streams.

However, the introduction of ABSs and the changing, more transient, nature of Generation Y careers has enabled talented lawyers to have highly rewarding opportunities outside of the traditional partnership model aided by efficient systems that free them to focus on their clients.

New entrants funded by external investment and free of the decision-making by committee often that often afflicts partnerships have invested in bespoke systems and bottom-up efficiency focused processes, said Arden.

“This has given them an advantage over traditional law firms that lack either existing scale or the capital to invest to achieve scale,” it claimed.

As traditional law firms strive for scale, consolidation will naturally occur with many prominent names set to disappear from the high street, added Arden.

“Those that cement positions as consolidators will be those that have evolved decisive governance and operational efficiency to capitalise on the opportunities that external investment have generated,” it said. “A new breed of regional law firm is rising to meet the demands of entrepreneurs and SMEs.

Arden’s full report, titled “Analysis of external and corporate investment in law firms: sustainable momentum established”, is published today.

For more detail on the UK 200 series, contact Richard Edwards on 020 7970 4672.