Introduction: Chopping and changing

First, a surprise. Although the total revenue generated by the UK’s 200 largest law firms fell by £676m last year, a 4 per cent drop to £14.94bn, these firms still generated more fees last year than they did at the height of the boom in 2007-08.

That year the top 200 posted a total turnover of £14.84bn. The year before, the first year that The Lawyer began tracking the top 200, the total was just £13.53bn, nearly 10 per cent lower than it was at the end of 2009-10. Indeed, the five-year increase since 2005-06 was 10.4 per cent.

It is a similar story when the focus shifts to the top 100 largest firms. Last year’s total revenue was £13.73bn, £667m and 4.6 per cent down on 2008-09. Compared with the boom year of 2007-08, however, there is virtually no difference (£94m or 0.6 per cent) between the two totals. For all the talk of the dire straits facing the UK legal market, that is some performance.

Over five years the story of the UK’s top 100 is even more ­dramatic. In 2005-06, a year after The Lawyer christened the term ’silver circle’ to describe a bunch of high-rolling, high-earning ­private equity-led firms capitalising on the corporate boom, such as Ashurst, Macfarlanes and SJ Berwin, the top 100 generated £10.88bn. Since then, despite the recession, the total has grown by 26 per cent (and if it is truly surprising statistics you are after, then how about this: the firm that put on most revenue over the past five years was DWF, which posted an 111 per cent bump, from £33.9m to £71.5m, closely followed by Bird & Bird, up by 109 per cent, from £96.7m to £201.8m).

So – the demise of Halliwells notwithstanding – it is by no means all doom and gloom out there. But as readers of The Lawyer often like to point out, building revenue is not usually the problem. Profit is what counts.

Profit of doom

Here there are signs of stress. The total net profit among the top 100 shrank significantly last year when compared with the height of the boom. That year, 2007-08, the top 100 generated a total profit of £4.79bn. Last year that had dropped by 13.4 per cent to £4.15bn, a figure that was also down on 2008-09 (£4.16bn) and 2006-07 (£4.26bn). You would have to go all the way back to 2005-06 (£3.57bn) to find a year when the top 100 made less profit than it did last year.

Indeed, a snapshot of the top 100’s average profit per equity ­partner (PEP), that oft-disparaged metric, is even more illustrative. Although it rose by 3.7 per cent last year, from £402,000 to £417,000, PEP at the largest 100 UK firms remained some way short of the boom year’s £497,000 and also a way off the figure in 2006, when it was £482,000.

But then, if ever there was a year in which the value of PEP as a guide to a firm’s financial health was undermined, it was surely 2009-10. This was the year of the double-digit bounce, largely the result of it reflecting a recovery from the lowest of low ebbs.

At times during this year’s financial reporting season it seemed that, if you were not posting hefty PEP increases, you were either in the wrong market or you were Halliwells.

This summer a succession of firms posted PEP increases that ­bordered on the farcical. One after another firms including LG, Shoosmiths, Blake Lapthorn and Travers Smith queued up to trumpet rises of 50, 60 and even 70 per cent (the highest The Lawyer spotted was Scottish firm Burness, where PEP was up by 94 per cent).

These results provided plenty of ammunition for those who claim it is a devalued indicator. As more than one law firm partner and legal market commentator pointed out, the astronomical rises in PEP figures were more often than not due to nothing more than the fact that said figures had been so dire the year before.

The final cuts

But they were also due to the extreme measures firms had been ­taking to get back on track, namely cutting costs. This is the flip side to these, at first sight, impressive returns to form.

So how to judge a firm’s performance in this most turbulent of periods? And what has been the impact on a battered profession of the most ruthless period of cost-cutting in living memory?

It is widely accepted that the only way to assess a firm’s ­performance accurately is to consider a range of indicators. Or, as Clifford Chance managing partner David Childs memorably
put it earlier this year: “Use a dashboard of metrics to review ­performance, including revenue, PEP, RPL [revenue per lawyer] and RPP [revenue per partner], and other important measures, such as client retention, client wins and so on.”

But if anything can be relied upon as predictable and certain at law firms, it is costs. Costs are harder to fudge than PEP. They are even harder to change. They are all but fixed except for headcount, the only variable that can be adjusted with any degree of rapidity and one that at most firms accounts for around 60 per cent of total overheads.

Consequently, over the past couple of years most firms have been taking full advantage of that fact.

Even so, only 60 of the 93 firms for which The Lawyer has costs data stretching back five years posted reductions in their total costs last year. Over five years 81 of the 93 saw their costs increase in line with the overall growth of their businesses, with the expansionist DWF and Bird & Bird seeing the greatest increases in costs (127 per cent and 122 per cent respectively) out of the top 50.

Only Hammonds from the top 50 saw a costs reduction over five years, with total overheads dropping by 6 per cent, from £101.4m in 2006 to £95.4m last year. Good news perhaps for its prospective merger partner Squire Sanders & Dempsey.

But what is astonishing is the firm that has reduced its costs the most – Freshfields Bruckhaus Deringer. The magic circle firm, which last year generated £3.1m per day, slashed £132m out of its overheads during 2009-10, from £684m to £552m.

Of course, what really matters is which firm saw the biggest ­reduction in total cost proportionately. And that firm, slashing its costs bill by 19 per cent, is Freshfields.

According to the firm’s chief executive Ted Burke, this stunning performance was helped in part by Freshfields’ disproportionately large European practice and the depreciation of the euro.
“Around half of our revenue and costs are in euros,” Burke says.

Other than that Burke struggles to pinpoint a single silver bullet solution to his firm’s record cost-cutting.

“We’ve outsourced some services and looked hard at our internal spend, and we were very careful about new hiring,” Burke adds. “Like all firms we’ve been pressured to be more efficient and to adjust to difficult conditions. But we started preparing for the downturn well in advance, as early as 2007, and that helped a lot.”

As part of that Freshfields formed an 10-member operations ­executive two years ago chaired by Burke, which monitors and ­manages any capital expenditure above £200,000.
“This growth has been really helpful in bringing a more disciplined approach to major expenditures,” explains Burke.

The Lawyer tracked the UK’s four largest firms’ performances over five years, monitoring costs growth versus turnover and headcount. Three statistics immediately leap out: the 15 per cent and 19.6 per cent reduction in partners and equity partners respectively at ­Freshfields since 2005-06; and the 25 per cent increase in equity ­partners at Linklaters over the same period, the result of the latter’s decision to head back towards an all-equity partnership.

What is also remarkable about Freshfields’ figures is that last year it was the firm that reduced headcount the least of the four. ­Freshfields cut total lawyer numbers by just 5 per cent, in contrast with 7 per cent at Allen & Overy (A&O), 8.5 per cent at Linklaters and 11 per cent at Clifford Chance (the latter firm reduced its total partner numbers by a similar proportion, again the highest of the quartet).

Almost as surprising as Freshfields posting the biggest reduction in costs last year is the gap between it and the firm that posted the smallest change, A&O. Between 2008-09 A&O managed a costs reduction of just £39m.

So while all four have improved, A&O reduced its costs as a ­proportion of turnover by just one percentage point last year despite its restructuring.

In contrast, Freshfields and Clifford Chance both cut proportional costs by five percentage points between 2008-09 and last year, the former without the benefit of any major restructuring during the past two years.

Clifford Chance’s figures, like Linklaters’, show that both firms took the hit of the restructuring, but also managed to improve the bottom line by reducing costs in spite of a reduction in overall turnover at both firms.

Super savers

A&O global senior partner David Morley defends his firm’s position by pointing out a few other headline stats.

“We had the largest increase in turnover over the period of the four firms [43 per cent], we have the largest number of offices [36, compared with Clifford Chance’s 29, Freshfields’ 28 and Linklaters’ 26] and we had the largest increase in the number of lawyers. Also our fees per fee-earner showed the second-highest increase at 29 per cent.”

Despite that growth the cost savings achieved by A&O and the rest of the magic circle reflect the cuts that have been taking place throughout the UK legal market over the past two to three years. Longer, if the increased efficiencies looked for by outsourcing are factored in.

“We’ve been outsourcing document production to India for seven or eight years – it’s as old as the hills,” says Morley.

Freshfields’ Burke agrees. “Outsourcing isn’t as new as some would have you believe,” he says. “I remember US law firms outsourcing cleaning, reproduction and so on as early as the 1980s. What is truly different is the increased momentum to outsource certain types of legal services.”

“What’s interesting now,” agrees Morley, “is that outsourcing is beginning to lap up against the shore of legal services.”

As he confirms, this recent trend towards legal process outsourcing (LPO) is also being driven by the increasing expectations of clients for greater efficiencies. Or to put it another way, a recognition that the conditions that have long applied to law firms’ clients and the rest of UK industry also apply to them.

“Law firms have been cushioned from market forces that apply to other industries,” argues Eversheds managing partner Lee Ranson. “Until now they didn’t have to do it. Look at the profit margins – there were so many firms with margins of 35 per cent or more. That’s unheard of in the vast majority of industries.”

Now those margins are attracting the attention of rivals – rivals without law firms’ historical hang-ups that could happily cut a swathe through the market.

“Couple that with increased competition and an oversupply of lawyers, and the conditions are ripe for change,” adds Ranson, who insists that cost-saving was not the primary driver for his firm’s ­decision to outsource much of its back office services to Accenture (the Eversheds boss says international expansion and best practice were two of the three key imperatives, along with saving money).

“Cutting costs is very important, but it’s not the only driver,” emphasises Ranson. “If it was we’d have come up with another ­solution. Accenture isn’t cheap.”

Human blights

The increasingly hard-nosed approach to the provision of legal ­services – the industrialisation of the law, if you like – has another cost, of course: human.

Along with the ranks of support staff fired during redundancy ­programmes or cut adrift as firms outsource to the subcontinent, hundreds of lawyers have lost their jobs during the recession. If ­outsourcing, and increasingly LPO, become widely accepted as tools to increase efficiency across the market, this is a trend that is sure to accelerate.

The likelihood is that, over the coming months and years, more firms will follow the lead of CMS Cameron McKenna, Eversheds, Pinsent Masons and others that have embraced outsourcing. Throw the implementation of the Legal Services Act (LSA) into the mix next year, paving the way for new business structures and external investment, and you have a market that is on the cusp of a ­potentially brutal new era – most of it driven by cost-saving.

Although there are currently signs of life in certain transactional markets and recruitment levels are slowly kicking back into gear, the widespread layoffs have left their mark. Morale among lawyers ­buffeted by layoffs, frozen salaries and long hours is said to be at an all-time low.

It is a situation not helped by the sky-high PEP increases posted by several firms this year. Mark Brandon of Motive Legal ­Consulting says the true impact of the volatility has not yet been felt.
“There’s a feeling that bridges have been burnt and that partners don’t get it,” claims Brandon. “They see their assistant resource base as being infinitely malleable. But there’s been a step change in morale, the glue is going, and although firms have kept the utilisation rates high, assistants are saying they’re suffering because they’re working weekends with a pay freeze while partner profits are back up.”

Table: DAYS TO PROFIT 2009-2010 (Click image to view full version)