What will the legal industry look like in five years’ time?
Uncertain times. In September 2008, we published the annual financial results bible that is The Lawyer UK 200 Annual Report. Law firms were riding high and clients were happy to pay more than ever for their services.
A month after that report was released Lehman Brothers went bust. The world went into financial freefall. Deals were pulled, redundancies were rife. All of a sudden clients were saying a whole swathe of legal spend was discretionary.
In the intervening five years that client pressure has shaped the legal market radically. At the same time, the advent of the Legal Services Act created alternative business structures (ABSs) which have allowed law firms to recalibrate their services to clients.
So far, those ABSs tend to be located at the consumer end of law. But how long until corporate clients – particularly SMEs – start wanting a fuller service than legal advice?
This issue of The Lawyer is dedicated to imagining the shape of the market in five and 10 years time.
Back in 2008 we asked four magic circle leaders to predict what the market would be like in 2013 and 2018. Five years on, all are still in situ, although David Childs is coming to the end of his term.
Freshfields Bruckhaus Deringer chief executive Ted Burke suggested that membership of the magic circle itself was subject to change: “Do I think that any firm will drop out of the magic circle in the next five years? No. In the next 10 years? Probably.” He refused to be drawn on which firm that might be (we’re guessing it wasn’t Freshfields).
Both Childs and Simon Davies of Linklaters argued that a continuing professionalisation of management was inevitable, but it fell to Allen & Overy senior partner David Morley to make specific predictions (see box). Much of what he said is on the way to being realised.
This time round we have expanded the project, consulting myriad managing partners, consultants and, most importantly, the people who are paying for law firms’ services: the clients. What do they want from their external lawyers, and how do they want it? What are the implications for the shape of private practice? Based on our own market reporting and their input, we’ve come up with a series of provocative predictions. Here goes.
Prediction: There will be seven international mergers among the Top 40 firms
As the table here shows, the top 20 UK-headquartered firms in 2008 are still recognisable, but via international merger many are serving much more globalised clients.
The most serious reshaping in private practice has come in the tier just below the magic circle: Lovells (now Hogan Lovells), Herbert Smith (now Herbert Smith Freehills), Ashurst (which merged with Australia’s Blake Dawson), Norton Rose (now Norton Rose Fulbright) and SJ Berwin (now King & Wood Mallesons SJ Berwin) have all since agreed enormous mergers with the emphasis on Asia and the US.
Their offering to clients has been transformed; it is clear that the vast majority of in-house lawyers are not fussed whether their external advisers use a Verein structure, despite snootiness on the part of some private practitioners.
Or, to put it another way, Eversheds, Simmons & Simmons, Pinsent Masons, Addleshaw Goddard, Berwin Leighton Paisner and Taylor Wessing are now lagging the top tier in terms of billings. So for these firms wanting to play on the international stage there remains a question: how do they cope with client expectations of global coverage? The more these firms offer one-size-fits-all deals for clients (as Pinsent Masons has done with Balfour Beatty and Eversheds with Tyco), the more critical mass those firms need globally.
“To paraphrase Harold McMillan, the wind of change is blowing through the City,” argues Peter Kalis, the global chairman of K&L Gates and the man behind his firm’s merger with City firm Nicholson Graham & Jones in 2005. “The growth of a globalised market for legal services is a fact. By 2018 you will see in the London market a further hollowing out of the middle as top talent migrates away from certain City firms.
Kalis believes the market in 2018 will be even more dominated by the magic circle and the London offices of globally integrated US firms.
“There will be a diminished number of independent UK firms as leading partners will wish to follow their clients onto the world stage,” he says. “To adapt to the out-migration of talent and stave off extinction more UK firms will append themselves to brand-sharing vehicles such as Swiss Vereins in hopes of creating a simulation of an international law firm.
“Such a convoluted adaptation in nature brought us the platypus – a mammal that lays eggs – but, in fairness, these firms would presumably argue that laying an egg is at least a sign of life.”
The Platypus Circle would certainly add an extra dimension to its firmly established magic and silver cousins. It would also add yet more segmentation into a rapidly differentiating global market, one that legal market consultant Alan Hodgart believes will continue to segment (see Opinions on page 9 for more of Hodgart’s crystal ball-gazing).
Kerma Partners’ William Arthur also believes the market will see significantly more consolidation.
“Twenty-five of the current names in the Top 100 will no longer exist [by 2018],” says Arthur, who argues this will be due to a variety of factors. “Some will have happily merged in execution of their strategic blueprint,” he argues, while “some, due to poor strategy/weak management/poor profitability/inability to invest, will have lost the ability to remain independent and merged into a supposedly safer haven. Ten large law firms will be plcs (not the largest firms with complex international networks).”
Bruce MacEwen of Adam Smith, Esq says that five years from now there will have been at least one “head-turning US-UK merger”, in other words a magic circle firm with a $700m (£450m) or bigger US rival, as “the spectre of Clifford Chance/Rogers & Wells finally loses its never-deserved cautionary spell, and the top-tier UK firms recognise membership of the ‘global elite’ is a hollow claim without critical mass in the one nation comprising half the world’s legal market”.
Prediction: Clients will still get tough on fees, but PEP won’t crash
Average profit per equity partner (PEP) will stay high in the top 25 firms and will not decline to civilian levels. Most firms in the UK 200 top 25 have stayed in the £400-£600,000 pay bracket. Eversheds, which has arguably gone through the most pain in terms of restructuring, is one of the best performers: PEP in 2008 was £552,000 and is now at £642,000. Mid-tier firms with large regional operations, such as Wragge & Co and Osborne Clarke, still comfortably hover in the £300,000 bracket.
Five years into a recession all this may seem counterintuitive. Yet as law firms may have reacted to client demand in terms of fee flexibility, there has been a big focus on maintaining margins. This has required investment in technology and
Do in-house lawyers care about private practice PEP? Not really. In the course of The Lawyer’s reporting of the legal market over the past couple of years it is fair to say that most in-housers don’t worry too much about profitability. As one GC in a major financial services business says, “As long as I don’t overshoot my budget I have no issues with my lawyers making a good living. As long as the service is good.”
David Morley’s predictions from The Lawyer UK 200 Annual Report 2008
When peering into the future it’s sometimes instructive to look at the past. For example, if Allen & Overy (A&O) grew over the next 10 years at the same rate as the last 10 we would grow from 3,000 lawyers to 10,000, from 500 partners to 1,500, and from annual revenues of $2bn (£1.05bn) to around $10bn. Improbable? Perhaps, but back in 1998 no-one would have believed we would grow to our current size in 10 years. So here are a few guesses:
A seemingly unbridgeable gap has opened up between a global elite of six firms (A&O, Linklaters, Freshfields, CC, Skadden and Latham) and the rest, based on scale, geographic reach and focus on high-end work. Other firms thrive and compete with different business models, but these six are market leaders.
Their geographic footprint continues to spread into emerging markets such as Turkey, Ukraine and Morocco. Emerging markets make up 15 to 20 per cent of the revenues of the global elite.
Regulatory regimes have begun to recognise that a different set of rules is needed to govern work for sophisticated business clients from those needed for consumers and small business clients.
Twenty per cent of the partners in global elite firms are women.
Sixty-five per cent of the magic circle’s revenues are outside the UK.
Most of the global elite have developed captive legal outsourcing operations in South Africa, New Zealand, India or Australia, and other business methods for delivering high-quality, lower cost work to very large relationship clients.
A flurry of US/UK mergers at the top level have been bedded in, creating a new competitive landscape.
India and China combined are now more important markets for the leading firms than the US.
Forty per cent of leading firms’ partners or equivalent are women
The global elite is unrecognisable from 2008. Consolidation has accelerated and new business models have developed, fuelled by external capital and technological shifts driving fundamental industry change. The winners are those with collaborative cultures that have adapted and innovated most consistently.
Hourly billing is long dead. (This last one is more of a wish than a prediction.)
Prediction: An elite group of litigation boutiques, dominated by US firms, will have emerged.
Feuding litigants will turn to dispute resolution boutiques to lead their court battles as demand for specialist advice on flexible rates soars.
Quinn Emanuel Urquhart & Sullivan is already flexing its muscles, with big-name clients such as Russian oligarch Oleg Deripaska. Another US litigation powerhouse Boies Schiller & Flexner opened its doors in London over the summer and is expected to provide some competition to its US counterpart, with clients such as Barclays and Goldman Sachs on its books.
Demand for flexible billing practices such as conditional and fixed fees deals will no doubt drive more in-house lawyers to boutiques such as Enyo Law and Stewarts Law, where such options are not restricted by corporate practices.
Stewarts Law has already shown it is willing to share risk by setting up a litigation fund, a service that will be attractive to clients as Lord Justice Jackson’s costs budgeting regime takes hold.
One firm already causing ripples at the bar is Hage Aaronson, launched by top tax silk Graham Aaronson QC and former One Essex Court barrister Joe Hage. The pair have been joined by a trio of leading tax partners from Dorsey & Whitney, and former Blackstone Chambers head Thomas Beazley QC.
Hage is keen to see the firm work more closely with the bar, offering joint services to help resolve disputes early. It is an approach that will no doubt help it maintain a pedigree client list.
David Morley, Allen & Overy