UK 200: The business of law

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Who do you see in the bathroom mirror each morning? A lawyer? A businessperson? Both?

Jackson
Andrew Jackson, head of services to the legal profession, KPMG in the UK

The idea that law firms need to ensure that they operate in a financially sustainable way is hardly a new one. The industry has made huge strides in this regard in recent years, managing their affairs more efficiently and effectively as a means to counter an increasingly tough commercial environment.

But is there more still to be done? The answer, in our view, is a resounding ‘yes’. Regardless of a firm’s size, specialisation and market sector, it has become essential to have a robust business model, improve cashflows and protect profit margins. The alternative, as numerous firms up and down the country are finding, is to face the threat of oblivion.

Of course, many of the firms which are struggling or have gone to the wall are minnows compared with the constituents of The Lawyer’s UK 200. But the number of practices – many of lengthy standing – that are either closing or keenly looking for a merger partner to shore up revenues because their business is no longer viable, should be cause for concern for everyone in the industry.

Even at the top of the profession – within the UK 200 – we can see the effect that increasing commercial pressure is having on the market. While the top 50 firms in the table posted relatively healthy year-on-year revenue growth of 5.16 per cent, the bottom 100 firms in the list actually saw revenues flatline (more precisely declining by 0.06 per cent).

As one of the ‘big four’ accountancy and professional service firms, KPMG is able to see both sides of an important equation – and it is becoming less equal. When we speak to general counsel in the large corporates that provide business to many of the top 200, they tell us they are looking to cut legal costs as well as achieving more transparency in what they are paying for. Many of these organisations have undergone huge cost-cutting and process improvement programmes in recent years, and they naturally demand the same slickness of approach from all their professional service providers, including their panel law firms.

One result is a growing trend towards fixed or capped fee work, a development that originated in the volume litigation end of the legal profession but which is now spreading further up the food chain. As in any open market, as soon as a price is established for a certain type of work, the buyer immediately has a baseline from which to drive reductions, and to extend the charging model to other types of work. As they come under greater budgetary pressures of their own, many general counsel are playing the market in the knowledge that there will be a firm somewhere that is willing – or desperate enough – to take the work at a lower fee.

Yet this new reality does not always chime with what we hear from law firms. But it should – even for those firms engaged in the high-pressure, high-margin world of M&A. That type of work remains among the least price sensitive within the profession, but we believe it is not immune from future pricing pressure as clients exploit their advantageous negotiating positions.

Do you know how profitable you are?

Do you genuinely know the profitability of every piece of work you do? As clients pressure your pricing models, can you identify exactly where your break-even points are?

We know these are provocative questions to many in the legal profession. But as the appointed administrator to Cobbetts we have seen first-hand what can happen when a firm faces numerous financial and structural issues. Many readers will also recall the demise of Halliwells in 2010, and this year has brought the failure of both Challinors and Blakemores, with more likely to come in the near future (possibly in London) as difficulties in finding professional indemnity insurance continue.

We have seen many firms reduce back office costs, but the challenge is to ensure that as we come out of recession there is no cost bounceback and that firms do not rest on their laurels but make the difficult decisions that are required to ensure that their business models are efficient and sustainable. 

Of course, one of the critical elements to maintaining your budgeted profit margin is to be able to estimate and track the actual direct and indirect costs that are involved in completing any given piece of work. Only then can a firm have the kind of transparency from which to forensically examine whether the work is being done as cost-effectively as possible.

Despite all this, as The Lawyer UK 200 Annual Report 2013 demonstrates, there are good returns still to be made from legal services. Combined revenues for the 200 of just over £19bn (up 4.37 per cent year-on-year) and net profit for the top 100 firms totalling £5.4bn (up 2.77 per cent) speak of an industry that remains in good health.

Furthermore, those firms that meet the financial management challenge are likely to grow even stronger as weaker competitors are shaken out. But to achieve this they will increasingly have to regard themselves first and foremost as businesses that deliver legal products and services.

The good news is that plenty of firms are already focusing on the financial aspects of what they do. We have seen the concept of ‘law firm management’ gain considerable traction in recent years, with the best practitioners now recognised in an awards scheme run by The Lawyer.

Firms are increasingly talking to us about methods to improve their cash management, reduce work in progress (WIP) and cut debtor days. These back office, ‘transactional’ procedures can be made more efficient, given sufficient management focus and appropriate resourcing. When working with clients we also find procurement processes that are far too immature, thus failing to get best value from key suppliers.

We are also seeing a growing trend for firms to appoint pricing specialists to help them to determine appropriate pricing strategies for the services that they offer – recognising that the heady days before the 2008 financial crisis are not going to return, so keen pricing will be the secret to sustainable future growth.

Understanding the full impact of legal process outsourcing

After a great deal of initial hype, legal process outsourcing (LPO) may have slipped off the radar a little. But it is not going away any time soon; indeed, like many technology-led inventions, its true impact is probably still to be realised.

LPO represents a threat not just to law firms’ bottom line, but also to their established organisation structures and to their future talent pipelines. 

From a client perspective, bringing the mundane, commoditised elements of legal work in-house or using an LPO provider in India, the Philippines or Israel can save a lot of money. Document scanning and search technologies have advanced to the point that routine activities such as e-disclosure no longer have to reside within the law firm appointed to handle a particular matter.

The net result for the law firm is not just reduced income – perhaps more significant is a lack of opportunities to upskill the younger talent within the firm, people who would historically have cut their teeth on the more routine aspects of a mandate. Ultimately, the traditional pyramid structure of most largescale law firms may end up being unfit for purpose, with its foundations hollowed out, providing fewer natural heirs to the present senior staff.

Firms need to respond to this challenge proactively, re-engineering how they work before their clients effectively do this job for them. LPO, and the technologies that underpin it, can be an opportunity to improve margins, given that it can never replace the value-add elements that an experienced and talented lawyer – and genuine client relationship and understanding – can bring to bear on complex matters.

In a broader sense, the commoditisation of law is a genuine threat to the established order. From our standpoint we have already seen the same process occurring within audit and tax compliance work, a development that has caused a major shake-up in our industry.

And all around us, on every high street, we can see what happens when businesses cannot or will not respond to a fundamental market shift. The internet has not killed physical retailing, as some predicted, but it has given the customer total control of pricing when it comes to commoditised items, forcing the weak to the wall but at the same time giving renewed impetus to the smarter operators prepared to embrace this new world as the opportunity it clearly is.

Survival of the fittest

The legal firms that can meet the 21st century challenges highlighted here may end up looking quite different to the typical organisations we see today. This is natural evolution and it happens in every business sector, although it is interesting to note that it is often the second-tier or mid-market firms that are the most proactive and which drive change within their sectors.

It is vital that all law firms seize the initiative, though. And the optimal time to do this is when revenues and profit margins are still strong. Those who wait too long risk leaving their clients and competitors to dictate their future, a process that will almost certainly be far more painful.

Nothing lasts forever. The successful law firms in five and 10 years’ time will be the ones that do not waste energy pining for the good old days but remain focused not just on law, but on the business of law.

KPMG office