Middle market firms must merge with accountants or financial practitioners to survive the magic circle encroaching on their work, a report has warned.

The report, released by stockbroker Arden Partners, said magic circle firms are increasingly taking a lion’s share of the work previously reserved for the middle tier.

It warned mid-market firms should consider forming multidisciplinary practices (MDPs), or face eventual closure.

The magic circle’s increase in nearshoring and contract work has hit the mid-market particularly hard, Arden said.

However magic circle domestic growth could also soon stall. The report predicted that the top firms will reduce the number of locations in which they are based and increase their presence in emerging ones. Those with a growing Asian strength would have a particular advantage.

“Our contention is that within the next five years the middle ground will change,” report author and Arden Partners’ head of business support services John Llewlleyn-Lloyd told The Lawyer.

“You’re talking firms typically in the £400m turnover to £10m turnover range. That’s something like 170 law firms in the UK.”

Accountancy firms will be keen to subsume mid-tier firms and MDPs, Llewlleyn-Lloyd continued, adding the legal services market “is in a perfect storm” as a result of regulatory changes, external investment and a “technological revolution”.

Arden, which based its report on data from The Lawyer’s UK 200 series, also claimed that the average profit per equity (PEP) model has led law firms to wrongly prioritise short-term partner value over long-term firm revenue.

“The theory behind the PEP model is that partners are happy providing their PEP is maintained. But you can actually maintain PEP by almost destroying value,” said Llewellyn-Lloyd. “You can maintain your PEP simply by significantly reducing the number of partners, which may be very damaging for the business.”

“PEP is a short term view because you’re fundamentally not looking at the best long term interests of the business. What you see in a lot of middle market firms is that their PEP has increased quite a lot but in fact their revenue per lawyer is reducing. That means the overall firm is not producing as effectively,” he added.

Firms that do not adapt to “unprecedented advances in technology” will experience terminal decline and eventual closure, Arden said. These advances include the rise of new “Law Tech” entrants such as artificial intelligence, document management and cloud-based technology.

“Cost consciousness is creating price pressure for providers of professional services in all but the very highest value areas of work. Clients and their services providers are increasingly using technology and non-traditional approaches to resourcing as part of more efficient and cost-effective solutions.

“Those unable to meet clients’ demand for technology-enabled engagements will increasingly struggle to compete,” the report said.

The stockbroker’s report stressed the influence of the Big Four accountancy firms: PwC, Deloitte, EY and KPMG. Between them, the accountancy giants employ around 6,000 lawyers globally. PwC’s estimated legal capacity of 2,400 means its legal arm is now the ninth largest in the world by headcount – “equivalent in size to a Hogan Lovells or Clifford Chance globally”.

“It’s difficult to see how you won’t see a significant merging of the two professions [accounting and law],” Llewellyn-Lloyd told The Lawyer.

Arden warned that the legal industry has been slow to adapt to a demand-led environment, with lawyers continuing to “sell what they do, not what a client wants or needs”.

It cited rigidity around pricing models, resistance from firms to move away from hourly-based billing, and regulations that until November 2015 had made it difficult for solicitor-owned firms to offer a range of different financial services as potential pitfalls.

Most significantly, it said, was “client dissatisfaction with respect to inconsistent ‘experiences’ and value-for-money”.

For more information on The Lawyer’s UK 200 series, contact Richard Edwards on 020 7970 4672 richard.edwards@thelawyer.com