Sir Nigel Knowles: The end of the legal market as we know it is nigh

Prosperity is all around, but that will only lay bare fundamental problems in a sector accelerating towards its judgment day

Knowles

The wave of positive economic data that ushered in the new year has become positively tidal as momentum and growth, now driven by increased business investment levels as well as consumption, has buoyed markets and even had commentators whispering that Bank of England governor Mark Carney will be forced to raise interest rates earlier than advertised. This now seems inevitable, even if the hike is unlikely until next year. The outlook is bright for corporate deal activity too, with IPOs continuing their upward trajectory and M&A volumes picking up significantly.

But this seemingly unstoppable march towards the sunlit uplands of sustainable growth is not reflected in the legal services market. Indeed, law firms are expected to experience a very different year to that enjoyed in the stock markets.

Change is coming soon

Last year was supposed to be one of major upheaval for the legal services industry. This did not happen in any meaningful way, but do not be fooled – it has merely been given a stay of execution.

The sector as it stands is unsustainable. Looking to the second half of 2014 and beyond it is hard to see the status quo holding. Commercial law is a $300bn global industry. No single firm has more than 1 per cent of the market and this strange state of affairs has to change. The sector remains fragmented: there are simply too many firms (and, inevitably, too many lawyers) offering services without any clear differentiation. Consolidation is a certainty – and expect to see this on an unprecedented scale.

The recent run of good economic data and increased deal activity should not fool anyone into thinking that the good times have returned for legal businesses. Law firms that believe recovering economic conditions, increased corporate activity and better markets will come to their rescue are deluding themselves. Reform is not brought about by an economic downturn, but rather is based on commercial imperatives.

In the past decade there has been a fundamental shift in the dynamics of the industry. The financial crisis only served to accelerate this trend and bring into sharper focus systemic problems in the sector – problems that no amount of burying ones head in the sand can solve.

Looking at the changes that have taken place, the principal factor is the seismic shift in client expectations and requirements. Clients are more savvy and demanding – something that can be attributed to a number of factors including the consolidation of legal panels, greater scrutiny of fees and the desire for global solutions (and corresponding global discounts). This trend is not going to dissipate and is rendering many firms’ business models obsolete. Alternative business structures (ABS) and their one-stop- shop offerings are taking business out of the hands of other firms.

Global or niche

The firms that will emerge from this struggle will be either truly global or highly niche. With the former, firms that can offer a comprehensive suite of services across all regions will be in a strong position. However, there are firms that claim to be operating globally but are in fact thin on the ground in many regions. They will be found out.

Firms will have to be creative in how they structure themselves and motivate and retain their key asset – the human capital generating fees. Successful law firms are run increasingly like any other big business and those looking for a place at the top table will need to streamline their management structures and employ managing partners specialising in running a business, rather than dispensing legal counsel.

Magic circle firms are changing too, as they partner with bulge-bracket investment banks and focus on major transactional work – a move that may pay dividends, given the recent uptick in dealflows.

For the rest, the pace of mergers will accelerate. Firms will merge to gain greater geographic exposure, particularly in Africa and Asia, while the walking wounded will merge simply to survive or cut costs. While the former strategy could be legitimately seen as part of a convincing growth story, the latter is indicative of clutching at straws – and such deals are likely to be increasingly frequent.

However, all is not doom and gloom. For the firms that survive there will be rich pickings. Who knows, it may be that by the end of 2014 some of the larger law firms will have finally secured that hallowed 1 per cent share of the market.

Sir Nigel Knowles is global co-chief executive, DLA Piper