Blind to strategy basics: law firms in Britain
20 March 2020
The clients of legal firms in Britain are pressing for “value” given the significant sums of money being asked to pay for legal support. Some of the ‘Circle’ firms (be they “magic”, “silver” or otherwise) remain non-plussed as their Profits per Equity Partner (PEP) continue to increase. Short-termism, canny management or hubris?
This attitude echoes that of the City of London’s brokerage firms before ‘Big Bang’ in 1986; and where are those brokers now? Those fortunate exiting partners may be wealthier, but what of the firms sold/merged/folded as well as their staff and stakeholders?
Experiences and lessons from other professional services would suggest that such hubris comes at a price for those who fail to appreciate Darwinian-Capitalist processes.
Other industries undergoing similar consolidation dynamics provide useful proxies for Britain’s Law industry. While not perfect, these proxies reveal the critical role that robust strategic plans play for those firms hoping to succeed in a consolidating industry undergoing accelerating change. Such plans, properly formulated and robustly implemented, can promote the longevity of a firm - for benefit of current (and future) partners and related stakeholders.
Challenges clear; but are they addressed?
The Law, as with other professions, is neither unique nor protected from economic imperatives that force change. In any transforming industry, the ‘winners’ understand this dynamic and enhance their positions accordingly.
Yet in an industry undergoing accelerating change, few law firms cited developing a proactive and robust “strategy” as an issue. The implicit assumption being that many British law firms possess leading-edge capabilities to compose strategy and implement the related changes required. Not even McKinsey & Co holds that view of itself.
In Britain, the Legal Profession (writ large) risks damaging its overall viability by its continued focus on the billable hour as a means of revenue generation. As recent study by Raktas echoed the well-documented challenges facing the English legal profession; perhaps better classified as an industry, and its participants. This report offers useful insights.
The main challenges UK law firms face include the following:
Securing sources of Revenue Generation (i.e., fee structures as well as business development/client retention).
Managing the adoption of Technology in their own sets (i.e.; adoption, productivity and investment requirements) and coordinating with their clients’ own initiatives.
Strengthening Cybersecurity (for themselves as well as their clients).
Enhancing Talent Development and retention.
Addressing Competitive alternatives and new entrants (technology- or foreign-led).
Adjusting to meet the impact of BrExit on serving non-British clients.
Over the last twenty years, in the search of growth and success, UK law firms have undertaken a number of opportunistic mergers. In part, these transactions have followed a geographical rational: either building an international footprint (e.g.: Freshfields, Norton Rose Fulbright, or Ashurst to name a few); or a regional firm seeking presence in London (such has Pinsent Masons). Also, they have been based on filling-out a suite of service offerings.
It is interesting to note that of ‘The Lawyer’s list of “10 firms to watch” in 2005, all but one had faded away by 2015.
The cull continues.
Yes, the industry has grown, driven by already high fee levels, yet it remains oversupplied for its domestic base. Economic profits being increasingly concentrated.
Inescapable economic logic prevails
Economic logic applies to the practice and business of Law as with almost all other commercial activities.
However, many senior members of law firms (be they barristers, solicitors, or senior clerks) often treat with disdain the practices of commercial management. These activities, such as Marketing, Sales, Account Management, Billings and Financial Performance are the bedrock for any sustainable commercial success. Being of an acute mind and providing excellent legal advice is no longer a sufficient, solitary skill for the viability of legal firm. In an increasingly global world with cost and investment levels increasing, where British law’s margins are lower than its American and European counterparts, something needs to give.
‘Capacity Utilisation’ is the bedrock of strategy. The search to maximise utilisation drives revenues, costs and investments for improved productivity and competitive service levels; enhancing demand and promoting longer term viability.
Managing (inevitable) changes to come
For any leadership team, a useful exercise to gain strategic and tactical insights is to “roll back the future” coupled with scenarios.
As a first step, this exercise can be achieved by utilising McKinsey & Co’s “Strategic Control Map”.
This framework is particularly helpful for any company in an industry at the cusp of consolidation, particularly when applied in a dynamic manner. It is an approach that Raktas has adopted and applied for clients on numerous occasions. It is a fundamental framework in the consultant’s toolbox and invaluable for senior management of a proactive law firm.
The SCM was originally envisaged for market capitalisation it is easily adapted. It encompasses two axes (Size horizontally and Performance vertically).
Scale: where industry players focus on becoming the largest producer-supplier, with a full-spectrum offering and thus realising the lowest industry costs. This drive helps fuel revenue growth, but leads to an inexorable decline in margins. In short: one becomes Big and Broad.
Performance: here the mantra is focus; to secure higher-than-industry average pricing, as well as margins, albeit at heightened costs. The ongoing demand for product/services are stronger due to discernible value-add and/or scarcity. Here one remains Small and Specialist
Participants can be ‘mapped’ along these axes which provides a neat two-by-two matrix that can be mapped dynamically, analysed and insights derived.
Precedents reveal that a vibrant, steady-state industry has the following SCM structure.
In the top right quadrant, with a handful of players; with leading position and collectively commanding collectively about 50% of the industry’s ‘profit pool’.
The bottom right is where the lumbering ‘also-rans’ (about 65% of the participants) eke out an existence, with marginal returns at scale. Their growth is driven by increasing service expansion and occasional larger (merger) acquisitions.
In the top left quadrant, the fleet-of-foot Specialist, about 10% of the industry’s participants with 15% combined of the profit pool, are capacity constrained and occupy niche positions. The represent attractive M&A targets (as do any firms in the middle).
The ‘dead-zone’, of the bottom left quadrant, is characterized by negative returns and occupied by about 20% of the industry. These firms languish; as they are unattractive and lack the resources to change.
The British Legal industry has not arrived at this steady-state yet. Hence the challenge: how to traverse to success?
Few solicitors and fewer barristers will countenance the comparisons with other industries. Yet, these consolidated industries provided clues and pointers to a possible future for Legal Britain. The automotive, brewing, medical supplies, oil and media industries all have followed this well-trodden path of utilisation/consolidation. In the brewing industry in the US alone, 11 brewers account for 90% of all beer sales. In 1999, it was 20 commanding a 50% share. There are an additional 3,400 brewers; mainly micro-brewers; yet the total number of participants has shrunk over time.
While an extreme, played-out example, the brewing industry provides a salutatory glimpse of a possible future for Legal Britain.
Regardless, the challenge for today’s Managing Partner of a British law firm is to understand where her/his firm is at the moment and whether it can make the journey to the Top-Right or Top Left quadrant. The general strategies and related actions of each quadrant are markedly different as an analysis of the dynamic landscape reveals.
Possible dynamic in the Legal Britain landscape
Utilising the SCM, an analysis of the structure of the British Legal industry reveals the following structure dynamics. The chart below provides a synthetic illustration.
The large number of smaller, local firms find themselves relatively protected. They are below any “Top 200” list (with revenues below £25m). These small firms will need to ensure they keep their local demand vibrant and invest accordingly. Growth prospects are limited. Intergenerational survival of the firm is uncertain.
The larger domestic firms /those with international footprints are jockeying for leadership across the spectrum of services. Essentially, these are the ‘Top 10’ firms (by revenues), with an average size of £1,400 million. Their challenge is the chimera of growth; based on investments in technology-led productivity gains as well as the costs of transformations and further service expansion. These firms are moving right, and hopefully up, if not to settle out. Firms such as Norton Rose Fulbright and Pinsent Masons are on this path.
It is the thick “wodge” of firms (over 25) that are exposed. They are a quarter/third the size than the Top 10 leaders, with revenues between £200-500 million. Their nature and positions pose a distinct competitive disadvantage to a law firm at this stage in the British Law industry’s evolution. These middle-tier firms are approaching the proverbial strategic cross-roads.
On the one hand: a firm can try to speed up its growth: either as a full range supplier or focused provider (moving right). Acquisitions will play an important role as well as obviating the need for duplicated investments in systems, processes and technologies as well as HR/Recruitment.
On the other hand: one can position to build a defendable and profitable position (staying still or moving left and up). Firms such as: Ashurst; Slaughter & May; Bird & Bird will jostle for position, whereas Kennedys, Mischon de Reya and Slater and Gordon will need to consider their focus.
Finally those also firms in the £75-200m revenue threshold are the most exposed and challenged: especially those that eschew international business (in a post-BrExit world). They have already arrived at the strategic crossroads. They generally lack the scale/resources or distinctive competitive edge (aka “Unique Selling Proposition” of successful commercial enterprises). These firms have an immediate set of choices:
(i) to bulk-up in short order and/or;
(ii) become an attractive target for their larger competitors and/or;
(iii) spend-invest resources to claim and own a specialist niche. They can become challengers. Firms such as Weightmans and Gunnar-Cooke for example must get organised and make the dash.
As with many systems, a move by one participant sets off a chain reaction; forcing others to react as a dynamic balance is re-established towards a steady-state. Hence, the rare case of ‘first-mover advantage’ may apply.
The British Law remains largely national in ownership nature, with light regulation and an ability to absorb the pressures of foreign entrants and alternative suppliers à la Tesco-law and online services. Less than 18% of the industry, and fewer still amongst the smaller players, felt that “alternatives” were a threat.
In an increasingly global world with costs increasing; British Law’s margins are lower than the American and European counterparts. That may provide a medium-term barrier to foreign entrants; viewed as financially unattractive. However, a weak valuation may attract (un)welcome bids.
The role of M&A to move across the Map
While British law firms acknowledge the role and increasing use of M&A to drive change; comparison with other industries suggest that the profession is behind the established precedence curve.
The historic focus has been on regional geographical expansion rather than broadening services or deepening established ones. Amongst the Top 10 firms in the UK, less than 60% were considering M&A; and for smaller firm, less than a third
Also, transactions are fraught with risks and dangers. The majority of transactions fail due to: questionable rationale, insufficient planning, weak implementation and poor cultural fit. The failure rate is high, over 80%.
The success of mergers and acquisitions is based on: integration of cultures; more so than in a talent heavy industry, such as legal services. Securing and retaining ‘top talent’ (however defined) is paramount. The rational must be compelling with near flawless implementation.
Fundamental resource – Human Capital
A firm’s value is based on its book of clients; who are attracted to a firm’s capabilities – i.e. individual solicitors, barrister and the all-important associates.
It is by no means obvious that many British law firms really consider the importance of their staff, especially the more junior members. Current partners are more fixated on the now and immediate future, rather than the firm’s viability once they have retired. Yet selfish vs institutional perspective creates a dilemma for the recruitment and staff retention.
The lessons from McKinsey & Co are germane here, a firm that is approaching its centenary. Intergenerational viability of the firm, as an enduring professional institution, is a central pillar of its ethos and actions.
Appropriate Pricing – for revenues or margin?
The charge that British law remains overpriced has not been addressed. As the NIA report concluded: “…there seemed to be no escaping the observation that legal aid in England and Wales was significantly more costly than elsewhere [in the world]”.
Those firms sticking to a billable-hour base may be causing self-inflicted harm over the medium term. The use of Alternative suppliers or even the actions of traditional clients may see a fall-off in demand; as experienced in a wide range of other industries. The traditional corporate fees may well also come under pressure as the economy languishes and corporate budgets are cut. With the return of interest rates, business prospects will be curtailed for other reasons. Inflationary pressures may replace recessionary dampening ones. The pivotal role of private equity and property demand may well diminish prospects and revenues for the less appealing and competitive law firms.
Law firms have traditionally been driven by fixed billable fees and PEP. Yet “revenues” may not be the correct lens for pricing, but rather “margins”. Furthermore, instead of traditional rate cards and billable hours, alternative fee structures (such as forms of ‘Value Pricing’) may be much more productive and competitive.
Leading management consulting firms have shown that there is a role for blended pricing structures.
Proxy industries for the Law
The Law is different from consumer and industrial product and service providers. It remains a people business, providing counsel and services to manage and protect one’s legal rights. Also, the industry is anchored, by and large, in national jurisdictions.
There is no perfect model nor proxy. Yet, five other professions do provide useful proxies for strategies and tactics. Each of these industries have varying degrees of regulatory oversight as well as exposure to global competition and competitive alternatives. Three of these have undergone rapid and rampant consolidation (Banking, Accounting and Asset/Investment Management); two others are on the cusp (Private Medical Services and Management Consulting). It is interesting to note that the first four are all subject to some form of regulatory oversight, and hence a cost-burden. Also, the Legal profession shares a national-market bias, as do Medical Services.
The following are the five proxy industries.
Banking. This industry has seen dramatic an ongoing consolidation through as well-entrench competitive practices, de-regulation as well as increased regulatory oversight. The rapid expansion and self-induced crises have seen the industry left in turmoil with hardly any smaller players left and the larger ones trying to be classified into an ‘Alice-in-Wonderland’ of too-big-to fail.
Accountants. The drive for scale has seen massive consolidation and increasing regulation. While aggregate revenues have increased margins have collapsed under the weight of investments in technology and costs of supervision. Arguably, standards have been compromised; as they continuing scandals and fines reveal. The industry has bifurcated into a myriad of micro/local suppliers and lumbering giants, with none having true industry leadership. Those caught in the middle ground are struggling and diversify through associations with law firms, private offices and asset managers. The industry faces continued rationalisation and associated turmoil.
Asset/Investment Managers have seen a massive erosion of numbers (especially the small and medium firms). This rationalisation is associated with the investment levels required, increasing costs of compliance and risk management. The turmoil of the banking sector has added impetus to the economic logic. With technology advances it is not inconceivable that this profession will more or less disappear within the next twenty years, reduced to a handful of jumbo players. The rise of robo-investors, digital and other AI-led alternatives already dominate over 80% of activity.
Private Medical Clinics and services. As the state dominates the market for health care (through the NHS); private practice has moved into and expanded the ‘Niche quadrant’. The likes of BUPA and others are driving scale to offset investments, “medical inflation” and capture share. Margins remain healthy for the moment. Yet in Britain it has attracted global giants such as AXA and Cigna. Spiralling premiums to consumers are likely to see increasing government intervention.
Management Consultancy. Has ‘escaped’ much of the draconian effects of consolidation; especially amongst the ‘niche’ players. The leaders, while commanding disproportionate share of mind; actually inhabit well-established niche positions. The ingress of Accounting firms and online alternatives have long posed a threat but can’t compete with the top-tier’s value proposition offered by the likes of McKinsey & Co, BCG and even Bain. While not above reproach; the correct issue, risk-mitigation/opportunity gain and arrangement is a value-for-money service.
The ongoing transformation of the Management Consulting industry provides lesson of better practice for the legal firms. Those proxies engaged in financial services (Accounting, Banking, Asset/Investment management) are bearing the brunt of their own individual and collective missteps. A situation, exacerbated by increasing regulatory oversight. Private Medical Clinics may well have their judgement day in the medium term, as pricing remains unchecked. Consulting is subject to continual critique.
Summary
Can British law firms heed advice?
Some UK law firms have appreciated the value of a distinct, well-crafted and implemented strategy. These score or two of law firms now need to play the consolidation game well, traversing the Strategic Control Map.
Of the rest, many others either do not see the need or lack the ability to engage. Unless strategic thinking, including pricing and recruitment become core activities they are likely to find themselves being acquired, on unpalatable terms; or lingering to a generational demise.
The choice is yours.
Be in touch!
Justin Jenk
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Justin Jenk is business professional who enjoys simplifying decisions by connecting dots.
He has a 40 year multi-sector global career It encompassess being a: Consultant (partner at McKinsey and Accenture); market listed CEO (Vivartia); FCA regulated Chair (Gate Capital) and transformational investor (Raktas). Justin provides professional support to organisations and high-achievers, with a track record of successes.
He is a graduate of Oxford and Harvard universities. Justin can be found at justinjenk.com or www.raktas.ee or gatecapitalgroup.com or researchgate.
