Law Firm Survey: Taking stock of the past five years – and building resilience for the next five

12 February 2019

Every year, PwC’s Law Firms’ Survey provides a fascinating snapshot of the current state of the UK legal sector. In this year’s study the picture appears fairly bright, with over 90% of firms reporting growth in fee income, and 40% saying it’s in double-digits.

But as well as depicting a moment in time, the survey also offers something else: a great opportunity to step back and take stock of the industry’s longer-term themes. And in that context, the relevance of this year’s strapline – “Resilience through change” – becomes apparent.

To explain why resilience is so vital, I’ve decided to write two blogs covering a decade of trends affecting law firms. In this first one I’ll look back over the past five years. The second will focus on the challenges yet to come and my views on how firms can best tackle them.

Let me start by focusing on this year’s report. At first glance, the rising revenues appear to signal good times for law firms. Well to some extent this is true. Fee income is on the up, however you cannot get away from the fact that all law firms are feeling the pressure on their profitability.

The result for many firms is non-profitable growth. Indeed, pressure on law firms’ margins has been a defining theme of the past five years, with no segment – even Top 10 – immune.

Why? In my view, the sustained squeeze on profits reflects three factors. I’ll categorise these as the “three Cs”.

First, costs. As US firms continue to enter the UK market – especially London – they’re throwing money at solicitors to get them on board. The big UK firms have to follow suit or risk losing their top talent. The resulting rise in costs has now rippled down from the magic circle to the rest of the Top 10 and beyond.

You only have to take a look at our survey to find hard evidence. In 2014 the Top 10 had an average profit margin of 40.0%, falling to 36.6% in 2018 – a decline of 3.4 percentage points. Conversely, the Top 10’s staff cost ratio rose from 35.7% to 39.4% – an increase of 3.7 percentage points. That’s hardly a coincidence: rising staff costs are squeezing profitability.

The second “C” is clients. Today’s clients want more for less – and the days when firms could rack up fees by charging hourly rates for every job are gone for good. Over the past five years, as demand for fixed-fee arrangements has grown, firms have faced intensifying pressure to use their resources more efficiently, by ensuring they have right grades doing the right work at the right time to turn a healthy profit.

Get the balance wrong – such as having partners doing work that senior solicitors could do, or senior associates doing work that junior solicitors could do – and profits evaporate.

And this brings us to our third C - competition. One obvious driver here has been the influx of US firms. But there are also a host of other new entrants out there targeting the legal sector, thinking they can do things better and cheaper by having a different culture, newer technology and a greater ability to adapt to change.

The main challenge from these players is currently in the smaller and sometimes mid-tier areas of the market. But it’s only a matter of time before the biggest firms start to be impacted.

All three of these Cs are squeezing margins for firms of all sizes. But at the top end of the market their impact is being compounded by globalisation.

In order to service increasingly global corporations, the biggest UK firms need to establish their brands and resources in the locations where their clients operate. But the profitability of international offices is well below that in the UK: for example, offices in China yielded a profit margin of 18% in 2018 – less than half the level achieved here in the UK. While perhaps vital to firms’ business models, it seems international offices are diluting the global profit pool for partners, and adding to the margin squeeze.

We’ve seen all these factors play out over the past five years, and a consequence of this has been a reluctance to invest, including in technology. Some would claim that this tightening of the purse-strings actually began back in 2008 with the onset of the economic crisis. But whenever it started, the result is that many firms’ current IT is not fit for purpose in an increasingly digital world.

If they are to be fit for the future, the priority for all law firms must be to invest in smart ways that create a resilient platform for profitable growth. In my next blog, looking at the next five years, I’ll examine how they can do this.

Leon Hutchinson | Senior Manager
Profile | Email | +44(0)7739 449052

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