Gap closes between top-tier and mid-tier firms - PwC annual law firm survey

• 82% of law firms increased fee income but mid-tier firms close the gap on Top 10 firms
• Profits per equity partner for Top 11-25 law firms increase by 17%; Top 10 firms’ up by 3.5% driven mainly by reductions in equity partner numbers
• International operations are increasingly diluting profitability: Top 10 firms’ UK profits per partner are 75% ahead of international
• Top 10 firms’ revenues reduced by 3.5% due to Euro exchange rate movement

PwC’s 2015 Law Firm Survey has found marked differences in the fortunes of top-tier and mid-tier firms. The number of UK law firms increasing UK fee income is higher than at any time since 2008, increasing at 82% of firms, compared with 70% last year. However, Top 10 firms fared worse than all other bandings with only half achieving UK fee income growth (vs 71% of Top 11-25 firms and 89% of Top 26-50 firms).

Profits per partner
All bandings of firm increased UK Profits per Equity Partner (PEP) in the current year, to varying degrees. Top 11-25 firms stand out with a 17.2% increase to £641k, achieved predominantly through improvements in underlying profitability with a fall of only 1% in equity partner headcount. Top 10 firms increased UK PEP by a marginal 3.5% to £1,067k, but with an average 5% reduction in equity partner headcount a major contributing factor.

Profitability
While Top 10 firms’ UK net profit margins continue to significantly exceed other bandings, the steady improvement of recent years has stalled with average margin broadly flat at 39.9%. Meanwhile the Top 11-25 have built on their prior year turnaround and have nudged profit margin upwards to 29.2% - the best margin recorded by that banding since 2009. A number of firms within this bracket have benefitted from mergers and lateral hiring programmes in recent years which are beginning to reap benefits, and there may be more to come as firms capitalise on economies of scale and refocused growth strategies.

For Top 26-50 firms, a slight improvement to 24.5% nonetheless leaves them significantly adrift of the larger firms (although the average masks a wide spread of performance). This banding has reported an 8% increase in UK headcount (against flat average numbers for Top 25 firms), with their high staff cost ratio presenting a competitive disadvantage from a margin perspective. Top 51-100 firms have reported a notable deterioration in margin from 24.1% to 21.2%.

Given the relatively fixed nature of the cost base for law firms, in the short term at least, it is interesting that of the 82% of firms reporting top line growth, only 46% have grown profits at a faster rate. Pricing, staff cost ratios, and fee earner utilisation all have their part to play, together with the need to maintain tight control of the cost base.

David Snell, partner and leader of PwC’s Law Firm Advisory Group, said:

“Our 2015 Law Firms’ Survey is set in the context of a recovering UK market, but with ongoing challenging macro-economic conditions for global law firms. The strength of sterling against the euro has adversely impacted many firms’ international performance on a Sterling basis - the basis upon which most firms distribute their profits to partners. However, the UK has enjoyed a more buoyant deals market, greater levels of regulatory activity and an active real estate sector.

“These factors are reflected in our survey, which shows a somewhat disappointing performance from the Top 10 firms, while at the same time a resurgent Top 11-25 who seem to have re-focused their strategic intent.

“Mid-tier City firms in particular have performed well through a combination of sensible lateral hiring programmes, M&A and a focus on cost control and key metrics such as chargeable hours. However, a slow-down in litigation, and difficult conditions in some industry sectors, have been a drag on performance for some in the Top 26-50.”

Other key findings from the survey include:

• Rate per hour is becoming ever more important to law firms, with pricing pressure remaining acute across the spectrum and clients increasingly seeking favourable alternative fee arrangements.
• Fixed fee arrangements are becoming more prevalent particularly outside the Top 25, with 32% (2014: 21%) of Top 26-50 fee income and 38% (2014: 26%) of Top 51-100 fee income being billed on that basis (vs 23% in Top 25 firms). 
• There has also been an increase in contingent/performance-based fees, predominantly amongst the Top 11-25, which now represent 15% (2014: 8%) of the total. 
• 80% of firms recognise ‘the need to respond to the Digital age’ but only 23% have so far made changes to how they operate. 
• 82% of firms acknowledge that digital technologies (including social, mobile, analytics, and cloud) will provide alternative channels to interact with clients and improve the client experience; yet most firms have yet to enable their websites or mobile applications to provide that level of interaction.
• 2015 has seen recruitment and retention firmly back on the people agenda, with the war for talent bringing disruption to reward strategies, particularly amongst the larger firms. US firms are recruiting aggressively, and lateral moves between law firms are prevalent.
• Our 2015 survey reports modest growth in UK fee earner headcount in response to increased activity levels. We continue to see excess capacity against target utilisation (averaging 7% in Top 10 firms, 12% in Top 11-25 firms, and 17% in Top 26-50 firms).

David Snell added:

“This year’s survey shows a sector that is continuing to evolve, with the pace of change beginning to pick up as global economies improve. Alongside economic improvement we see rapid technological change, innovation in business models and changing client buying patterns. The agile firms are not only responding to these factors, but beginning to anticipate the next likely developments. They are not alone: at the same time, new market entrants are bringing disruption to the market and fuelling the need to innovate.

“All of this will require significant investment and firms will need to consider how best to fund this, against the backdrop of a traditional ‘full distribution’ partnership model. For those who don’t - or can’t - respond to this change, the future will become increasingly difficult.”

Ends

Notes

About the report
The survey results are presented by size of firm using the bandings Top 10, 11-25, 26-50, and 51-100 (except where otherwise stated). The classification is by annual global fee income. Our report is based on survey responses from firms at consistent response rates to prior years. We have also drawn upon selected information from our quarterly survey and, where relevant, other published financial information.

About PwC
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Contact:
Hilary Downes, media relations, PwC
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