Last year saw the first double-digit growth for the legal sector since 2008, with a 10.5% increase in fee income for the first quarter of 2013, according to figures from Deloitte.
The trend for growth has continued into 2014. The PwC 2014 Law Firm Survey reported that: “stability and confidence is returning to the legal sector. The number of UK law firms increasing fee income is higher than at any time since 2008, increasing at 80% of firms, compared with 63% last year. 70% of all firms increased their UK revenues above inflation (43% in 2013).”
This is great news for the legal industry. But what factors are driving growth – and should we be cautious? Is it just the larger firms that are increasing fee income, or are smaller firms benefitting too? How can all legal practices capitalise on sector growth opportunities?
(1) Legal sector mergers and acquisitions
The ongoing trend for mergers and acquisitions has reduced the number of practices competing for work. The PwC report cites “a combination of the economic downturn and an over-supply of firms offering legal services” for previous slow trade in the legal sector, and goes on to say that the sector “has benefitted from the economy’s return to growth and consolidation in the market.”
David Snell, partner and leader of PwC’s Law Firm Advisory Group, is optimistic: “Notwithstanding this atmosphere of cautious optimism, the environment facing UK law firms remains fluid and challenging. Mergers and acquisitions, alternative business models, talent wars and data security threats are just some of the issues that this year’s survey brings to the fore.”
What else driving this trend towards legal sector mergers and acquisitions?
(2) Legal sector compliance obligations
The compliance regime is getting much tougher. Many smaller firms are seeing the benefits of merging with bigger firms and pooling resources for the (often onerous) task of compliance. Government regulatory changes have increased compliance obligations for law firms. These have arisen as a result of legal firm structural and governance changes. In the past, only qualified lawyers could own a legal firm. Recent deregulation to allow law firms to become limited companies and draw in external capital means that law firms can now be owned by (for example) venture capitalists as well as qualified lawyers. The government therefore increased compliance obligations to ensure legal compliance and consistency in the quality and integrity of services being offered.
(3) The collapse of the partnership model
The traditional legal practice model was based on career progression for lawyers from junior to senior lawyer, then eventually partner of the firm. Law graduates would join a firm to gain experience and qualify as an associate, then work with the firm over a number of years and progress through the ranks to become a partner. As partners retired, their shares would be bought up by others in the firm. Since legal sector profitability has decreased, there are less resources available for training up young lawyers, so internal succession planning has become more difficult. Many partners are looking outside the firm for successors, and bringing in external investment, which is in turn fuelling practice growth.
Another legal industry trend is the move towards specialisation and disaggregation of legal services. More and more firms are specialising in particular areas of law, rather than offering a full legal services package. Since the removal of legal aid, the number of practices offering criminal law services has decreased, while more profitable services such as commercial law, and consumer law (including debt recovery and personal injury) have seen expansion. This trend has therefore boosted overall sector profitability and growth.
The typical legal practice business model has changed as a result, moving from hourly charging to fixed fee models – especially in the consumer market. Specialisation has allowed lawyers to focus on one particular area, which is a much more efficient way of working.
(5) Housing market growth
The Law Society has also recently cited housing market activity as a driver for legal sector growth. Law Society president Andrew Caplen described the buoyant housing market as good news for solicitors. “If household incomes rise as predicted, our members with clients buying and selling property or needing legal advice for their businesses will benefit from housing market and business activity,” he said. “High export predictions for 2015 will be welcomed by firms of all sizes having a role in meeting the increased demand for international transactions.”
But should we be cautious about legal sector growth?
While legal sector growth is good news, there are reasons to be cautious.
Pricing pressures remain a concern. Despite the increase in chargeable hours, there is a sizeable gap between actual hours recorded and target hours (by 9% on average in the Top 10 and 12% in the Top 11-25). This indicates that there is still spare capacity within firms, with the 2014 PwC survey indicating the greatest gap between actual and target at partner and trainee level.
With regard to the housing market, the Law Society added a word of caution about its growth figures, noting that they are based on forecasts of households’ real incomes growing by 2% in 2014 and 2.9% in 2015. Lower actual growth would affect the legal services market in turn.
The thirst for mergers may also be waning. Following a number of high profile acquisitions Australian group Slater and Gordon announced in February that it was calling a halt for mergers for the time being to focus on operational improvements.
Group managing director Andrew Grech said: ‘By compressing our acquisition programme in the UK into a shorter time frame we have given ourselves the opportunity to move more quickly to improving operational performance as we have been doing in Australia in the past 12 months.
What is the key to profitability for all practices going forward?
As we have seen from the change in Slater and Gordon’s strategy, operational efficiencies within legal firms are key to achieving sustainable profitability.
Whatever changes occur, whether to the external environment or internally (for example a change in specialism), it is crucial that legal practices ensure they are operating as efficiently and effectively as possible.
I’m interested in your thoughts around recent legal industry changes and how you think growth will be delivered over the coming months.
Has your legal practice increased its margins through a change in strategy? What systems do you have in place for monitoring profitability? Which factors do you think will be most important or influential for legal sector growth over the next few years?