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4 February 2014

Economic progress won’t delay the need to reform the legal services industry

There are many systemic problems in the sector - too many lawyers, too many firms - and the financial upheaval of the past 5 years has done little to slow things down.

By nigel knowles

As 2014 gets underway, it seems we are riding a wave of optimism brought about by positive economic data from the US and UK which has buoyed markets and persuaded the Federal Reserve to begin tapering its asset purchasing programme. The outlook appears bright for corporate deal activity too, with IPOs likely to continue the upward momentum of last year and M&A volumes expected to pick up significantly in 2014.

However, the story for legal services in 2014 is likely to be very different. 2013 saw a major shake-up in the legal services industry given a stay of execution. But the legal services sector as it currently stands remains unsustainable. Looking ahead to 2014 and beyond, it is hard to see the status quo remaining. Commercial law is a $300bn global industry. No single firm has more than 1 per cent of the market and this has to change. The sector is still remarkably fragmented: there are simply too many firms (and too many lawyers) offering the same services without any clear differentiation. Consolidation is an imminent certainty and, furthermore, I expect to see consolidation on an unprecedented scale.

The recent spate of good economic data shouldn’t fool anyone one into thinking that the good times have returned for legal businesses. Law firms that still believe that recovering economic conditions, increased corporate activity and better markets will come to their rescue are deluding themselves. Reform is not predicated on an economic downturn, but on commercial imperatives. Over the past decade there has been a fundamental shift in the dynamics of the industry. The financial crisis has only served to accelerate this trend and bring into sharper focus the systemic problems within the sector.

Analysing the changes that have taken place, the principal factor seems to be a shift in client expectations and requirements. Clients are more savvy and demanding – something which can be ascribed to a number of factors, including the consolidation of legal panels, a greater scrutiny on fees and the desire for global solutions (and corresponding global discounts). This trend is not going to recede and is rendering many firms’ business models obsolete. In addition, alternative business structures (ABS) and their one-stop shop offerings are taking business from the laps of other firms.

The firms that will emerge victorious will be either truly global or extremely niche. In the case of the former, firms that can offer a comprehensive suite of services across all regions will be in a strong position; however, there are many firms that claim to be operating globally but are in fact thin on the ground in many regions and will eventually be found out. Firms will have to be creative in how they structure themselves and how they motivate and retain their key assets – the human capital generating fees. Successful law firms are run increasingly like any other major corporation and those wishing for a place in the top league will need to streamline their management structures and employ managing partners specialising in running business, rather than dispensing legal counsel.

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Magic Circle firms are evolving too, as they are increasingly partnering with bulge bracket investment banks and focusing on major transactional work. For the rest, the pace of mergers is set to accelerate. Firms will merge to gain greater geographic exposure, particularly in the emerging markets of Africa and Asia, while the walking wounded will merge simply to survive or use to reduce costs. While the former strategy could be legitimately seen as being part of a convincing growth story, the latter type – the cost-cutting merger – is indicative of failing firms clutching at straws and such deals are likely to be increasingly frequent in 2014 and beyond. However, all is not doom and gloom. For the law firms that survive the Darwinian struggle there will be rich pickings to be had. Who knows, it may be that by the end of 2014 some of the larger law firms will have finally secured at least a 1 per cent share of the market.

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