Apocalypse now

The UK legal market today has 9,000 legal practices, 150,000 lawyers and is worth £20bn. It is a world-leading, dynamic, fragmented and successful part of our service-based economy. But dig a little and you'll find that this is not necessarily the case. Ask a partner in an average legal aid practice about the profitability and sustainability of their practice and you're likely to be faced with a deeply furrowed brow. Ask the finance director of a top-20 law firm about its underlying profitability and you might be surprised. Headline profits may be better than ever, due to the current merger and acquisitions (M&A) boom, but the ratio that really matters '“ revenue per lawyer '“ is actually now lower in real terms than it was in 2002.

The market is over-lawyered. There are now twice as many lawyers in the UK as there were in 1987. Even allowing for the remarkable growth in the industry over the last 10 years, there are too many lawyers, particularly qualified solicitors, chasing less and less work per capita. Add to this the fact that the government believes the consumer is being poorly served and you have two compelling triggers for a wholesale shake-up. This is what the Legal Services Bill is all about.

Ninety-five per cent of those 9,000 practices have fewer than 10 partners. They are very small businesses, employing fewer than 50 per cent of all lawyers. That is just eight lawyers, on average, for every small practice. By contrast, fewer than 450 so-called medium to large firms, those with between 10 and 500 partners, employ 33 per cent of all lawyers '“ the remaining 20,000 lawyers are employed as in-house counsel '“ each with an average of 120 lawyers. The giant, 'global' firms employ almost 20 times this number in the UK alone. This does not include organisations like Halifax Bank of Scotland (HBoS) or Countrywide Property, which also employ many hundreds of lawyers between them in the provision of consumer legal services. Has there ever been a more polarised market?

Consolidation of firms

This over-capacity and polarisation, combined with the Legal Services Bill, means there will be unprecedented levels of consolidation in the next few years. Predictions vary, but between 10 per cent and 20 per cent of the 8,500 small practices could disappear altogether in the short-term. That's 850 - 1,700 practices; or to put it another way, 10,000 lawyers. Even the banks estimate that they could withdraw their support from as many as 1,500 firms. This is not scare-mongering: it is a clear signal that you need to take action now. If small legal aid firms wish to retain a slice of the government's diminishing legal aid cake, they will have to accept there will be fewer legal aid contracts awarded to fewer, larger 'preferred suppliers'. And these firms will win such contracts through the process of a 'best value' tender.

This is undoubtedly the time to turn a threat into an opportunity. Right now, there are people plotting new ventures, which are designed to take advantage of deregulation (or re-regulation?). Some of these new entrants are obvious: the Co-op for example. Others will take you by surprise. They have deep pockets to go with their big brands, think Virgin, Easy and AA.

The answer is to embrace your own destiny and take control of it. There will be a good many opportunities to be a driving force of the M&A activity at the smaller end of the market. But the choice is stark: lead the charge or become a victim of it. Whichever it is will be, in part, determined by the answer to the following three questions: How profitable is the firm? In which market do partners wish to operate in future? Of what sort of business do they want to be a part?

Then there is the so-called medium sized law firm, the firm with 10-30 partners. Here, the picture is much the same: there will be upward pressure over time. As groups of 5-10 partner firms merge to create larger practices, gradually shifting their market positioning, some will want to enter the domain of the medium- sized law firm. They will slowly encroach on that client base. This, in turn, will cause further consolidation in the 10-30 partner section of the profession (already the fastest consolidating area in the UK). The result? A greater number of large firms with 50-plus partners is likely to appear. Competition will stiffen here too as the effects of consolidation move up the food-chain. The only firms likely to remain unaffected by all of this are the top 10-20 firms with 100 or more partners. These firms operate at an international, institutional level.

Long-term strategy

Small and medium-sized law firms will need to have a clear and realistic medium to long-term strategy for their business. Certainly the banks will be unprepared to help unless this is the case. Firms will need to know exactly where they are now, who their competitors really are, how they intend to compete with them and how they can become truly superior to them. Above all, they will need the wherewithal to provide superlative customer service. Virgin, the Co-op, the AA '“ they all do customer service. They also understand that value for money is determined by the consumer; not by the provider!

So, where should firms begin? Firstly, take a reality check and establish how the firm compares with others. Is it as profitable and successful as peer firms?

If a practice is in good financial shape and commands a leading position in its part of the market, aggressive growth may be the right approach. But how will this be funded? Can it rely on the bank or does it need to adopt an alternative business structure to widen its ownership and attract new capital and management? If the business is robust and has strong management with a clear strategy, it is unlikely that a bank '“ increasingly discerning though it may be '“ wouldn't provide the financial support. Careful thought is therefore required before changing the ownership structure. If a firm is not so strong, but still wishes to grow, it needs to put a plan in place to ensure rapid profit improvement.

Whether the firm is in good shape or not, it may be concluded that M&A is the right strategy for survival. Clearly, the dynamics would be different for a profitable, leading player than for the marginal, struggling firm. However, there are still decisions to be made: Which firms are the right targets for the business? Are they likely to be smaller or indeed larger than the firm? Where are they located? Are they even a law firm? What would the merged entities bring to one another? And how does one set about starting a dialogue with those firms?

Alternatively, the strategy might be more radical. For example, the development of a franchise operation might be suitable in some parts of the market; perhaps even the development of 'white label' legal services, which is marketed through a third party. Again, however, the same question applies: which firms would be the right ones?

Now, let's assume that a firm has identified the right strategy and finds what appear to be the right commercial partners with which to join forces and attack the market. Many due diligence processes focus on financial issues at the expense of other critical issues. It is absolutely vital that culture, people, strategy, clients and operational risk are also thoroughly analysed for strategic rationale, compatibility or indeed skeletons in the cupboard. This requires an holistic approach to due diligence. Conducted
properly, it will make the ultimate process of transition and integration much easier.

Prior to creating a new legal practice or a newly merged entity, it is important to establish a clear vision and a realistic plan of action. The new business will need a strong sense of momentum in order to implement change effectively. Those who underestimate the need for planning '“ and for consultation, patience and communication '“ will find it more difficult. Changes have to be prioritised. Client-related changes should take precedence with other big changes, like technology or premises, being implemented on a phased basis over the longer-term.

For many years, research into the success of mergers has found that a significant majority (approximately 70 per cent) failed to meet the expectations of the merging parties. In know-how-based businesses it is especially important to invest sufficient time and effort in post-merger implementation plans. One of the keys to success is the involvement of as many people as possible in the process. They must have a clear sense of what the benefits of the merger are. After all, they are the brand. If some of the investment funds are ear-marked for brand awareness campaigns, the last thing a firm needs is the brand being undermined by its people at the point of purchase. Competition is set to intensify. The basis of competitive advantage will become all too apparent to more and more firms whichever part of the market they occupy. Their offering will need to be unique, positively different, or simply cheaper.

The legal market has seen a good deal of development over the last 15 years; however, it is my belief, that the next five years could bring change of a seismic nature. There may well be 40 per cent fewer firms by 2012, possibly even half the number. There will also be fewer partners and possibly (despite current trends) fewer solicitors in the longer term, but there are certain to be more legal executives. Practices that have not already started thinking like a business should not delay and should take decisive action now to become visionary, innovative, bold, courageous and determined. There is no time to waste. The time to act was yesterday.