Colonising London: The US law firms that are conquering the London legal market

US law firms have been a prominent feature of the London legal sector for many decades. The City of London is undisputedly one of the top three financial centres in the world, together with New York and Hong Kong. English law is the most popular choice of governing law worldwide, especially for cross-border matters. The London Court of International Arbitration (LCIA) is universally recognised as one of the world's leading arbitral institutions. The United Kingdom has a regulatory framework that is very welcoming to international business, with the result that, in 2014, the country was the fourth-largest recipient of foreign direct investment (FDI) globally, after China, the United States and India.

Nearly 100 American law firms have established offices in London. These range from global firms like Latham & Watkins (the 2014 leader in London with $210.6m in revenues), White & Case and Baker & McKenzie down to offices that comprise little more than a lawyer or two and a proverbial brass plate on the door. The number of lawyers practicing in US law firms in London grew from 2,876 in 2004 to 4,362 in 2009 to 6,327 in 2014, according to The American Lawyer. This constitutes a compound annual growth rate (CAGR) of 8.2 per cent over that period.

Hardly a year goes by without another US firm or two setting up shop in the City. In 2014/15, Cooley and Jenner & Block joined this well-trodden path. Rumours abound of others poised either to do so too or to bulk up their current presences. More than half of the AmLaw 200 law firms do not yet have a presence in London.

Over the past decade, there have been some major transatlantic law firm mergers. Several, like DLA Piper, Hogan Lovells, Dentons and Norton Rose Fulbright may be characterised as true 'mergers of equals' and have created (with other simultaneous or subsequent combinations) some of the largest law firms in the world. Use of the verein structure, pioneered by the 'Big 4' accounting firms and Baker & McKenzie, has allowed post-merger integration to be tackled over a longer period and less rigidly than is typical with traditional 'one-firm-firm' combinations. In some cases, these mega-firms have no plans to integrate
profit pools.

US firms that have either entered or significantly bulked up in London over the past decade or so through more conventional mergers include:

• Mayer Brown and Rowe & Maw in 2002;

• Jones Day and Gouldens in 2003;

• K&L Gates and Nicholson Graham & Jones in 2005;

• Reed Smith and Richards Butler in 2007;

• the now Edwards Wildman Palmer and Kendall Freeman in 2008;

• McGuire Woods and Grundberg Mocatta Rakison in 2009; and

• the now Squire Patton Boggs and Hammonds in 2011.

Mid-tier strategy

In the years following the global financial crisis of 2009, mid-tier UK law firms had to cope with a sharp contraction in commercial work, especially related to real estate and corporate finance. This led to speculation that the London market may experience a new wave of defensive combinations with US law firms. However, this has not materialised. The mid-tier legal market in London has recovered, with 2013 being the best financial year for them since before the global financial crisis; the figures so far for 2014 are also looking positive.

Although the pressure has diminished, mid-tier UK firms are not complacent. Client concerns about price, lack of scale, the future of legal services generally and other competitive issues are bringing new pressures to bear. Legal sector surveys indicate that many such firms remain open to merger possibilities.

For some of these law firms, the main thrust is the strategic response to the recovery has been to look outside the UK for new business. Some see opportunities in Europe. Projections for growth in GDP per capita and the emerging middle class have underpinned enthusiasm for Asia.

The increasingly global nature of their most important clients, and even some medium-sized corporations, have also supported the case for international expansion - if the assumption is accepted that clients generally would prefer to have a smaller number of law firms service their needs across multiple jurisdictions. Research amongst in-house counsel is somewhat ambivalent on this issue and some law firms have found that their forays into Europe and Asia have not delivered the results anticipated in their business plans.

In pursuing this strategy, though, a link-up with a US law firm that already has a network of international offices would seem a sensible step. Building an international presence from scratch is a slow and expensive process and such a merger would also deliver the 'Holy Grail' that has driven many transatlantic merger discussions over recent years, at least from the UK perspective, of stronger access to the domestic US legal market. In 2015, this market is estimated to be roughly $300bn, compared to roughly $45bn in the UK.

US law firm strengths

For US law firms, the imperative to grow
in London is more incursive than defensive. In several important ways, US law firms enjoy a competitive advantage in London
at present and they have not been slow
to capitalise on this.

The US economy is recovering more rapidly than many other parts of the world. Underpriced assets in the depressed markets of Europe have US corporates exploring investments there and London
is traditionally a popular city from which
to establish a beachhead into Europe.

European banks have remained far
more risk averse than US investment banks as the world has emerged from the global financial crisis. US capital markets have
also recovered faster than Europe's, and
cash-starved European corporates are turning to both of these as sources of funding. This has obviously been to the advantage of the US law firms, which
have entrenched relationships with the
US institutions involved.

Finally, the US dollar has performed well over the past few years against the sterling and even more so against the euro. The UK law firms have generally more exposure to the Euro than US firms, so the profitability divide between them has widened. It is now probably so wide, especially amongst the premium firms, that a transatlantic combination of premium law firms is
probably unlikely for the foreseeable future
- especially between firms employing lockstep compensation systems.

Market positions

We have assessed the relative market positions of the major US law firms in London, using revenues per lawyer (RPL) as the primary metric. This is a 'cleaner' indicator of both productivity and relative
fee levels than profits per partner and is
also more easily derived from data
submitted to Companies House.

Against this, we have assessed the relative bench strength of the firm's practice in London, which we measure in terms of what we call 'talent intensity'. This is defined as the number of Chambers & Partners rankings (UK-wide and London, in this case) awarded to lawyers in the office, divided by the number of partners. The results of this analysis are presented in Figure 1.

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FIGURE 1: TALENT INTENSITY VS RPL FOR SELECTED US LAW FIRMS IN LONDON IN FY 2013/14

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Given the lag time between the release of Companies House data and Chambers & Partners publishing its league tables, some firms will have recently gone up or down in terms of their talent intensity, because of lateral hires or departures. We have listed the firms which made partner-level lateral hires between 1 July 2014 and 30 June 2015 in Figure 2.

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FIGURE 2: PARTNER LATERAL HIRES BY US LAW FIRMS IN LONDON FROM 1 JULY 2014 TO 30 JUNE 2015, INDICATING NUMBER OF CHAMBERS-RANKED LAWYERS AND PRACTICE AREAS

Source: Edwards Gbson "Lateral Partner Moves in London"

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We have also assessed the correlation between RPL and scale, measured in various ways (see Figure 3) and compared the RPL of the firm's London office against its firmwide RPL (see Figure 4).

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FIGURE 3: STATISTICAL CORRELATION BETWEEN RPL AND OTHER METRICS FOR SELECTED US LAW FIRMS IN LONDON, 2011-2014

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FIGURE 4: COMPARISON BETWEEN AVERAGE LONDON VS FIRMWIDE RPL IN SELECTED US LAW FIRMS IN LONDON, 2011-2013

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Statistical analysis of RPL against the other metrics has yielded the following
key findings.

• Almost all the scale-related metrics
  (fee-earner headcount, partner headcount, gross revenues) correlate negatively with RPL. Generally speaking, in other words, the larger
  the firm, either in headcount or in revenues, the lower the RPL.

• Correlation with profits per equity partner (PEP) is more complex
  because leverage has to be incorporated. Interestingly, though,
  our analysis shows that increases
  in leverage show a positive (though weak) correlation with RPL. This may indicate that firms with greater leverage are able to deliver services more cost effectively and therefore win more work, counteracting the dilutive effects of lower average office-wide rates by increasing average utilisation. Leverage, along with utilisation, margin and rates, is one of the four traditional levers for increasing PEP (along with shrinking
  the equity pool, of course).

• The two metrics that correlate most strongly with RPL in London are: 

1. The RPL being achieved across the firm; and 

2. The bench strength of the legal talent in the office.

In Figure 1, we divide the range of firms illustrated into four quadrants, above and below the medians of the X and Y axes. Especially when read together with Figure 4, this makes for interesting comparisons.

The four quadrants

Quadrant A - Higher talent intensity;
higher RPL

The London offices of US law firms in Quadrant A are in the top 50 per cent, both by talent intensity and RPL. With the exception of Latham & Watkins and Quinn Emanuel, they are all based in New York, with a heavy emphasis on finance and capital markets.

Milbank Tweed has invested significantly in developing a range of competencies in London that project the firm's core strengths in New York into London. Latham & Watkins has, over the past years, built up a formidable transatlantic finance team.

Davis Polk has been steadily building up its premium English law capabilities and Quinn Emanuel's credentials in litigation require no recitation.

Weil Gotshal and Simpson Thacher have developed market-leading private equity and related finance capabilities. Skadden has a very strong corporate M&A position, in particular, mirroring its firmwide core strengths.

Quadrant B - Higher talent intensity;
lower RPL

The London offices of these firms have relatively high talent intensity, but RPL below the median for the sample. There are several reasons why this may be so, for instance:

• lawyers are Chambers-ranked in
  less lucrative practice areas;

• utilisation is lower than it should be;
  and/or

• inefficiencies are leading to lower
  fee recoveries.

There is a wide RPL range across this quadrant, though, from roughly $700,000
to $1m per annum.

Quadrant C - Lower talent intensity;
higher RPL

Some of the finest US law firms fall into this quadrant, achieving high RPL in London, despite having a lower talent intensity. Sullivan & Cromwell is surprising, especially because its RPL in London is greater than the firmwide average.

Gibson Dunn's and Kirkland & Ellis' talent intensity would be somewhat higher now, given recent lateral hires and the stellar capabilities that they have built up as a result, especially in private equity and restructuring.

Some firms in this quadrant may also score lower in talent intensity, simply because their partners place less importance on being ranked by the league tables.

Quadrant D - Lower talent intensity;
lower RPL

The positive correlation between talent intensity and RPL is greatest across the 14 firms that fall into quadrants B and D. Read together with the strong negative correlation generally between scale-related metrics and RPL, this suggests that the best avenue to enhancing RPL in London would be to focus tightly on increasing talent intensity (i.e. the number of partners that secure Chambers rankings).

This is especially true in high-value areas; firms in these quadrants should perhaps even scale back on lower-value areas or the areas in which they do not enjoy pre-eminence and which do not align well with their firmwide strengths. This may be especially true for firms that are recent products of transatlantic mergers, where legacy practices with poor strategic alignment to the firm's core strengths may still persist.

Five London strategies

At a generic level, US law firms seem to be pursuing one or more of five strategies in their London office:

1. a full-service offering, targeting any business in London (including US clients of the firm) and offering both English and US law services;

2. a targeted offering aligned with a firmwide practice, industry sector or other specialisation and offering both English and US law services;

3. a small office mixing US and English law or offering only English law advice, focused on servicing the specific needs of US clients in London/Europe;

4. an office practicing only US law for US clients (up until about 10 to 15 years ago, this would have been a fair characterisation of most US law firm offices in London); or

5. a representative office that practices little law at all in London but maintains relationships with clients and referral sources, channelling work back to the US offices.

Further differentiations that may be identified include:

• using London as a springboard to project English law capabilities to other parts of the world (especially the rest of Europe, the Middle East and Africa);

• using the provisions of the Legal Services Act to experiment with business structures and service offerings that are currently not permissible in US jurisdictions; and

• establishing practices focused on arbitration and other forms of alternative dispute resolution.

Different law firms have also adopted different strategies in establishing their presence in the London market and then growing it. Here, the key differentiator is between firms whose growth has been driven by a carefully-formulated plan that ensures that the London office supports and, in some cases, even drives key aspects of their firmwide strategy, and those whose growth has been more opportunistic.

To emphasise, our analysis shows that increasing scale for its own sake is negatively correlated with economic performance. In other words, as a general rule, growth for growth's sake is more likely to be dilutive to firmwide profitability.

London lateral hires

The leader of a prominent US law firm in London (whose strategy falls most certainly into the carefully-planned approach) commented to us recently that an opportunistic approach to lateral hiring usually leads to recruiting lawyers who:

• will move on as soon as they get a better offer elsewhere;

• are leaving magic-circle firms whose client relationships are well institutionalised (so their projected
  book of business is overstated); or

• are frankly not as good as their colleagues in the US offices and are therefore unable to develop trust and solid collaborative relationships with those colleagues.

One specific example of this phenomenon occurs when a firm 'bulks up' its headcount in London with lawyers who do have portable books of business, but in areas or with clients which are not core to firmwide strategy, simply to generate cashflow while the office develops.

This may seem justifiable at least from an accounting perspective, or perhaps because a local book of business is at least evidence that the lawyer can win clients. However, the risk of 'strategy creep' and the London office ending up misaligned with firmwide strategy may be severe enough to negate the benefits of short-term cash. This point is obviously as relevant to any remote office as it is in London.

London strategy tips

From the above, we deduce the following general principles for US law firms (and arguably also other international law firms) seeking to enhance their performance in London. Some of these may be intuitive but, given the frequency with which we see them being ignored, they deserve repetition.

1. Alignment of the strategy of the London office with the firmwide strategic objectives is crucial.

2. The scale that is required for critical mass needs to be achieved as quickly as possible, but growth thereafter needs to be carefully considered and deliberate. Talent should be added which is a good 'fit' both strategically and culturally, rather than being opportunistic. A smaller, tightly-focused office will almost always deliver better economic performance.

3. Consolidation is a fact of life in today's market and several US law firms have entered the London market through mergers, or used a merger to develop scale. In the case of large-scale combinations, it is important to evolve the talent composition as quickly as possible to a model that reflects the quality and the firm-wide business model - unless a deliberate decision is made to develop the London office along different lines. The latter may especially be the case where UK/European clients are being targeted, especially clients with significant interests in the USA where the strategic intent is to advise those clients in the USA too.

4. Hiring lawyers with books of business that are poorly aligned with firmwide strategy can be risky in that it can
   induce 'strategy creep' and be dilutive
   to performance.

5. The opportunity to use London to project English law capabilities across other geographies is often underestimated.

London strategy pitfalls

Two pitfalls exist that are not directly related to the analysis presented in this article, but that US law firms should heed when considering their strategy in London.

1. Brand recognition does not necessarily transfer well across the Atlantic. Even when a good relationship exists between a US law firm and a US client back home in the United States, that client may not instruct the London office of the same US firm, given the range of English alternatives available. This phenomenon also explains, to an extent, why UK law firms have had difficulty penetrating the US market, except through mergers that are significant enough for US clients to at least view the US component of the combined firm as American.

2. Collaboration between the London office and the firm's other offices is absolutely crucial if client relationships are to be effectively leveraged. It is surprising
   how poor the referral streams can
   be between partners in different
   offices of international law firms.

Future issues

The world remains a volatile place and there are many factors at work that could change the competitive dynamics between US and UK law firms in London, at least in the medium to long term. In particular, the re-entry of the 'Big 4' advisory firms to the legal market and the growth of alternative business structures generally may generate change that is not yet visible.

In the short term, though, the US law firms seem to be enjoying fairer winds and firms that are able to trim their sails best
to benefit from them are likely to continue
to prosper.

Rob Millard is a partner and head of the strategy practice at Møller PSF Group at Churchill College, within the University of Cambridge (robert.millard@mollerpsfg.com). Edward Hunt is an analyst in the
Møller PSFG strategy practice
(edward.hunt@mollerpsfg.com).