Law firms see income growth but new challenges on horizon

22 November 2018 6 min. read
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With the Big Four breathing down the necks of top firms, leading legal organisations may be weighing up changing their business models in the coming months. According to a new study, the distribution of profit per equity partner at UK law firms is currently outpacing revenue growth and the pay of staff, while fees per fee earner at the firms look to have plateaued, leading to questions of the sustainability of this practice.

The UK legal services market (including private practice firms, barristers, patent agents, and other legal services providers) was valued at an estimated £32.7 billion in 2017, an increase of 3.8% on the market value the year before. Despite the expansion of the market outpacing the UK economy over that period – which grew at just 1.8% – the legal services industry faces a period of uncertainty, and not just because of impending Brexit changes set to disrupt businesses across the spectrum.

Thanks in part to the legal scene’s performance in spite of a sluggish UK market as a whole, the world’s four largest consulting firms have long been said to have set their sights on expansion into the lucrative sector. The Big Four, consisting of Deloitte, PwC, KPMG and EY, have shown their ability to enter new markets and consolidate share, and by leveraging practice areas they already serve, the Big Four are gaining legal market share at a rapid pace by providing legal services in tax, finance, M&A (for lower value deals) and labour.

Percentage of firms that showed an increase in revenue

Judging by the results of global professional services firm Crowe’s annual law firm benchmarking, this interest is set to continue into the future, as regardless of the uncertainties around Brexit, the regulatory environment and the economy in general, the majority of law firms surprised both researchers and themselves by demonstrating revenue growth, while the majority of those firms also enjoyed improved profits. Now in its seventh year, Crowe’s 2018 survey collects a range of information pertaining to financial years ending in 2018, with participants ranging from larger law firms with more than £50 million in revenue to smaller firms with revenue of less than £10 million. Of those polled this year, 90% of city firms and 71% of regional firms experienced revenue growth, though this slowed from the 92% and 80% respectively seen in 2017.

At the same time, a sizeable chunk of 40% of city firms reported increases in revenue of more than 10%, while 50% saw growth of up to 10%. Regional firms again enjoyed slightly more muted results, but a large group of 28% still saw growth of more than 10%. These increases were accompanied by generous boosts to profit per equity partner (PEP) too. Last year, regional PEP averaged £197,000, while average city firm PEP was £209,000. Now, those figures have doubled to £407,000 and £440,000 respectively.

To what extent do you feel the threat of non-lawyers entering the legal market has been realised

Commenting on these surprisingly positive results, Louis Baker, Head of Professional Practices at Crowe, explained, “Understandably, uncertainty remains the key word in the industry this year. Given the protracted Brexit negotiations, this is not unsurprising… [But] this uncertainty appears to have encouraged most firms to focus on what they do best. The majority of participants are basing future growth expectations on expanding their existing market, rather than diversifying into new types of work.”

New threat

These are figures which will undoubtedly excite the Partners of the Big Four, and further fuel their appetite to make inroads into the legal sector. That appetite has already made a noticeable impact though, and a growing number of those polled now feel that the threat level by non-lawyers entering the legal market is increasing. While most regional firms have seen the level of threat from such encroachment remain steady, 20% suggest they have seen a ramping up of the threat, while non-legal competitors are yet to realise their disruptive potential.

While this might seem low, regional business is unlikely to be where the likes of the Big Four truly have their hearts set on when it comes to disrupting the legal sector. They will instead be looking to tap into the lucrative fare of the big city lawyers, and it is these firms which fear their presence the most. A major 44% of city firms believe the threat has increased, with a further 11% adding that the threat level has not only grown, but to some extent been realised, possibly as they lose market share to the newcomers.

How important are the following to your firm's strategy to achieve this

With a tightening human resources market, the arrival of new competitors adds to one key concern of the legal sector: the retention of high quality staff. Last year, respondents to Crowe’s poll said such retention was crucial for their future success. This year, respondents highlighted the best ways they thought they could engineer that.

Once more, regional and city opinions diverged slightly. Many regional firms felt they could still cash in on small town mentalities among their staff, and rely more heavily on their reputation than a competitive remuneration package. 72% said their reputation was very important to retaining staff, compared to 67% of those in the city. At the same time, 82% of city respondents said remuneration equal to the market rate was essential, compared to just 64% of regional outfits. Either way, however, both agreed that this was an important factor to gaining and maintaining talent.

Talent shortage

Despite this purported belief, however, the staff costs as a percentage of fee income at legal firms decreased across the UK in the last 12 months. City firms saw the portion of fees going to salaries reduce from 34.8% to 34.6% in 2018, while regional firms saw a more drastic fall of 0.7%. In the regional firms, this saw the average employment cost per head at firms fall from £36,700 to £36,200.

Staff costs as a percentage of fee income + Average employment cost per head

Though city firms saw the average employment cost per head increase by £100, the rapidly increasing profitability of legal firms and even simple inflation position the miniscule rise as wage stagnation. In this context, it would be unwise to assume that reputational prestige or the potential of career advancement without a salary to match will mean employees are unwilling to look elsewhere.

An ageing population and the possibility of continental talent drying up after Brexit mean that legal firms will need to do more than ever to keep hold of staff, or risk losing them to competitors offering an improved pay-packet. This is particularly clear, as these employees will also be aware that PEP rates are increasing substantially at their firms, suggesting they may do well to look elsewhere for more immediate opportunities.

Related: Big Four eye potential $30 billion boost via legal market expansion.