Market winners: How law firms can gain a competitive advantage in China

Rob Millard explores the key factors that determine law firm success in China

Who will win the legal services game of competitive advantage in emerging markets? Will local firms sustain their client relationships or will international firms capture them?

This is the first of a two-part series exploring this topic. This first article deals specifically with China; the second will address other emerging markets.

Before the 2008 global financial crisis, the rationale for western law firms in China was clear. They focused on clients from home jurisdictions who were pouring foreign direct investment (FDI) into China. They relied upon expertise that was well beyond what the local firms could provide: entrenched relationships with western clients and, for some, global reach. Local firms found advantage in the prohibition on foreign firms practising Chinese law, lower cost bases and being local in a market where national pride runs high and cultural attributes are unique.

Things have changed. FDI into China has declined significantly since the crisis. In the medium term, multinational corporate investment strategies are focused on the wallets of the middle class that is expected to burgeon in Asia, but deal flow, for now, is stagnating. Some Chinese state-owned enterprises are investing in the west, but they are currently little more than cherry-picking bargains. As to skill and expertise, Chinese firms are rapidly catching up to the international firms. The market has become hypercompetitive.

Market developments

In 2011, a merger was announced between one of China’s largest law firms, King & Wood, and Australia’s Mallesons Stephen Jaques. Their reported intent is to achieve full integration by 2015.

Chinese firms have opened offices in several western countries, including the US. In the past year, Dacheng, Yingke and Zhong Lun have all established offices in London. Given the dependence of western firms on Chinese firms in China, the newcomers have been viewed more synergistically than competitively.

The offices appear to be outposts to serve Chinese clients in western markets. Whether they remain as modest in ambition remains to be seen. Many Chinese law firms have also set up offices in Hong Kong, where competition with western firms is more direct.

The ‘one country, two systems’ principle that applies in Hong Kong, '¨a former British colony, makes it a very different case to the mainland. Until the 1970s, only British Commonwealth lawyers could practise in the territory. Prompted by Richard Nixon’s visit to China in 1972, Coudert Brothers became the first US law firm to establish a presence there. In 1992, it also became the first foreign law firm to obtain a formal licence to practise law on the mainland, having established a representative presence there in 1979.

Hong Kong has seen an influx of US firms recently, but in the past decade or so has also seen some of those same firms close offices and leave. If the strategy this time round is driven by systemic changes in the world and the prominent role that China will play in years to come, then cyclical economic pressures may not cause those firms to abandon Hong Kong as quickly as last time.

UK-based firms point to their long-established presences as evidence that they have stayed the course thus far and will continue to do so. Both in Hong Kong and on the mainland, the battle for talent is intense. US firms have successfully raided high-profile partners away from UK firms. Part of the reason for this is that the US firms have simply offered more money, although in non-lockstep firms especially, more money comes at a price. Some partners who have moved to US firms have expressed a view, though, that they think US firms have a more general edge in China.

US involvement in China does have a higher dimension that probably works to the advantage of US law firms. Through both republican and democratic administrations spanning several decades, US foreign policy towards China has been one of engagement – over as wide a front as possible, as deeply as possible.

This includes in the legal profession. A range of US-sponsored legal conferences take place in both countries on topics related to China. Initiatives such as Peking University’s School of Transnational Law, which offers a US-style JD programme and a Chinese law Juris Master degree, with US faculty, are further evidence of this close relationship. So, too, are collaborative initiatives between the American Bar Association and its Chinese counterparts.

Conversely, the Lord Chancellor’s training scheme for young Chinese lawyers in England has had its funding terminated. Fortunately, it has at least partially been replaced by the new Bar Council training scheme for Chinese lawyers.

Freshfields Bruckhaus Deringer also announced in late 2011 that it was actively recruiting Chinese students at premier UK universities for law training and placement in their Beijing, Hong Kong and Shanghai offices. Such initiatives are vital. A steady flow of young English-qualified Chinese lawyers would go far in enhancing the competitiveness of UK-based global '¨firms in China.

US firms have less pressure. During the cultural revolution, many Chinese intellectuals and others fled from China to the United States. Now, a steady flow of their American-born, US-law qualified children are returning to practise law in their ancestral homeland.

Strategies for success

A law firm’s success in China or any other foreign market depends far less on the grand strategy of nations, though, than it does on that firm’s direct efforts and ability to sustain a profitable revenue stream from a critical mass of clients. Looking to the coming years for western law firms in China, one might suggest three key challenges.

1. Cultural empathy

A fine balance exists between what a firm needs to do to optimise the performance of any local office’s operation, and maintaining a common strategy and common standards across the firm. The more different a local market is to the firm’s home jurisdiction, the more difficult this is.

Cultural empathy involves far more than trying to avoid being inadvertently offensive in an unfamiliar culture. It is about developing a deep understanding about what is important in that market and sincerity in one’s dealing with people in that market. It requires that people go out of their way to develop local relationships, not just because that is what is required to do business and make money, but because they want to.

At the very least, in China as anywhere else, it is about taking the trouble to learn to speak the language, even poorly (although fluently is better).

2. A differentiated value proposition

Differentiation does not just mean being the same as competitors, but better. At its purest, it means doing things that no other firm can. If this is unrealistic, then that leaves the other traditional differentiators such as deeper relationships, wider understanding of the client’s business, better contacts in government to get things done, and so on.

A firm that cannot convincingly articulate why clients should prefer it '¨over its competitors should not expect clients to be able to do so.

3. A clearly defined strategy

Many foreign firms have set up offices in China without a clear plan of what they intended to achieve and how they will do it. Strategy is as much about what the firm will not do as about what it will do.

In small offices in far-flung corners of the globe, it is easy for an office to take on work that it should not, or to stray otherwise from the firm’s central objectives. Before long, differentiated '¨value propositions are blurred and then lost. This risk is greatest in firms where short-term performance is highly prized and rewarded. A western firm’s strategy in China needs to be carefully considered, tightly focused and accompanied by a detailed plan of action.

Long-term winners

As to who will ‘win’ in the long term, perhaps it is inevitable that local Chinese law firms will be the preeminent legal service providers in China. A good parallel to the difficulty that would be involved in '¨a western firm achieving this may be seen in how the very best UK firms have struggled to grow market share in the US and, similarly, how the very best US firms have struggled to do the same in Europe.

More important than focusing on ‘winning’ is to understand with immense clarity why the firm needs to be in China (or any other emerging market), and then to craft a strategy that focuses relentlessly upon achieving objectives that specifically discharge that need. Such an approach to strategy yields the greatest likelihood that one will, in one’s own chosen market space at least, successfully compete and sustain a profitable business.

 

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Evolution of a nation

China’s transition in just 30 years from governance by edict to the rule of law is as noteworthy as its economic miracle. 

Joseph Cohen’s 1919 book, The Law – Business or Profession?, notes that in China “a man who attempted to appear for another in a court of justice would probably render himself liable to a penalty under the clause in the penal code, which orders a flogging for any person, who excites and promotes litigation”.

Under the nationalist government of the early 20th century, efforts were made to modernise China’s legal system along western lines. These were short lived. In 1949, the communists came to power and installed a system loosely modelled upon that of the Soviet Union. 

By the 1950s, there may have been 800 law firms in China. Thereafter, the practise of law as a profession declined before being entirely eradicated during the cultural revolution of 1966-76.

China’s modern legal profession dates only from 1979. At that time, there were approximately 2,000 law firms in the country. By 2011, this had grown to roughly 200,000 licensed lawyers and more than 17,000 registered law firms.

China’s modern business law has generally followed western concepts. This '¨might be at least partially a response to what has been required by investors; an extreme example of such pragmatism being that Hong Kong law should apply to dispute resolution in Shanghai. (China has as a national objective that Shanghai '¨be the preeminent Asian financial centre by 2020.) 

It is naïve, though, to assume that China will slavishly embrace western models '¨of jurisprudence as its legal system evolves further. Like its economic and socio-political policies, its jurisprudence will likely evolve in ways that reflect the societal values and norms of its people. 

China’s views on the conduct of international trade is one such example. Eschewing the dollar as global reserve currency, bilateral trade agreements are concluded with the renminbi and the counterparty nation’s local currency. 

While western nations frequently make trade with emerging markets contingent on adherence to minimum standards of governance and human rights, China has traditionally applied the ‘five principles of peaceful coexistence’ (first articulated by premier Zhou Enlai in 1953) to its trade policies. These require, among other things, non-interference in each other’s internal affairs, to its trade policies.

Henry Kissinger, writing in the March/April 2012 edition of Foreign Affairs, warns of greater global rivalry emerging if China’s approaches continue to diverge from those of the “current world order”. It is unsurprising that China feels less constrained by that order, though, given that it had no involvement in crafting it. 

Relationships between China and the US in particular may become complicated, from time to time, as growth returns to western nations and China continues to exert its global influence both geopolitically and economically.

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robertfmillard@mac.com