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Top-tier UK law firm profits weakened by international offices

'Few firms are confident in their ability to manage pricing decisions successfully,' research finds

19 October 2015

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By Manju Manglani, Editor (@ManjuManglani)

The global offices of UK-based law firms are increasingly diluting their profitability, PwC research has found.

At the top-10 firms, UK profits per partner are now 74 per cent ahead of international partners, up from 66 per cent in 2014. This disparity rises to 88.5 per cent at top 11-50 firms, compared to 67 per cent in 2014.

The research found that top-10 firms have an average of 63 per cent of partners based outside the UK, but those partners deliver only 57 per cent of global fee income and 51 per cent of global profits.

"The strength of sterling against the euro has adversely impacted many firms' international performance on a Sterling basis - the basis upon which most firms distribute their profits to partners," commented David Snell, a partner and leader of PwC's law firm advisory group.

"However, the UK has enjoyed a more buoyant deals market, greater levels of regulatory activity and an active real estate sector."

Meanwhile, top-tier US firms (>£1bn fee income) continue to outperform their UK rivals. US firms reported average fee income growth of six per cent and profits of 10 per cent, compared to just two per cent and three per cent, respectively, among their UK counterparts.

Consequently, profits per partner at top-tier US law firms are now £1.5m, 36 per cent ahead of partners at the UK's top tier, which earn £1.08m. In 2014, the gap was 29.1 per cent.

The net margin at top-tier US firms is up a percentage point on last year, at 46 per cent, compared to 37 per cent among UK equivalents.

"Higher chargeable hours are definitely a contributory factor, but pricing differences also seem significant, with the much discussed change in corporate procurement habits witnessed in the UK market perhaps yet to hit the US," the report says.

Fixed fee arrangements and profit margins

In the UK, the gap between top-tier and mid-tier law firms is closing, the research found.

The number of law firms increasing UK fee income is higher than at any time since 2008. Fee income increased at 82 per cent of firms, compared with 70 per cent last year.

However, top-10 firms fared worse than all other bandings, with only half achieving UK fee income growth, compared to 71 per cent of top 11-25 firms and 89 per cent of top 26-50 firms.

Fixed-fee arrangements are becoming more prevalent outside the top-25 firms, among which 23 per cent of fee income was billed on that basis.

By comparison, nearly a third of top 26-50 fee income (up from 21 per cent in 2014) and 38 per cent of top 51-100 fee income (compared to 26 per cent in 2014) was billed on a fixed-fee basis.

There has also been an increase in contingent/performance-based fees, predominantly amongst the top 11-25 firms. These alternative fee arrangements now represent 15 per cent of the total, up from eight per cent in 2014.

"Where firms are sharing risk with clients, there is opportunity to benefit from a pricing premium for successful work; but what is clear is the need for partners to be equipped with the right management information, tools and training to lead effective pricing negotiations (and to be held accountable for their results)," the report says.

"Few firms are confident in their ability to manage pricing decisions successfully, and in particular, to take into account the estimated profitability of matters when making these pricing decisions."

Top 10 firms' UK net profit margins continued to significantly exceed other bandings, but the steady improvement of recent years has stalled, with the average margin broadly flat at 39.9 per cent.

Meanwhile the top 11-25 have built on their prior year's turnaround and nudged profit margins up to 29.2 per cent - the best margin recorded by that banding since 2009.

Mid-tier City firms, in particular, have performed well through "a combination of sensible lateral hiring programmes, M&A and a focus on cost control and key metrics such as chargeable hours," according to Snell.

Firms in the top 26-50 rankings recorded a slight profit margin improvement to 24.5 per cent (with a wide spread of performance).

Top 51-100 firms reported a notable deterioration in margin, from 24.1 per cent to 21.2 per cent.

Rise in cybercrime and technology investments

More than three fifths of top-100 UK law firms have suffered a security attack in 2015, up from 40 per cent in 2014, the PwC research found. The majority of incidents were due to phishing attacks on staff.

Research by Managing Partner has also found that, in the July-September quarter, there was a 46 per cent quarter-on-quarter increase in scam alerts to the Solicitors Regulation Authority.

Firms which were targeted for cybercrime last quarter include international law firms Clifford Chance, Berwin Leighton Paisner, Nabarro, Dechert and Bird & Bird.

Ninety-five per cent of respondents to the PwC survey plan to undertake major IT projects in the next 12 months to "improve efficiency".

Four fifths of firms recognise 'the need to respond to the digital age', but only 23 per cent have made changes to how they operate.

In addition, 82 per cent acknowledge that digital technologies (including social, mobile, analytics and the cloud) provide opportunities to improve the client communications experience. However, most have not yet enabled their websites or mobile applications to provide that level of interaction.

"Alongside economic improvement we see rapid technological change, innovation in business models and changing client buying patterns," commented Snell.

"The agile firms are not only responding to these factors, but beginning to anticipate the next likely developments. They are not alone: at the same time, new market entrants are bringing disruption to the market and fuelling the need to innovate.

He continued: "All of this will require significant investment and firms will need to consider how best to fund this, against the backdrop of a traditional 'full distribution' partnership model. For those who don't - or can't - respond to this change, the future will become increasingly difficult."

Participants in the survey include 80 per cent of the top-50 firms, as well as nearly 60 per cent of the top-100 UK law firms. The full findings are published in Law firms' survey 2015.




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