Consolidation now: The implications of the 'law firm merger mania

There is a higher level of consolidation in the legal market today than ever before and it is gaining pace. This consolidation is occurring at three levels: the global, the national and the local.

In the US, over 50 of the mergers reported in 2011 involved at least one firm in the AmLaw200; many were in the AmLaw100. In the UK, there were 11 mergers involving at least one top-100 firm last year. That may not sound significant at first, but it means over 120 commercial law firms – mostly in the world’s two largest legal markets – joined forces in one year, or ten per month. If that isn’t a sign of market consolidation, then what is?

At the global level, there have been more mergers and takeovers to launch foreign practices in the past two years than at any other time since the rush of US and UK firms into Europe in the late 1990s. What is more impressive this time is the scale of the mergers and their geographical breadth. Some recent examples include:

• Hogan & Hartson merging with ?Lovells – arguably the first merger ?of equals across the Atlantic; ?

• Ashurst linking to Australia’s Blake Dawson with an aim to merge in the near future;?

• China’s leading firm, King & Wood, merging with Australia’s Mallesons to create what could be a game-changing Asia-Pacific powerhouse; and ?

• Norton Rose merging with firms in Australia, Canada and South Africa ?to create a global firm of wholly ?new dimensions.

The list goes on and it would fill this article just to name all of the deals, let alone all of the partner teams hired to launch foreign offices, such as those by Clifford Chance and Allen & Overy in Morocco last year.

On a national scale in the UK, there was also plenty of activity in 2011. Recent examples include:

• Clyde & Co merging with Barlow Lyde & Gilbert;

• DAC merging with Beachcroft;

• Martineau merging with Sprecher Grier; and

• Shakespeares completing four mergers in the past 18 months.

Even at the Bar – a traditionally more conservative side of the English legal profession – there have been national mergers and the creation of a new ?largest set in the shape of St John’s Buildings in the North West which, ?after two regional mergers, now has ?over 200 barristers.

And then there is the local high street. Change here is only just beginning in 2012, but will increase rapidly. The market consolidation is not just driven by ‘traditional’ law firms. Change will also be driven by the Legal Services Act and its powers to create Solicitors Regulation Authority-regulated alternative business structures since January 2012.

A flat conveyancing market, cuts to legal aid fees and the difficulty for small firms to compete against the likes of new entrants such as Co-op Legal Services and other growing legal brands all signal the beginning of huge competitive pressures.

Some high street firms will merge defensively, others will be taken over by new entrants and, sadly, many more will simply go out of business. The closure over the coming years of many smaller firms will in itself create relative consolidation due to the reduction of legal businesses sharing the same legal segment.

Reasons for consolidation

The reason why consolidation would happen at the high street level is understandable. But, the reasons for the national and global merger surge are perhaps less obvious. A preliminary look may show these far larger firms still apparently delivering significant profits to their owners, the equity partners. But, success is relative to one’s peers and the larger firms are operating in a more competitive environment.

Client pressure on fees is having a significant impact on production costs and that harms firms that are too small to wield significant leverage or to invest in new means of production. As the struggle to boost revenues increases and competition mounts, a growing number of firms are seeing that the only way to improve their future market position is to merge.

For the law firms with clients that are expanding abroad, globalisation has become both a challenge and an opportunity. Lawyers must service their clients’ needs or risk losing them. Following clients abroad offers partners a chance to increase their share of the client’s legal spend and maintain high levels of premium work that resists pricing and commoditisation pressures.

However, expansion abroad can be costly and, for firms that are not as large as the magic circle, mergers are often a logical response. Also, once merged, having more equity partners can lower the cost per partner of any future investment the law firm makes, such as integration or new office costs.

For national or regional firms, there are also strong geographical benefits to mergers. Companies continue to merge and expand within national borders and this provides the opportunity for advisers to grow with them. Larger firms can offer a more complete service to clients, build deeper relationships and cross-sell more practices.

However, even more so than global law firms, they are faced with the very real challenge of commoditisation and client pushback on fees for standardised or process-based work. Size will matter to clients that want to see capability to handle both the labour-intensive process work and the premium work.

Size delivers greater leverage and, if managed well, can enable firms to exploit economies of scale, while still offering clients higher-value work. With more and more clients reviewing their external legal needs and reducing the size of their legal panels, it becomes imperative to show the depth and breadth the client requires or risk missing the cut on a panel review.

Economies of scale also help to reduce back office costs, as large firms do not necessarily need exponentially more support infrastructure than smaller firms. A merger also creates a bigger brand in a market that is still very much populated with largely undifferentiated firms whose client base is increasingly less loyal to any particular adviser.

On the horizon

Is there a limit to consolidation and, if so, are we close to it? Go back a few decades and many lawyers would have claimed that the global firms of today with many hundreds of partners would already be impossible to operate without major conflicts, management breakdown and general chaos breaking out inside the partnership. And yet, law firms keep merging and growing larger, year on year.

Ironically, it is often the smaller, more loosely-managed firms that tend to fall apart, not the larger firms that take a more business-focused and corporate attitude to running a law firm.

Each segment of the market will be different, but potentially there are massive amounts of future consolidation possible. The largest global firms now wield around 500 partners around the world. Clearly, the UK-based ones are not focused on a merger with other top-tier UK firms. However, they may look for mergers in America, Australia and perhaps via a Swiss verein system with a Chinese law firm or other emerging market firm. Such firms could move into the 1,500 partner range over the next ten years.

There is a sufficient number of global companies to support such ‘mega’ law firms, particularly as nations such as China, India and Brazil produce more Fortune Global 500 companies of their own. Yet, such mega law firms would still remain small compared to the ‘big four’ accountants that are perhaps the pinnacle of professional services consolidation (and to some represent overconsolidation).

For example, PricewaterhouseCoopers has global revenues of around US$29bn (£18.1bn). A law firm combination between a magic circle firm, a top-20 US law firm and perhaps additional mergers in China and Australia would still only produce a law firm with revenues of around US$5bn (£3.1bn), with perhaps 7,000 lawyers in total. This would be quite small compared to many businesses operating at the same global level.

The point for the global firms will not be to grow massively in their home markets; in fact, there may be a reduction in partner numbers in mature home locations such as London. Rather, the aim will be to build a firm that has strength and depth in every major jurisdiction where its clients have significant, high-risk and high-value legal needs, with each office suited to the scale of the legal market there.

At a national scale, there is just as much potential. Consider this: out of the top 100 largest law firms in the UK by revenue, nearly 60 per cent have 50 or fewer equity partners. Of these, around 20 have fewer than 20 equity partners. After a couple of team moves, one may not even have much of a firm left.

By the standards of some sectors, these are still cottage industry scale businesses. And yet, the UK is the second largest legal market in the world, with £23bn annually spent on legal services. There seems to be a disassociation between market size and firm size, but this appears to be reducing now.

Consider this too: the top-100 law firms in the UK earned £14.3bn in revenues in 2010/11 – or well over half of the nation’s total legal spend (although this figure is significantly inflated by the leading firms’ international practices). And yet, despite this massive sum, 80 of the top-100 firms have less than one per cent market share of this £14.3bn. The firms that sit between 70 and 100 have even less, and none of them has more than a 0.2 per cent share.

This appears to be an incredibly unconsolidated market. By way of comparison, the ‘big four’ accountants receive 74 per cent of all money spent on the top-50 accountancy firms in the UK. While it is true that at the lower end of ?the accountancy market there is also ?a high number of small firms, the upper end dwarfs the consolidation of the ?legal market.

One reason many give for this lack of consolidation is conflicts. Clearly, legal conflicts do exist. There may also be perceived commercial conflicts. Some large corporates are excessively possessive about their legal advisers and will not let them advise competitor companies. Conflicts issues can result in some partners having to leave the firm, or a handful of major clients referred to rivals. Painful, yes. But a reason to abandon a merger that secures the firm’s future? ?Not in most cases.

But, perhaps the last and the best reason for merger, at least for the entrepreneurial management team, is that markets are what you make of them. There was never any rule that a firm must stay where it is. Law firms, like any business, can within reason be taken where their management want them to go. Clients must always come first, but no firm must sit in its corner of the market and passively watch the world develop around it.

Naturally, expectations have to be realistic. A firm at the bottom of the top-100 cannot expect to challenge the magic circle though a series of mergers. But, such a firm could realistically become a powerful presence in the UK and internationally that benefits from economies of scale, greater brand impact and lower costs per equity partner.

---