Gap closes between top and mid-tier law firms

The number of law firms increasing their fee income in the UK is higher than at any time since 2008, and has increased at 82 per cent of firms, new research has found.

PwC's latest survey of the legal sector has found marked differences in the fortunes of top and mid-tier firms. All bandings of firms reported increased UK profits per equity partner (PEP) in 2015 to varying degrees. Top 10 firms, however, fared worse than all others, with only half achieving UK fee income growth.

Results from the Top 11-25 firms stand out with a 17.2 per cent increase to £641,000, achieved predominantly through improvements in underlying profitability and with a fall of only 1 per cent in equity partner headcount.

Top 10 firms increased UK PEP by a marginal 3.5 per cent to £1,067,000, but with an average 5 per cent reduction in equity partner headcount a major contributing factor.

Though UK net profit margins at the Top 10 continue to exceed other bandings, the steady improvement of recent years has stalled, with average margin broadly flat at 39.9 per cent. Meanwhile the Top 11-25 have built on the previous year and have pushed profit margin up to 29.2 per cent.

A number of firms within this bracket have reaped the benefits from mergers and lateral hiring programmes in recent years. Firms may continue with these approaches to capitalise on economies of scale and refocused growth strategies.

For firms in the Top 26-50 bracket, a slight improvement to 24.5 per cent leaves them significantly adrift of the larger players. The banding has reported an 8 per cent increase in UK headcount, with their high staff cost ratio presenting a competitive disadvantage from a margin perspective.

David Snell, partner and leader of PwC's law firm advisory group, explained that the 2015 survey is set in the context of a recovering UK market, but with ongoing, challenging macro-economic conditions for global law firms.

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

'These factors are reflected in our survey, which shows a somewhat disappointing performance from the Top 10 firms, while at the same time a resurgent Top 11-25, who seem to have refocused their strategic intent.'

Snell added that mid-tier City firms have performed well in particular through a combination of sensible lateral hiring programmes, mergers and acquisitions, and a focus on cost control such as chargeable hours.

'However, a slow-down in litigation and difficult conditions in some industry sectors have been a drag on performance for some in the Top 26-50,' he remarked.

Other key findings from the survey include a finding that clients are increasingly seeking favourable alternative fee arrangements, with fixed fee arrangements becoming more prevalent outside the Top 25 firms.

There has also been an increase in contingency-based fees, predominantly among the Top 11-25, which now represent 15 per cent of the total.

Some 80 per cent of firms recognise 'the need to respond to the digital age' but less than one in four have made changes to how they operate.

Four in five firms acknowledge that social media, mobile, analytics, and the cloud will provide ways of interacting with clients, yet most firms have yet to enable their websites or mobile applications to provide the requisite level of interaction.

The war for talent in 2015 brought disruption to reward strategies, particularly among larger firms. US firms in particular are recruiting aggressively, and lateral moves between firms are widespread.

The survey also reports modest growth in UK fee earner headcount in response to increased activity levels.

'This year's survey shows a sector that is continuing to evolve, with the pace of change beginning to pick up as global economies improve,' added Snell. 'Alongside economic improvement we see rapid technological change, innovation in business models and changing client buying patterns.

'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.'

Snell concluded by saying that all of the above required significant investment and firms will need to consider how best to fund this, against the backdrop of the traditional partnership model.

'For those who don't - or can't - respond to this change, the future will become increasingly difficult.'