Squeezed middle: What law firms can learn from accountancy firms

When I started working over 35 years ago, the makeup of the accountancy market was markedly different from today. We had the 'Big 8' accountancy firms and a plethora of mid-market firms competing for clients. They tried to differentiate from each other by saying they were all 'partner led' and really interested in delivering superb performance to clients. In reality, the services they delivered for audit or other routine accountancy services were identical and their real skills were often around personal marketing, historic relationships and, increasingly, price.

The old-fashioned client, who appreciated you for your skills, your firm for its brand and paid you accordingly, was increasingly replaced by 'consumers'. You could tell the difference as they started each discussion with the question "How much
will this cost me?" So, the value of the
audit was suppressed each year and
the firms had to become increasingly focused on the process of delivering the service at a suitable price. We have seen
the consequential move of accountancy
firms towards becoming advisors as
opposed to bean counters.

Now we have the 'Big 4' dominating the accountancy space (and soon the
legal market?), with the 'Mid 3' (Grant Thornton, BDO and Baker Tilly) trailing some way behind, followed by a number of smaller firms. By the time we get to number 50 in the list, the turnover level has dropped to £12m. This change in the market did not happen overnight, but it did become inexorable as medium-sized firms realised they could not compete with the
largest players.

Why has this consolidation taken place in the accountancy space and what lessons does it have for the legal market?

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KEY ATTRIBUTES OF SUCCESSFUL FIRMS

• A clear strategic goal that is understood by partners and towards which everyone is aligned

• A common firmwide purpose which underpins short-term tactical decisions

• Positive investment in IT, marketing and training and development at all levels, with the next generation actively trained by the previous one to ensure continuity

• Commercially agile, with the ability to nimbly react to opportunities and threats

• Up-to-date with what competitors are doing well and responding to those challenges

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Disruption ahead

One wave of consolidation started with a few mid-tier accountancy firms seeking external capital and using this as a model to start 'consolidating' or 'integrating'. The bigger firms joined together for more global structural reasons and a number of stressed firms had to merge. We have even seen distressed takeovers most recently, with Baker Tilly picking up the failing RSM
Tenon business.

This concentration of influence and power in a few large firms has attracted much discussion around conflicts of interest and limited choice for clients, but it is the reality we now have. It has allowed super-specialist smaller firms to arrive - often using new working practices in order to remain competitive and relevant.

The legal sector is now facing a tsunami of change, with regulatory, commercial and technological waves all rising at the same time. The Legal Services Act has resulted
in the well-publicised arrival of commercially-financed organisations, although some are sceptical about the ultimate success of these new models. The reality is that these disruptive forces are not going to go away. This leads to the question of how the legal sector will respond to those challenges.

I recently attended a conference where a PwC partner explained to the audience how her team had reacted to an announcement by the government on limiting the numbers of people who they would allow to have work permits. This announcement would obviously have an effect on many of PwC's clients, so they decided to analyse the potential effect for each of their clients.

This involved seconding a substantial number of additional staff to the assignment so that, by the next morning, the general counsel at every client organisations had received a personal thought-leadership
note by email from the firm explaining the impact of the decision and how it may
affect their own business, enabling them
to immediately raise the issue with their senior management team.

To me, that demonstrated the real power of thought leadership. Imagine being the general counsel getting that note. You were immediately thankful, impressed and made
to look good to your superiors - all in
one move.

Someone then asked the question "who paid for that?" The answer was immediate: "no-one, it's all part of the service that we give to clients". It was an immensely powerful message and starts to explain why the largest firms can have a wider view on making material investments in terms of time and money in order to establish strong links with key individuals in organisations.

I am sure a number of law firms were equally reactive and proactive with their clients, but the message here is clear: in a world in which reaction times are getting increasingly faster, using IT and a joined-up approach will demonstrate to clients that
you do understand them and their needs.

The challenges are not limited to the way in which firms manage themselves. We will also see some external pressures become increasingly relevant, especially to mid-market firms.

The rise of in-house legal teams cannot be underestimated. Historically, the work done by lawyers was a mystery to many corporate clients and, as a result, they relied on their trusted advisors to help them when they needed. Whilst there was a cost, it was recognised as essential and there was always the fear of the unknown - moving to a new advisor who did not know the business was considered dangerous and risky.

But, in a world increasingly led by technology, it is now easy to use an internet search engine to quickly gain a general grasp of an issue. For larger organisations with an in-house legal team (which, for many, is a very small team) they can now start to shop around. They will look at law firm websites to see how good they are, start to disaggregate the advice they need and move from being a client to becoming a customer.

The lesson for law firms from accountancy firms is that customers buy services by price, whether by a fixed price for a defined job or by limiting hourly rates to reflect their buying power. These were
all painful lessons for the accountants
and the rise of in-house lawyers cannot
be ignored.

How will firms react in this changing world? Will they be light on their feet and speedy in their decision making? Unfortunately, the inherent make-up of professional service firms does not make that easy. In the traditional partnership (either unlimited liability partnership or LLP), governance is driven by a legal agreement setting out everyone's power. Important decisions are usually made by consensus with everyone having their say, which is not usually easy, particularly when structurally-important decisions are being made.

Some firms now have internal governance models, where management teams are given wide-ranging powers to decide the future of the firm and are empowered to make important decisions,
but that is yet to be the norm. Some firms also seek to bring in wider management skills at a senior level. An objective view from strong independent non-executives can bring real value to board decisions. I would be very surprised in 10 years' time if I did not see non-lawyers at the heart of the business decision-making process at many of the most successful law firms.

The age demographic of the partners is also a contributor to decision making. In too many firms, the greatest challenge will be achieving a controlled succession to the next generation. The reduction in training contracts from 2007 to 2014 has started
to feed its way into firms. Today, the staff
who are the engine room for many firms
- those who are three to five years' PQE
- are in short supply, so their cost is rising. Do they feel wanted or will they move on
for a pay rise?

How each firm looks after this 'marzipan' layer of lawyers is really important. These are the key staff who sit between the cake, the essential staff and the icing on the top - where the partners like to think they are. The development of this layer is critical to the firm's long-term wellbeing. They also need to be given management skills and experience as part of their development if they are to take that next important step in their careers and for the longevity of the firm.

One question often asked is whether it is better to specialise or to remain as a generalist delivering a wide range of services to clients and consumers alike. There is no obvious answer, as both have proven to be successful and viable. However, generalist firms will need to be much better at cross selling other teams' skills and services.
A firm of five to ten separated departments, all working in isolation, which only share a common umbrella - a property and a name
- will not fare well.

The globalisation of legal services is an opportunity for many and a threat to others. Law firms from the US and other nations have increasingly set up footholds in the UK - its £29bn legal industry and worldwide reputation for quality, service and professionalism is a tasty target.

As always, some of these moves will not work out, but the momentum is clearly there for more overseas entry into the UK market. The US model of remuneration is largely based on cash collected, while the UK model more usually relies on work in progress and billing to determine drawings. Do not be surprised if, in future, UK law firms increasingly adopt a US-style model
of remuneration.

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COMMON FEATURES OF LESS SUCCESSFUL FIRMS

• Keeping doing the same old work in the same old way, assuming change will not affect them

• Having numerous internal issues which limit their ability to make decisions

• Not understanding working capital cycles, with the firm financially overstretched

Waves of change

Having considered these influences, the question is how they may affect the legal market in the next five to ten years. If we look at the make-up of both accountancy firms and law firms by turnover, we can see they are grouped in bands (see Figure 1). Whilst the Big 4 and Mid 3 dominate the accountancy space, lawyers have many more firms in the upper bands. This of course reflect the wider range of legal services available, but increased globalisation may well eventually reduce the number of
larger firms.

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FIGURE 1: MARKET GROUPINGS BY SIZE

The marked difference is in the mid-market of firms with £22m-200m in turnover, where only 20 accountancy firms survive, yet 78 law firms operate. It is in this space where the challenges outlined above all come to the fore. Being big will not be everything - strong niche, specialist or regional firms can still survive. But, it will be increasingly important that management have a clear strategy if they are to steer their firms through the waves of change that are on the way.

Steve Billot is managing director of the global restructuring advisory practice at
Duff & Phelps (www.duffandphelps.com)

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