The Legal Services Act: growing concern?

The potential impact of the Legal Services Act on the typical ‘high street’ solicitor model has been widely debated, with predictions many may pass away. But what competitive threat does a more diverse legal market pose for the UK’s larger law firms?

By Iain Miller, partner, Bevan Brittan LLP

“The greatest advantage lawyers have is that they compete only with other lawyers.”1

Life is not great in the world of legal services. The recession has caused downward pressure on volume and rates, and therefore also on profits. These cyclical pressures have, in turn, led to firms reducing their headcounts and looking to more efficient ways of delivering legal services, most notably through outsourcing and the commoditisation of certain types of legal services. These latter developments, which have come about owing to direct demands from clients, are likely to be structural rather than cyclical. Or in the harsh words of Bruce Springsteen: “these jobs are going boys and they ain’t coming back”.

In this current climate, most lawyers could be forgiven for focusing on the present rather than looking to the future. However, my impression is that for many lawyers the impact of the Legal Services Act is something they think they should consider, but feel they don’t need to yet. There is also a widespread feeling that it is something that will have an impact on small high-street practices but not larger firms that act for commercial or public-sector clients. Discussion in larger firms often seems to be framed in terms of whether we decide we want external investment, rather than how this shift will change our market. However, it is the second question that is much more important to a firm’s survival.

Before we can examine these issues, however, it is vital to understand what the Legal Services Act actually does. I should add, in this article, that I refer to “lawyers” and “law firms” as it is no longer meaningful to treat each legal profession separately when they can now practise together and are subject to the same overarching regulation.

There are certain types of legal services that parliament has long since established can only be provided to the public for a fee by persons who are regulated. These are, broadly: preparing documents for the transfer of land; taking out probate; conducting litigation; exercising a right of audience; acting as a notary; and administering oaths. Historically, the right to carry out these functions was limited to certain legal professions. In turn, one of the main mechanisms of regulation was that these regulated services could only be provided to members of the public by organisations owned and controlled by members of each profession. One point of note here is that regulated activities were never as wide as one might imagine. Anyone can give legal advice, or indeed act in relation to a commercial transaction not involving land. However, the ability to provide regulated legal services gave legal professionals credibility and freedom within the market, which meant they have had a competitive advantage in a broader range of non-regulated legal services.

Stripped to its essentials, the Legal Services Act does two things that change the legal services market.2 First, it takes the strategic control of regulation away from the legal profession and places it in the hands of an independent body, the Legal Services Board (LSB). Day to day control remains in the hands of the current front line regulators, such as the Solicitors Regulation Authority (SRA) and the Bar Standards Board (BSB). The LSB is intended to be less sensitive to concerns about how the regulatory framework impacts on the fortunes of individual lawyers, and more sensitive to the interests of the public as consumers of legal services. Policy, not regulation, will drive it. Second, the Act removes the restriction that only organisations owned and managed by regulated legal professionals can provide regulated legal services to members of the public. This does not mean that regulated legal services will become deregulated. Quite the opposite in fact. The regulation of a profession (or perhaps now ‘an industry’) with no ownership restrictions is a more complex task, and certainly for those already in the legal services market, and those seeking to enter it, the regulatory burden will be more onerous than it is currently. However, what the Legal Services Act will do is broaden the business models that are available to organisations in the market to deliver those regulated legal services. This is because ownership, funding and management are now no longer proscribed. These new structures are known, within the Act, as Alternative Business Structures (ABSs).

The LSB is in the process of determining the framework for ABSs, which will, in turn, inform the rules adopted by front line regulators. Not surprisingly the LSB is not lawyer dominated, and it is likely to look towards other regulated industries, such as communications and financial services, to inform the approach to ABSs. The LSB wants the regulatory changes that allow ABSs to come into effect in 2011.

Impact assessment

So how will these regulatory changes have an impact on the legal-services market? Well, the first point is that no country has gone this far and there is no real precedent for this type of regulatory change. Lawyers here may be understandably concerned that they are the Petri dish for an experiment on legal services regulation.

In judging the likely impact of the Legal Services Act it may be sensible to start with the current structure of the legal market, and for this purpose this can be illustrated by reference to solicitors. There are currently 112,433 solicitors with practising certificates in England and Wales, an increase of 232 per cent since 1978. There are 10,267 solicitors’ practices, of which 8,826 have five partners or fewer. Most economists will tell you that this level of market fragmentation is inefficient and is therefore ripe for consolidation. While historically this level of fragmentation may have arisen as a result of geography and less advanced communications, it is also a factor of ownership restrictions. As such, the introduction of ABSs (coupled with the rise of the internet) is likely to cause the number of firms to reduce, and probably quite drastically.

It is not difficult to see how this might happen. One or more of the large organisations in the financial-services sector will see legal services as an obvious area for expansion. Individual consumers may well see a trusted brand such as Co-op or the RAC as a more attractive provider of legal services than their local solicitor. They will almost certainly have a better website. The shift will not be overnight or indeed absolute, and there will be exceptions, but solicitor practices that rely upon work from individual consumers (such as probate and residential conveyancing), and if they do nothing, will see a drop in revenue over time. At some stage they will cease to be viable. They will be competing against organisations that have a completely different business model based around processes that are designed to deliver legal services more cost effectively by commoditising them. The service will be delivered with very few qualified lawyers. Many lawyers will think that this amounts to a ‘dumbing down’ of legal services but it actually mirrors a process that has already taken place in so many other markets, from food through to insurance. For these reasons it is quite understandable that there is a general view that the future is challenging for ‘high street’ practices. However, it does not follow that the impact stops there.

False assumptions

The view that larger corporate firms are immune from the impact of the Legal Services Act is based on the false assumption that all their clients are very happy with the amount they are paying for their legal services and don’t really see the need for change. That assumption is self evidently not right. The pages of the legal press are full of stories of clients pushing for innovative ways to change the way legal services are delivered in order to reduce their legal expenditure. Some, like ITV, are focusing on getting rid of the hourly rate. Others, such as Rio Tinto, are focusing on outsourcing. BT recently used an online ‘reverse’ auction as a way of selecting some of its legal panels. There are many other examples. As I observed at the beginning of this article, the current economic climate and these client demands has meant that most firms are trying to respond to these market forces now to make themselves more efficient. It is painful, but these changes are still based on the existing ownership model. Delivering change in large law firms is challenging to say the very least, and as David Maister states above, the great competitive advantage firms have is that they are competing with themselves. All the organisations in the market have the same business model, because that model, a business owned and managed by lawyers, has had a monopoly. That is about to change.

It does not take that much imagination to see that once ABSs are introduced, someone, somewhere will look at the commercial law market and say we can do this more efficiently. We can buy in a few big hitters in the markets we want to target, perhaps even buy a brand, and then build a new type of business model that maximises outsourcing, commoditisation and capital to deliver a service that corporate clients expect at a price they prefer. This business won’t have partners, only shareholders.

The new organisation would not need to obtain partner buy-in for radical change over a number of years or months, or politely explain to its associates that they will not make partner this year (or maybe ever). The new firm may not be as profitable as existing firms, but neither will it be sharing its profit among over 100 people. It may still hire out its wise counsel at an hourly rate, but many of its other services (which can be bought separately) would be efficiently delivered at a fixed price. If the business model is successful, other similar organisations will enter the market.

Where will this leave a law firm owned by lawyers, run by lawyers, and slow to change? This is a relationship business, and all firms have clients who hold them in high regard and are very loyal, but they will lose some clients to the new firms and the loss in revenue will lead to a loss in profit and a need to cut overheads, which is a dangerous downward spiral. Like high-street practices these firms may also cease to be viable.

Of course, none of this may happen quickly, but I suspect few managing partners, as currently structured, are able to say that they are an efficient business that can compete with any business model in a regulated but open market. Very soon they will need to be. If this view is right, or even partially right, law firms may well be asking themselves the wrong question when they focus on the opportunity of external investment provided by the Legal Services Act. The right question is: how is it going to change our market and what do we need to start doing now?

References

David Maister, Are Law Firms Manageable?
The Act does other important things such as set up an independent statutory complaints handling function, the Office for Legal Complaints, but this will have a
less direct impact on the market.

Iain Miller is a partner in Bevan Brittan LLP and head of its professional regulation group. He is co-editor of Butterworth’s Guide to the Legal Services Act 2007 and an editor of Cordery on Solicitors. He can be contacted at: iain.miller@bevanbrittan.com