Feature

posted 3 Feb 2010 in Volume 12 Issue 7

The worst of times…?

“It was the age of wisdom, it was the age of foolishness”, wrote Charles Dickens some 150 years ago. It might also seem to serve as a summary of the credit-crunched past two years. As the legal profession prepared to bid a taxing 2009 farewell, Managing Partner asked law firm leaders for their reflections on a year in recession.

By Richard Brent

Some brave souls may still resist the suggestion, but the reality is that the law is a business. Granted it is not necessarily a business quite like any other, but it is certainly subject to the same economic pressures. Legal advice does not operate in a vacuum. It is closely connected to clients’ businesses and consumers’ choices, and the markets in which those individuals are operating. For evidence we need look only at the now well-worn observation that while the cream of many a corporate practice have been concerned at work dropping off in this recession, the world’s leading litigators can hardly believe their luck.

This might sound obvious, and naturally law firms have long recognised that their client service credentials and depth of market understanding are of paramount importance to winning – and keeping – work. However, what the credit drought has highlighted above all else is just how vulnerably connected all those in the business world have become in increasingly complex and consolidating global markets. Although obvious in theory, it could be argued that the impact of a worst-case scenario (a plethora of unaffordable mortgages, for example) on this vast maze of manic mutual dependencies had never quite been given adequate consideration.

Managing Partner’s editorial board of professional experts agreed that compliance, and the manner in which risk is managed or shared, has been a key concern and theme for the profession throughout 2009. A number of firms have demanded extra funding from their partners or deferred profit distributions, while much concern has been voiced at a sudden surge in the cost of professional indemnity insurance (PII) to guard against liability claims.

“Partly owing to economics and partly through regulatory changes, risk management and compliance have been taking up a lot more time across the board,” says Lewis Silkin managing partner Ian Jeffery. “A lot more firms have ended up in the assigned risk pool this renewal season. It isn’t such a concern for the larger firms, but it’s still very much an issue for the wider profession.”

Profit warning

The impact of the economic crisis perhaps became most clear, however – at least to external observers – when law firms reached the point many had to publish their profits for the full past year in June. Numerous practices experienced what they admitted were disappointing drops, with the slowdown in transactional activity, such as mergers and acquisitions, especially pronounced. Corporate-heavy Clifford Chance (CC), formerly the largest law firm in the world in terms of revenue, probably received more than its fair share of attention when average partner profits fell by more than a third (37 per cent) – from £1.156m to £733,000 – and cost it its top-ranking title. It highlighted just how focused the global giant had become on the investment banking and private equity work dealt one of the severest blows by the downturn. “Very challenging” was global managing partner David Childs’s summary of the situation back in June, although he added that the firm expected to bounce back strongly with a new string of matters resulting from the meltdown itself over the months to come. CC was in so sense isolated in the extent of its difficulties, however. The PriceWaterhouseCoopers (PwC) annual survey of the financial performance of UK law firms found average take-home profit decline among the top-100 was 30 per cent. Average profits per partner in the 11-25 bracket was £444,000 – just over half the average for the top-10 City firms. “A relatively small number of firms predicted the likely extent and severity of the recession,” said PwC partner Alistair Rose.

Prior to such annual profit announcements it had already become apparent that all was far from plain sailing of course. Cost control quickly emerged as a clear priority for all businesses in 2009, with restructurings confirmed at partner level for some firms in the midst of multiple rounds of redundancies at many more.

Nicola Palios, chief executive of Mourant Ltd, which includes offshore law firm Mourant du Feu & Jeune, believes a combination of such factors and uncertainty over the future led many firms to apply the breaks to their businesses in 2009.

“I think people went into a bit of a short-term mode for a period of time. It became difficult to take long-term bets, and I suppose recessions always focus more attention on the bottom line. Major decisions tend to centre on cutting headcount and other costs,” she says.

“There will be a continued squeeze on margins, and I think that is likely to have a lasting impact. In the longer term firms, especially those in London, will probably stay leaner. I think some law firms probably have been a bit myopic about their cost base in general.”

Outsourcing option

Client pressure will intensify this movement towards tighter control of spending, she explains. Faced with the difficulties of the downturn themselves, buyers of legal services will start to be more insistent about lower or new billing formulae, which could also lead more firms to turn to an outsourcing model for some of their more routine tasks, including lower-end commoditised legal work. A number of law firms announced strategic outsourcing initiatives in 2009, while global mining business Rio Tinto generated a host of headlines by announcing it would look to cut as much as 20 per cent from its external legal spend by instructing panel firms to partner with legal process outsourcing (LPO) provider CPA Global.

“The natural inclination for law firms is not to do something like that because they’re conservative by nature. They might be forced down the outsourcing route more by clients now,” Palios says. “Previously there was an assumption, and almost an aura, of having to pay for expertise and quality, but now clients don’t want to pay for work that isn’t particularly innovative or complex. I think they will be questioning those margins much more.”

However, outsourcing more functions might actually have the added benefit of helping law firms manage their own work, she adds. “The ability to expand and contract based on demand could become easier than in the past, and you might not have seen that happen but for the economic situation.

“I think the interesting thing will be to see whether law firms generally outsource to specialist third parties or try to set up offshore divisions of their own.”

Counting costs

Jeffery says his is not a firm that can yet lay claim to headline projects such as major outsourcing or offshoring initiatives, but he can certainly see the business case. “The considerations with outsourcing – especially on an international scale – are different for very large firms. Our current focus is on making continuous improvements across all areas of the operation,” he explains. The past year’s projects at Lewis Silkin – well known for its employment and media offerings – have, for example, included a recent IT overhaul, which will see people given a “much more informed view” of firm-wide practice management and the most cost-effective handling of a constantly changing workload. The solution (the ThompsonReuters Elite 3E model) has already been implemented, although it is still too early to calculate the true impact and return on investment, Jeffery adds. Nevertheless, while Lewis Silkin’s profits, as other firms’, were predictably impacted by the recession, he is comfortable with its annual financial performance of increasing revenue by between six and seven per cent in a difficult market.

While not necessarily changing the direction of the profession, Jeffery believes this recession – widely reported as the worst for some 50 years – may well have accelerated the inevitable movement to greater streamlining of certain legal processes, including that move to greater outsourcing and commoditisation of the more volume-oriented and standardised legal services.

“Although in some respects this should be seen as just another economic cycle, which the profession and others have been through before, I think this recession will, perhaps, leave its own legacy,” he suggests.

“The economic pressures have led to a lot more focus on headline charging rates, billing structures and value in client relationships. It has probably accelerated the dialogue between law firms and clients on these issues.

“It may not have taken us to a position that we never would have got to but for the recession, but perhaps it will have taken us there more quickly. These developments would have happened over time in any case, but I do think they may now evolve faster.”

However, he says the overall fundamentals of his firm’s strategy – “who we are and what we want
to be” – haven’t changed at all as a result of the recession. “Like everybody else we’ve had to manage the particular impacts of the downturn on the different sectors we service.

“On top of that, as a lot of firms are obviously exploring, we are thinking about how we run the business to deliver the services we do, at the same quality, but in a way that is as cost effective as it can be. We have to keep looking at all aspects for improvements that can be made, but that’s always a work in progress.”

Pay back time?

Michael Shaw, the longstanding managing partner of national law firm Cobbetts, suggests that law firm remuneration is another area where law firms may need to learn from this recession. Although clearly not subject to quite the same political pressures as the banking wizards “people are now likely to think quite carefully about how they remunerate their staff”, he says.

“Undoubtedly we did get into a bubble where there was an automatic expectation on the part of lawyers that the business would be increasing their remuneration significantly every year. That will have to be rethought.”

Nevertheless, Shaw agrees with Jeffery that businesses should also be wary of being too short-termist by responding to a downturn through overly vigorous cost reduction.

“At Cobbetts we were very conscious, even in the darkest moments of this recession, not to compromise our competitive abilities by taking short-term decisions. It’s a fairly fine balancing act,” he says.

“I think there will be more caution adopted by all firms in the sector, but that will then relax over a period of years and people are likely to become more bullish and expansionist again in time.”

“However, it will probably be another four years before we get to where were two years ago,” he adds.

“It is very easy to cut costs at such times. Sometimes it’s harder to maintain or increase expenditure when that is what is vital in the longer term.”

“Firms that cut quite heavily last year might have improved profitability this year, but what one doesn’t know yet is whether there will be a continued improvement,” Jeffery adds. “A lot of time could need to be spent refilling those seats.”

Moreover, while Cobbetts – like many other law firms – has had to restructure to some extent, Shaw says it has actually bulked up the marketing team, for example, to ensure the pitching process is as efficient as it can possibly be. “We see that as being very important in a more difficult economy,” he explains.

Palios says the recession has also led her to re-examine the rationale behind the relationship of Mourant’s approach to performance management with its remuneration strategy. Something of a “philosophical” point, she concedes, it occurred to her in 2009 that there might be “a lack of clarity” when incentivising employees. It becomes necessary for firms to decide between two possible approaches, she explains – “either just to accept that because we are in a recession nobody is going to do very well, or to decide to lower individual targets in an effort to motivate people more and drive some further profitability”.

People power

International law firm Reed Smith is another that has remained very focused on talent management in turbulent 2009, with initiatives including the launch of a brand new competency-based careers programme as recently as October. Performance and progress, and indeed some pay decisions, will now be assessed against key capability benchmarks, rather than referring to the traditional years of post-qualification professional experience (PQE) of old. Covering legal and wider business skills, as well as aspects of managing client relationships, Europe and Middle East managing partner Roger Parker explains that this was a “proactive” initiative rather than a direct response to the recession, albeit one “that clearly suits the time”.

Parker says the move reflects a number of factors, including “existing practices, changes in markets and what we’re hearing from our lawyers”, as well as cementing a structure in the wake of a string of mergers such as that with UK firm Richards Butler in early 2007. He adds, however, that people management concerns are also “inextricably linked” to client satisfaction and efficient delivery of services.

“There’s no doubt at all that there is a continuing shifting of those sands around the importance of career-development opportunities. That includes listening to clients about what they expect from lawyers,” Parker says.

“Our approach involves trying to develop deeper and closer relationships with clients, and we do that through our staff. If we can achieve closer people engagement that will materially enhance our prospects. A programme like this has a clear business advantage for the firm as a whole.”

Laywers and clients in the downturn have also both benefitted from a deeper firm-wide emphasis on “industry sector focus”, he continues. “I think the profession has generally done quite well at that. Genuinely reflecting industry sectors, rather than just paying lip service, has focused our know-how and helped in areas where, like others, we have been affected more profoundly.

“In real estate, for example, our team has been very creative in terms of new product development and reading industry movements. It is an approach that can help you to avoid the real depths.”

However, people management is also an area of strategy that the experience of the recession should cause to be raised higher as a more general internal priority, Parker argues.

“The people issue is material because the recession has also posed a considerable challenge to traditional thinking about the relationship between the profession and its recruitment and development of talent,” he explains.

Careers advice

It was none other than The Law Society that officially cautioned would-be lawyers about the precariousness of their chosen careers and the extreme difficulty in securing a training contract in 2009, and law firms have visibly been considering their individual changing human resources needs over the past year too.

Although the idea of alternative legal career paths and the relative desirability of partnership is not a trend that the downturn has initiated, these are clearly issues firms will need to tackle to safeguard the retention of their most important talent and knowledge as people give fresh thought to how safe and secure their careers really are.

“One medium-term impact may well be to reduce the number of people who go into the professions and City institutions in the first place,” Palios suggests.

“A City career was seen as a passport to riches, but the reality clearly hasn’t been as glittering for some as they may have hoped. People will now see the training contract as a lot of effort if you may come out with nothing, even if a degree in law does stand you in good stead for different careers.”

Michael Shaw believes The Law Society did the right thing in issuing its summer warning, however.

“I do think somebody had to say something. A lot of young people have gone into the law assuming it is a guarantee of a highly-remunerated career, and then found they can’t get a training contract,” he explains.

“Price sensitivity means new efficiencies have to be driven out, and that means there probably will be an acceleration of commoditisation processes for large tracts of law. I think that is bound to limit the profession’s ability to keep absorbing more and more qualified young lawyers.

“Sadly, that process will be self-selecting. Inevitably there will still be competition for the cream of the talent, but not everyone will be able to pursue the careers they had hoped for.”

Leaving a legacy

Has the effect of this recession on law firms been at all overexaggerated, however? Shaw thinks not. “If anything it’s probably even more profound than reported. I think there’s probably still a degree of machismo in the legal profession. I’ve been a partner for 25 years and I have certainly never seen anything like it,” he says.

If securing funding from banks continues to prove difficult, however – and with a likely limit to how much partners are prepared to fund the business themselves – opportunities might also now begin to emerge for the much discussed attraction of external investment, he adds. To date a common reaction has been that it is difficult to see why many firms would want to take advantage of this option
under the Legal Services Act, but the downturn’s challenges could now drive a wave of interest in
such a move, he predicts.

Jeffery points out that the change in income tax for top-earners will also be a concern for partners in the years ahead, many of whom will inevitably fall into this bracket

Palios also agrees firms will probably need to give greater thought to their financing options in future; if necessary, making lasting management and procedural changes to boost their chances in an increasingly competitive market.

“Larger amounts of bank borrowing will probably be needed,” she suggests. “That will require a degree of discipline that partners in a traditional partnership may have elected to do without.”

A lawyer herself, but also a full-time chief executive, it is a surprise “how many leaders at top firms are still also doing fee-earning”, Palios says.

“The traditional charging methodology and business models are both undoubtedly challenged by the impact of this recession,” Reed Smith’s Parker adds.

“We are no different from other providers into major corporations. We have to find ways of providing more efficient service delivery.”

“People are still assimilating all the lessons there could be from the last year,” concludes Jeffery. “It’s going to be some time before people will be able to look back with the benefit of enough hindsight at all the actions they have or haven’t taken.”

Shaw may not remember a time when law firms have had it so bad – but he concedes that any business would need to be cautious about automatically rewriting a strategy because of an event that happens every 80 years, however problematic that period proves.

It was widely believed that the forces of consolidation and commoditisation were here to stay before the credit crunch struck in any case. The real question is to what extent the recession has persuaded law firms to question their most basic structures and processes; and when – or indeed if – they choose to change.