Forecasting the creative impact of alternative business structures on law
The challenge of alternative business structures (ABSs) appears to have given fresh legs to a neologism. Lawyers should be ‘pessoptimistic’ – that is, in a state of contradiction, living with both dread and a sense of opportunity.
A pessoptimist (the word was coined by Palestinian writer Emile Habibi) reacts to change with a shrug, a shudder – and a visit to a strategy consultant.
The profession could perhaps have coped well with the structural and regulatory changes which are being heaped upon it – were this its only demanding challenge.
But the fact is that ABSs could not be happening at a worse or better time (depending on whether you are feeling pessimistic or optimistic).
Like the straw that overburdened the camel, ABSs are coming at a time when law firms are coping with an extremely sluggish economy, hefty public funding cuts, new technologies, and more articulate and demanding clients.
The licensing of ABSs from 6 October has also brought to the fore concerns over reserved activities and the uncomfortable truth articulated by Professor Stephen Mayson, director of the Legal Services Institute, that 80% of lawyers’ work falls into the unreserved category.
But any analysis of ABSs should start with what lies at their ideological heart. The Legal Services Act 2007 was the product of the then Department for Constitutional Affairs’ 2005 white paper, The Future of Legal Services, which itself originated in an Office of Fair Trading report on competition in the professions back in 2001.
The OFT report stated: ‘Markets generally work best for consumers when there is unrestricted competition between existing suppliers, and unrestricted potential competition from new suppliers and from new forms of supply.’
What ABSs are designed to do, therefore, is increase competition between existing law firms and introduce new entrants to the market for the benefit of the client.
Whether or not one agrees with the OFT’s hypothesis as it applies to legal services, many lawyers would say that competition has been a fact of life for partnerships for a very long time, and firms have streamlined their operations in consequence.
But ABSs not only challenge the way that partners run their operations, they challenge the very entities themselves.
Driven by an imperative to drive down costs, as a very different kind of competition bites, the partnership-based law firm will become just one of myriad possible business models.
We will see incorporation, joint ventures, mergers, acquisitions, franchises, outsourcing and even shared services.
To take just one example: today’s typical in-house legal team comprises a cohort of lawyers covering a broad range of practice areas, such as commercial, compliance and employment. In-house departments have grown inexorably over the last few years as a response to a combination of increasing levels of regulation, greater demand for industry specialisation and growing awareness of the cost of using private practitioners.
Come 6 October, it will be far simpler for an in-house team to deliver legal services directly to other organisations, as it will not have to set up as an independent law firm to do this. In this way, the team could become income-generating instead of a cost to the business.
What could be more attractive in a recessionary economic environment?
Denise Nurse, a director at Halebury, one of the so-called virtual law practices, works very closely with one of the firm’s client’s in-house teams at BSkyB.
She explains: ‘These in-house teams are in a good place right now. They combine legal knowledge with real business knowledge and skills, so they have something to offer other corporations which private practice cannot.’
The net result is that law firms could find themselves competing with their own clients: curiouser and curiouser.
In-house teams could even follow the shared services model. This emerged as a cutting-edge concept in business efficiency as long ago as the 1980s.
More recently, it has been employed in local government, where councils’ legal departments have combined to deliver legal services back to their authorities, reducing costs. In the private sector then, instead of a standalone in-house team providing legal services externally to other organisations, teams could do this in combination.
Another feature of the newly liberalised market will be consolidation among ‘suppliers’. This happened in the accountancy profession a decade ago.
Peter Clements, director at Global BPO, the legal process outsourcing firm, was formerly with Ernst & Young. He says: ‘There will inevitably be fewer suppliers.
'The combination of the current economic environment and ABSs will encourage consolidation to lower per-transaction fixed costs.’
Of course, amid the creative destruction many will perceive opportunities.
Certainly, one of the more obvious shifts will be to incorporation, not only for its own sake but also as a means of opening new doors in respect of joint ventures and, potentially, as a means of selling on the business.
Paul Quain and Jon Gilligan set up GQ Employment Law, a boutique employment practice in the City, a year ago and are seriously considering incorporation. Quain says: ‘Part of our rationale is that, if we did want to consider aggressive growth or were seeking external investors, or even buyers, then incorporation makes that much easier and cleaner.’
Gilligan says: ‘We could also look at joint ventures and, again, the incorporated model makes that much more doable.’
But there is more to it than that, says Quain: ‘A company structure is just more modern. If you want to take on someone new, then you can think about shares and share options. And it will be more attractive to the next generation, who prefer to keep things portable and exchangeable, like shares.’
An open and competitive legal market will, then, bring about a variety of business models as the traditional law firm structure is undermined by ostensibly more cost-effective alternatives. In parallel, firms will also pursue new financing options, raising external capital either on the open market or privately.
Traditionally, external capital has come from the banks.
Chris Marston, head of professional practices at Lloyds TSB, is sceptical about the degree of innovation one can expect in this regard and is comfortable about the potential threat to his business.
He says: ‘We have seen no trend away from our core lending such as overdrafts, longer-term loans and partner equity loans. In fact, lending in January was up 8% on January 2010, and this followed growth in 2009. I believe law firms will still come to us for financing because we have expertise in their business.
'Our solicitor customers are very important to us and we have 150 CPD-trained relationship managers who are trained to understand their business.’
Nurse disagrees: ‘It is actually really difficult for law firms to get an injection of cash, because the banks always ask: "where are your fixed contracts?", and firms tend not to have them.
'Firms that have long-standing relationships with banks will get loans, for sure, but often there are personal guarantees involved which will become less attractive when there start to be other financing options.’
Given that last year private equity accounted for three-quarters of UK mergers and acquisitions activity, it would seem inevitable that private equity will have a prominent role.
Yet private equity houses remain sceptical. Jon Moulton, former managing partner of Alchemy Partners and now founder and manager of Better Capital, is not jumping up and down with excitement about ABSs.
He says: ‘There have been quite a few telephone calls with law firms, but when you actually sit down and talk about it, it is hard to see what would work. If you invest £10m in a law firm, private equity would want to take out £20m in four years’ time. That’s how we operate.
How is that going to happen in a law firm? How can the private equity investor make the money which is, after all, his job?’
Moulton outlined two possible scenarios that could interest private equity.
The first is in extending the concept of litigation funding: ‘There may be potential to set up a new firm which only did large-scale contingency litigation cases.
'Existing firms may not do these because of the risks involved, but you could have a big win here which would bring in sufficient income to make the project worthwhile.’
Moulton’s other scenario relates to what he calls ‘the processing points’ – by which he means highly commoditised work. Private equity investment in, for instance, IT for this type of work could generate increases in income at the level and speed required by private equity.
There may be a few flotations to fund growth, and much has been said about the pros and cons of listing.
The first flotation of a law firm was that of Australian firm Slater & Gordon in 2007 – its shares have more or less tracked the market since.
It is more likely that many law firms will find themselves being consolidated within larger cross-professional practices. Global BPO’s Clements argues: ‘Accountancy firms have been waiting to buy up law firms for a long time.
'We know one of the big four accountancy firms is more than a long way down the road towards opening up its "professional services suite", which will involve buying in a law firm.’
So, if other businesses want to buy law firms, the next question is: will law firms buy other businesses?
There may be firms which buy into accountancy and tax practices, but in theory at least the door is open to a whole range of services into which lawyers could diversify.
The elephant in the room, of course, is the extent to which firms that provide consumer legal services will be swamped by major brands such as retail giants entering the market.
Co-op Legal Services is already present in a limited way, exploiting its status as a member organisation. The Co-op claims to have far exceeded its original targets when it opened for business in 2006, when it forecast a staff of 150 five years on. Today Co-op Legal Services employs more than 300.
Much has been written in the Gazette about QualitySolicitors and its high-profile bid to compete in the new environment by carving out a national franchise on the Specsavers model.
Guy Barnett, managing partner at Blakemores, also understands the pull of an attractive brand, as founder of consumer-led Lawyers2You.
This operation does not have offices or outlets, but bright and unintimidating stands in shopping malls (indeed, almost every shopping mall in the Birmingham area and at Birmingham Airport).
The stands are manned by sales staff who are, quite deliberately, not lawyers. They are there to find out what the passing customer needs help with, to talk about what Lawyers2You could do to help, and to get personal details so that a lawyer can call back later.
This is about as far from a traditional law firm as has so far been seen in the market.
Barnett is up front about the competitiveness of the big brands: ‘Make no mistake, they want legal services because they want to control all their customers’ buying power.
'They want you to buy everything you need in the world from them: food, clothes, white goods and so on. One day, without any big fanfare, there will be leaflets at the till, selling you legal services, as happened with insurance.
'And they know how to upsell. They will sell you your will, but they will also talk about burial options and sell you a plot. They will take on your personal injury claim from a car accident, and they will sell you a new car, and insurance for that car, and so on.’
Still, market observers reckon it is not all bad news: many major brands may use the franchise model and firms will continue as they are, but under that brand’s wing.
And it is conceivable that the supply of legal services by major brands could create a whole new set of customers who have never consumed legal services before (economists call this ‘induced demand’).
Those who come up with innovative ideas such as Lawyers2You and QualitySolicitors look set to be the beneficiaries.
However, there are some practice areas which the major brands will avoid, Barnett predicts: ‘What [they] won’t do is offer matrimonial or civil litigation, because it tarnishes the brand. If you are getting a divorce and you get a letter from Sainsbury’s Law, you are not going to shop at Sainsbury’s again.’
And that is not all that could be tarnished. Lawyers are concerned that inviting non-lawyer participants into the market could undermine the brand of the entire profession.
Consider personal injury. After ABSs, one of the more plausible joint ventures will be between claims managers and lawyers. It is argued that this relationship could be unhealthy if not regulated robustly.
Andrew Parker, head of strategic litigation at Beachcroft, says: ‘With the additional pressure on solicitors to cut corners, could not the interests of the client conflict with the interests of the business in such an arrangement?
'Regulatory standards must be kept high and must be enforced.’ Much now rests on the professionalism and diligence of the Solicitors Regulation Authority, which is applying to regulate ABSs and is expected to begin taking applications from 6 August.
What the arrival of ABSs has also done in the sphere of regulation, says Crispin Passmore, strategy director at the Legal Services Board, is call into question the concept of reserved activities.
The Legal Services Act lists only six activities which are reserved and which therefore only solicitors can deliver. We are all fully versed in what they are (and their origins, thanks to the research of professor Stephen Mayson).
At the time, the then Labour government did not choose to investigate why these six were reserved in contrast with those activities which make up the other 80% of the work done by lawyers, such as employment law, will-writing, corporate law, or tax (though some of this activity is bound by codes of conduct from other sources).
But it did empower the LSB to add or remove activities from the list.
So will it? This is work in progress at the LSB. It has commissioned research on the list and is currently conducting consumer analysis on the specific issue of will-writing.
But one must remember that the whole rationale behind ABSs is to open up the market for the benefit of the consumer, so it seems unlikely that the list is going to get much longer.
If it is the case that much of the lawyer’s work need not be done by lawyers, but by paralegals instead (as at present, but under supervision), are we going to need so many lawyers in future?
Comfortingly (perhaps) Clements concludes: ‘We need lawyers but we don’t need law firms; we don’t need vast offices in prime locations; we don’t need legal secretaries. Lawyers will practise under different brands and umbrellas.’
Which makes sense – just don’t let them come to be called ‘legal services managers’.
Polly Botsford is a freelance journalist