Most people would stop short of calling a $10,000 (£6,300) bonus for a one-year-qualified London-based lawyer at a US-headquartered firm a crisis. Indeed, that particular statistic is a modest improvement on 2011. But consider this. In 2007, the bonus at that same firm for a one-year-qualified would have been over $30,000. That is just one small indicator of how a quarter-century of ever-upward growth at the major commercial law firms has been compromised.

These figures, from an annual salary and bonus survey by City-based recruiters Edwards Gibson, accompany other data that point to a freeze in London salaries that track US rates. And analysis last year by Royal Bank of Scotland concluded that UK commercial firms were over-lawyered by up to 5%.

Hidden position

As individuals, lawyers in City firms may see their rewards progress upwards – lockstep and merit-based rewards keeping in reasonably close alignment. But the general picture is cause for reflection on the standard business model that firms have employed. As Tony Williams, principal at Jomati Consultants, puts it: ‘A system we all knew and liked delivered above-inflation growth for 25 years – and even with blips, that trajectory was always resumed.’ Notwithstanding the restructuring that took place at many firms in 2009 and 2010, ‘firms haven’t really stood back and asked questions about how [they] deliver what the client wants’, says Williams.

According to one analysis, law firms have been reprieved in this regard only because corporate clients are not acting uniformly to adjust their demands on firms’ pricing and resourcing models. However, Williams counsels that the legal sector must not be slow to look at lessons from other sectors: ‘As customers, a manufacturer buying components, or a supermarket buying groceries, demands that costs go down year on year – even though the quality of what’s provided to them may have increased and the supplier also has to invest in innovating new and improved products.’

He may not yet be in the majority, but as a corporate client, Bruce Macmillan, senior vice-president, senior commercial legal counsel at Visa Europe, applies this thinking to the purchase of legal services. Putting it bluntly, as a starting point he wants to know the lowest level of competence at which legal work can be done. ‘Show me what features define competent performance in your areas of expertise and then show me what you offer over and above competence,’ he urges. ‘Then I can decide whether to pay extra for your additional service quality features, beyond what I need to pay anyone for competent performance.’

What the legal profession tends to do, he says, is to blur those distinctions. But in an increasingly commoditised legal services market, ‘this failure to show that the value you add supports your prices, merely offers opportunities for new players to make you look too expensive’.

Shape changers

For clients such as Macmillan, being able to ‘disaggregate’ legal advice in this way pushes legal needs both up and down the traditional City ‘pyramid’ – in cost terms at least. Hence a range of business realignment decisions made by leading commercial firms that have involved farming out ‘non-added value’ work.

In April 2011, Herbert Smith Freehills opened a Belfast office, specialising in document management and review, principally for major contentious cases. The Belfast office is partly about process – ‘a highly structured approach to document management and review’ – but also about ‘competitive pricing’, using Belfast’s lower cost base. Just behind was Allen & Overy, opening its ‘Support Services Centre’ in July 2011. Styled by managing partner Wim Dejonghe as the firm’s ‘near-shore support and legal services centre’, the facility enables A&O to ‘serve clients more flexibly, handling the high-value work for them and holding on to work that might otherwise have gone to lower-cost rivals’. The centre kicked off 2013 by adding another 67 staff.

In 2000 Baker & McKenzie began the process of moving ‘back office’ tasks to Global Services Manila (GSM). And while arrangements such as the Hogan Lovells’ ‘Mexican Wave’ have been in operation for a while, non-City firms report that such pairings with City firms to keep costs down are becoming more common.

Such moves have captured headlines in the business and legal press, but Williams believes this is just the start. ‘Firms are starting to ask, "do we need all of our staff all of the time?",’ he says. ‘If the flow of M&A work is lumpy – perhaps a firm only needs to retain people to do 85% of the work, knowing that it has ways of calling in extra resource.’ Firms are being ‘experimental’ at the moment, he adds, but more far-reaching decisions will follow as their confidence in new working models increases.

Staffing and salary figures for this market indicate that reform of working practices is indeed imperative. The Edwards Gibson research discloses below-inflation salary rises for assistants at UK-headquartered firms for the fourth year running, with a fifth year predicted for 2013. And the bottom of the firm ‘pyramid’ is on some counts narrowing – turning the pyramid into more of a diamond at some practices. Edwards Gibson partner Scott Gibson notes: ‘There was almost no external newly qualified market for August and September qualifiers. It appeared that many firms had fewer lawyers qualifying, on account of a reduction in trainee places being offered. This is likely indicative of a continued overall reduction in lawyers at the newly-qualified level in commercial law firms.’ To make matters worse, there was also an increase in redundancies at the PQE seven-and-over level in larger City and magic circle firms.

These findings would seem to support the arguments made by US lawyer-economist Michael Trotter in his provocative book Declining Prospects: how extraordinary competition and compensation are changing America’s major law firms. He believes the very largest corporate law firms are wedded to an unsustainable business model that is designed around support for the massive overheads such firms have acquired. Though his arguments are based on the New York legal market, the parallels are clear. This model, he argues, embodies inaccurate assumptions about a close link between the highly leveraged legal teams and profitability. ‘There is no correlation between the size or leverage of the top 200 US firms and their average profits per partner,’ Trotter concludes.

According to this argument, what huge, highly leveraged teams on top pay have created is a system where the most experienced lawyers are effectively focused on management, and on the marketing that will win the lucrative instructions that can support those teams and their rewards. Targets for billable hours are now so high that they have contributed to poor career satisfaction for lawyers working to them.

The rewards themselves are a problem, Trotter concludes. As incentives, they have attracted an oversupply of firms and lawyers working to the New York model. Current market conditions cannot support such oversupply, rendering the model at best unstable, he contends. The result has been dramatic law firm failures like the collapse of Dewey & LeBoeuf last year. Dewey, Trotter claims, ‘was caught short by fundamental changes in the dynamics and economics of the top end of the legal profession’.

Solid or declining?

The top-25

2012 was ‘another tough year’ for the upper quartile, the PwC Law Firms Survey concluded. Although 82% of firms who took part had increased fee income in the previous year, mergers and lateral hires were part of the explanation. That figure could not reflect ‘absolute growth’, it stressed.

‘Firms remain a long way short of performance levels at the peak of the market back in 2008,’ the report found. In real terms, average top-10 UK fees per partner fell 22% between 2008 and 2012, while profits per equity partner dipped 24% – even though there has also been a 6% fall in equity partners in that time.

Firms in the top-11-25 experienced an even greater drop in PEP – 31% on 2008 figures in real terms, even though equity partner headcount was down 20% over the same period.

PwC did however strive to be positive: ‘Against a difficult backdrop, 2012 can be characterised as a solid year in the legal sector.’

Source: PwC

Falling down?

Trotter notes there is ‘client resistance to increasing costs’. Certainly, commercial firms confirm to the Gazette that the dire state of the economy has led clients to be more demanding in service negotiations – and this in turn has prompted law firms to be more creative. ‘Clients have become more aggressive on price,’ the managing partner of one top-20 firm tells the Gazette, ‘and many take a much more direct interest in how deals are staffed’.

The same managing partner notes the consensus that ‘there are too many lawyers in London – but at all levels’. That view is supported by PwC’s annual law firm survey for 2012. ‘Firms remain a long way short of performance levels at the peak of the market back in 2008,’ the survey report notes. ‘In real terms, average top 10 UK fees per partner have fallen 22% over that period… and average PEP is down 24%.’ There has been a 20% reduction in equity partner headcount since 2008.

Squeezed middle

Assistants see salaries and bonuses fall

While non-partners continue to see their salaries increase year on year, that is in large part down to their progress up their law firm’s lockstep, according to recruitment consultancy Edwards Gibson’s annual survey, published this month.

That reality masks a fall in real-terms rewards at each level. For the fourth year running, this research showed below-inflation salary rises for assistants at UK-headquartered firms. In those same firms at each level, there was also a fall in bonuses for the second year running.

The news was better for US-headquartered law firms in London, where bonuses increased by more than a third on 2011 – averaging between $10,000 for a one-year PQE lawyer, and $50,000 for a seven-year PQE.

However, bonuses at these same firms were over $30,000 and $60,000 in 2007.

Source: Edwards Gibson

So why the continuing mismatch between numbers and demand? Some Gazette interviewees who preferred not to be identified described the sense of ‘obligation’ to try and take on lawyers who have trained with them. Others allude to their experience of rebuilding teams at great expense, having cut too far and too fast in previous downturns. In other cases, firms are bidding low for work, knowing that although they are simply ‘buying turnover’, it is at least keeping teams together.

It should be re-emphasised that clients who have disaggregated each part of their instructions to make decisions about the precise resourcing of each component part are in a minority. ‘There isn’t an across-the-board rejection of very junior lawyers being used on matters,’ one international senior partner contacted by the Gazette notes. ‘If it is reflected in the bill, they may want to know why you brought three lawyers to a meeting where one would have done, but their demands are mostly at the levels of seeing greater efficiencies reflected in price, and wanting the certainty of fixed or predictable pricing.’ It is, the managing partner notes, more pertinently a case of law firms themselves driving the disaggregation of services in response to pressure on fee margins.

Williams advises firms to get used to the idea that, in all other areas of activity, the corporates that instruct leading commercial law firms look for further efficiencies year on year. But there will always, he says, be ‘bet the company’ matters where the outcome, not the fees, is the priority for the client. ‘If there is going to be a significant impact on the share price, if a regulator may fine you hundreds of millions, if the executives could go to jail – then that remains at the high-value end,’ he stresses.

For work that does not fit into that category, however – not a £500m merger, but an acquisition worth £50m, for example – the pressures are real and growing. One possibility is that firms who do not start to respond to such challenges will find clients looking to do the work themselves. As Gibson concludes: ‘In the latest figures available, there was a 12% increase in the number of solicitors with practising certificates working in commercial roles in-house – it is clear that in-house constitutes the greatest ongoing competition to law firms for legal talent.’