City firms are felling the pinch in a depressed M&A market. As they look for new ways to win business, cost-saving measures such as cutting the number of partners may not work, says Lucy Trevelyan


It has been a tumultuous few years for the UK’s largest law firms. The boom of the mid to late 1990s, where every law firm seemed to have the Midas touch, no matter how the firm was run, is a nostalgic memory. The new century has heralded a downturn in the economy and seen the volume of heavy-duty merger and acquisition (M&A) deals – the lifeblood of most City firms – go through the floor.


In the past two years, introspection has been the name of the game with firms undertaking massive internal strategy reviews and striving to slash costs, while the shedding of partners is becoming more and more common.


Across the City, there have been stories and rumours about large numbers of partners being axed or ‘de-equitised’ – the days back in 2002 when there was a huge fuss about Addleshaw Booth & Co, as it was then, taking the bold step of letting 11 partners go seems small beer now. Foreign operations have also been realigned and slimmed down – Denton Wilde Sapte being one to have taken this step.


Tony Williams, founder of UK legal management consultancy Jomati and former managing partner at Clifford Chance, says the way many firms are now addressing the partnership issue is long overdue.


‘Partner take is still a big part of law firms’ cost. It comes down to running the business properly and getting the head count right to run effectively. If partners aren’t as profitable as you would like, profits go down and you demotivate those lawyers knocking on the door of the partnership as well. You have to make sure you don’t lose good future partners – if you don’t address the partner issue, those wanting it will go somewhere else.’


He adds: ‘When you’re getting rid of partners, the key thing is to get the process right, with a proper review prior to any changes made. You can’t have people thinking that someone is out because the managing partner didn’t like them or they weren’t part of his club. It’s also an error to assume that it is only the managing partner who can understand where the performance issues are – trainees and secretaries could often identify under-performing partners too.’


However, he says that 360-degree appraisals – where an employee is evaluated by their supervisor, peers and the people they supervise – are the exception rather than the rule in law firms. Lovells’ managing partner-elect David Harris says: ‘Obviously rationalisation of staff can act as a boost to morale when there’s a clear strategic logic – the rationalisation creates career opportunities – and is well handled. It will not have the same positive effect if it is seen as pure cost-cutting.’


Ashurst’s senior partner Geoffrey Green says: ‘You always have to look at whether you have got the right partners in the right areas. You need to do that in good times as well as tough times. This sort of house-keeping is something all firms have to do and we’re no exception.


‘You can’t have people kicking their heels, but on the other hand departments like our finance business can’t grow people fast enough. We do switch people between departments, which helps.’


Giles Rubens, director at professional services consulting firm Hildebrandt International, warns that cutting partners will not produce instant savings. ‘It takes some time for savings to come through. You can’t expect partners to leave and not get some kind of pay-out. That will have some effect on profitability.’


According to a survey of financial performance in the top law firms by accountants Pricewaterhouse Coopers (PwC), despite 40% of the UK’s leading 25 firms trimming down their number of equity partners in the last year, and more than half cutting fee-earner jobs, profits have dropped in 41% of top-25 firms, and 54% reported only slight rises in profits per partner. Indeed, it was the next 25 largest firms that have apparently prospered, with 29% recording a profits increase of more than 10%.


So does this mean that the 25th-50th largest firms are taking work off the big boys? Alistair Rose, a partner in PWC’s professional partnerships advisory group, says that is not the case. He maintains: ‘The last two years have seen a downturn in large M&A deals and the IPO [initial public offerings] market which has hit big firms hard. It’s been difficult for them. This is predominantly a London issue. Firms further down the tables aren’t so exposed to that market.’


Mr Green says: ‘Over the last two years, corporate has been really tough. Volume is down. More recently there have been some big strategic deals done – if you can get on them. We have had our fair share of strategic deals. The leading firms in M&A – of which we would count ourselves one – are still going to get the work that is going. It’s just that there is less of it.’


Mr Harris comments: ‘Clients are considering price closely, in some cases rather more than focusing on the value-added aspects of legal services or the quality of advice, all of which emphasises the cheaper provision of legal services.


‘The relative increase in mid-market work – because of the low deal volume in big-ticket premium quality work – means that smaller firms with significant corporate capability can compete more easily; on this mid-market work, price is more of a driver.’


He says the legal market over the last year has been a challenging one. ‘There has been strong competition among firms for the available work and quite significant downward pricing pressure from clients.’


Mr Harris explains that the volume of work in major cross-border transactions and mainstream M&A is generally down, while there has been significant activity in private equity. Banking work has increased, although there is strong pricing pressure because of levels of competition in the market. Activity in the areas of projects, capital markets, dispute resolution, business restructuring and insolvency, has also been strong.


Mr Green says that since late last autumn, activity levels have picked up. ‘There seems to be more confidence to undertake transactional work. There’s plenty of money available and the economy is strong; it’s just down to business confidence but that does seem to be returning.’


Competition for work is certainly fierce, says Baker & McKenzie’s London managing partner, Gary Senior. ‘In the recession of the early 1990s, I heard that some UK law firms were doing work for free just to get in on a deal. I’m not sure if that is going on now but there are certainly more lawyers around being more aggressive about the way they seek to win work – and you hear about more aggressive pricing on jobs.


‘Our approach has always been about relationship-building with clients – and with that approach we hope the relationship is going to survive whatever the economic conditions. We haven’t changed our overall strategy. It’s quite important not to panic because market conditions are a bit tough. You have to work out what the right things are to do and continue doing them and doing them better.’


Mr Green says that a strategic decision to diversify, made by Ashurst’s management team in the early 1990s, has stood the firm in good stead during the recent downturn.


‘We were very, very corporate. It was 40% of our business but now it’s about 30%. In the nineties’ recession we decided we didn’t want to get caught up in the boom-and-bust cycle; it was a deliberate strategy. We’ve been big in finance and private equity for a long time but we’ve broadened areas such as real estate and energy.’


Mr Rubens says many firms have had change imposed on them and although the top five firms appear to have got their strategy right when it comes to surviving a downturn, others in the top 25 are struggling.


He says: ‘Those who are struggling are those with little self-awareness. They are living in the past and aren’t competitive. They’re not going to get the big deals any more. Some are doing lower-value work but they still have a large number of senior people working on it. The cost base isn’t right. They need to start thinking about delivering to a price. They have found themselves misaligned with what the market is looking for.’


However, he concedes that law firm costs – building, insurance, support costs and so on – are ‘pretty much fixed’, a sentiment echoed by Mr Senior, who says: ‘The great proportion of costs of a law firm are largely fixed. We have not done that much over the last year, although we have kept things fairly tight over the last few years and reduced costs where we can.’


Mr Rose says large City firms are looking at new ways to win business to counter the effect of the depressed M&A market. ‘I’ve heard of magic circle firms turning up for pitches in Birmingham and Manchester which they wouldn’t have done before,’ he says.


Many of the largest firms, says Mr Rubens, have a bigger presence in the European markets than their smaller rivals at a time when these have also been difficult places to be over the past two years . ‘Building up European capability is expensive and then when they don’t get the quality of work they want as well, it’s a problem. Some law firms are finding that their European operations are leading to a dilution in profits rather than an accretion. They may, however, require that sort of coverage and so may be stuck with it.’


Mr Senior agrees. He says: ‘Cross-border work has suffered more than domestic work and bigger UK firms tend to be more international. So for this reason, more domestic firms seem to have done better than UK international firms, although I don’t think this will be long-term trend.


‘Europe has been good for us but I get the feeling that a lot of UK firms are struggling there. Many expanded quite a lot but are not making any money out of their international practices at the moment.’


These problems have not hit all firms hard, though. Mr Green says: ‘Our growth in western Europe has exceeded our growth in London. Germany, for example, has been tough for all firms since 2000, but our German offices taken together have seen 70% growth in the last three years with only a 17% growth in lawyers.’


Baker & McKenzie, of course, also has a large US presence, which Mr Senior says is a ‘mixed market’ at the moment. ‘The technology firms suffered with the downturn, of course, but those with big litigation and restructuring practices are doing pretty well.


‘The US is seeing some positive growth but sometimes when you do have a bit of a downturn this can be good for lawyers. The worst thing for lawyers is a flat market and that is what we have seen in the UK since 2000. It is difficult to know what’s going on but my sense is that things are certainly better than a couple of years ago. This doesn’t mean that all law firms are going to be [on the] up, because things are still patchy.’


Although cutbacks have increased efficiency in terms of staff billing, with an average of 200 more hours recorded last year, firms are still not taking full advantage of their junior and non-qualified staff, according to the PwC survey. Longer hours are being billed by more senior staff than junior colleagues, with newly qualified staff billing 22% fewer than the survey’s target of 1,512 hours per year.


Mr Rose says: ‘We used to think it would be the other way round. But most firms are saying that the more experienced people become, the more busy they become, because the more valuable they are to clients. Clients are more demanding generally – that’s part of the impact of the market conditions.’


So the good old days when partnership was a signal for solicitors to put their feet up and reduce their golf handicap are long gone.


Mr Rubens warns that law firms should not always give in to client demands for senior lawyer attention. ‘There are too many senior people doing the work that should be done by junior people. Of course clients want senior people doing the work but if you use processes and technology properly, you can provide quality without the costs.’


Mr Green says much of the problem is down to poor habits of time recording. ‘The perception is that lawyers record every moment and then maybe add a bit more. But lawyers tend to take a value judgement of how long something should take to do and feel they will be criticised if it takes longer than they thought. We have been operating more efficiently since we got a new managing partner at the beginning of 2004 – real attention has been on costs.’


Fee collection among UK law firms continues to worsen too, the survey revealed, as many firms resort to higher levels of profit retention to improve working capital. In 2004, equity partners’ current accounts provided an average of 42% of the firms’ total funding requirements, compared to 34% in 2003. Among the top 25 firms, the value of debts more than 90 days old increased from 19% in 2003 to 24%.


PwC partner Peter Buckle, head of the receivables management group, says: ‘Partners are feeling the pinch of poor fee collection rates. More attention should be paid to integrating the fee-earners into the collection process as working capital management continues to underpin profitability. More efficient management of the receivables process cuts costs and improves financial performance.’


For years, law firms have been warned of the need to shake off the old ways of practice and operate along more corporate lines. But it remains an irony among City solicitors that while they increasingly position themselves as business advisers to their clients that the one business they still struggle with advising is their own.


Lucy Trevelyan is a freelance journalist