Spreading the risk

City firms are celebrating another year of growth, but managing partners and finance directors are preparing for a war to keep rising costs in check, writes Anne Mizzi

'Revenue is vanity, profit is sanity and cash is reality,' goes the old saying.

Even so, it is still hard not to be impressed by the kind of growth in fee income that top corporate law firms have been reporting this year.

A handful of firms have published their financial results showing a 40% increase in turnover over the last financial year, while the average is a slightly more modest 21% growth.

However, most remain reluctant to reveal their overall profits, which are the only real indication of how well they are doing.

Richard Parker, managing partner of City firm Richards Butler, says firmly that profit is sanity: 'It's all about profitability.

It's all about what you can pay your top people.'

While turnover has grown for many firms, so have overheads such as salaries and rents.

There has been much talk of these costs, especially that of junior lawyers' salaries and an increasing range of other benefits, being passed on to clients.

But another possibility is that some of the cost will be borne by the firms themselves - or more precisely, by the partners.But despite these outgoings, some firms seem to have managed to have their cake and eat it this year.

Lawrence Graham's impressive average partner profits of 380,000 are a 35% increase on last year, while turnover is up 24% to 49.3 million.

On average, DLA's partners are taking home profits of 395,000, a 36% increase from last year, while revenue has grown 26% to 175 million.

Leeds firm Walker Morris has also done well, increasing partner profits by 24% to 420,000, with fee income rising 20% to 26 million.Among the biggest climbers so far is Cambridge technology firm Hewitson Becke & Shaw.

Its average profits per partner have shot up 35% to 193,000, despite a mere 10% climb in turnover.

So far, it is the larger City firms that seem to be tightening their average equity payouts the most.

Norton Rose's average partner profits are up 16% from last year, with fee income growing by 25%, while Linklaters' average profitability has reportedly increased 12% to 795,000, despite a 28% jump in turnover to 505 million.

Freshfields Bruckhaus Deringer's chief executive, Alan Peck, points out the problem with comparing year-on-year turnover in a merged firm: 'It's not a like-for-like comparison,' he says.

'I don't even know what our year-on-year growth has been like.

It was a jolly good year, but because the firms have been incorporating, there is a lot of distortion in the figures.'

The figures for both Freshfields and merger-happy City rival Clifford Chance are still being audited, but predictions are that Freshfields will apparently grow by 65%, while Clifford Chance will seem to have grown by 56%.

But how much of these figures will be accountable to merger distortions? The reality is that both these firms are likely to have suffered from the very thing that gives them their magic circle kudos - the fact that they do a lot of work for the investment banks.

A Clifford Chance spokesman says firms which have focused heavily on capital markets work have been more directly affected by the US economic downturn than others, but that 'well-hedged' businesses have been sheltered from the full impact.

Mr Peck is also looking on the bright side.

He says: 'We can still eat.

It was a very good year for M&A.'

He says that although the investment banks are making cuts, private M&A remains strong.

'It's been more of a change in the mix - less public work,' he says.

'There's not been much of a slowdown in continental Europe.'

Former Eversheds managing partner Peter Scott, director of Horwath Consulting, says: 'I suspect firms outside the magic circle will find it hard to keep up with salary hikes and it will be taking a toll on profitability.'

But a handful of medium-sized firms have achieved a very healthy growth around the 40% mark.

Bristol-based Osborne Clarke, Birmingham firm Wragge & Co and City IT specialists Bird & Bird have revealed turnovers around that level, although profitability remains under wraps.

Simon Slater, director of strategy at Osborne Clarke, attributes the 40% increase to a 'breakthrough in the quality of clients and work generally, as a result of a successful strategy to recruit the right people in the right places'.

He says: 'It's all linked to bringing in the right people with the right experience and access to clients.'

Private equity is up 26%, corporate 27% and property is up 32%.

There is more dramatic growth in other areas: employment, pensions and incentives is up 61%, interactive media up 97%, technology and telecoms 120%, and banking a massive 248%.

'Despite the fact that in recent months there has been a tailing-off of activity in the technology area, it remains strong as a whole.

It's only in the last four months that it's begun to be felt by law firms this side of the Atlantic,' says Mr Slater.

Like Bird & Bird and media firm Olswang, Osborne Clarke escaped being dragged down by the dot-com fall-off by spreading its business across a range of new and old media sectors, and not focusing too heavily on Internet start-ups.

But whether it will achieve this kind of growth again next year is another question.

There are indications that these results may be hard to sustain.

Partners at other firms have reported a slowdown.

One partner says that his firm may well rein in targets in the coming months.

Another says: 'Clients are taking much longer to pay so there could be cash flow implications and much tighter credit control.'

Mr Scott cautions firms not to ignore the warning signs of what is to come.

He says: 'A firm with 50 million turnover inputs at least 1 million a week.

If in one week it goes down to 750,000, and then again the following week, you spot a trend.

You are going to look at it very hard.

Managing partners and finance directors will be monitoring input trends very, very carefully, because that could mean there's a levelling off or recession approaching.'His advice is clear: 'In good times, put something away for bad times.

I think they should be squirrelling something away for bad times.'

Mr Slater says he will be keeping a close eye on income and costs: 'We will be watching our cost-base.

Looking further ahead, I would imagine the more successful firms would be seeing more realistic growth.

We are now seeing growth of 30-40%, and we will get a bit of reality coming back, to more like the mid-20s.'

But it is not just the technology sector that has provided firms with strong results.

Mr Slater says construction is booming despite the slow-down: 'It's not a property-led downturn, unlike ten years ago, and also the banks are stronger,' he explains.

Mr Parker says Richards Butler's 'star performer' is litigation, but that corporate finance has done extremely well because 'we've managed to progress our client quality and get better quality deals and clients than we had a few years ago, and keep our very good players'.

Mr Parker says his firm has been well insulated against the US slowdown, despite having international offices.

'We are not acting for the big banking and corporate multinationals, and our deals are not governed by whether the stock market has wobbled,' he says.

He adds that in Richards Butler's key areas - media, rail, and construction, and in south-east Asia - 'there's been no slow-down at all'.

Another key area, which is likely to remain buoyant despite recession, is litigation.

Mr Parker says that top-level litigation firms are likely to remain strong.

'Litigation is so profitable and so successful,' he says.

'That doesn't mean we're screwing the clients, it means that the quality is high.

It's not a volume business.

Whether it's a weak or strong economic cycle, we are insulated.'

But for the time being, the legal market is growing.

The UK legal sector is now worth almost 10 billion.

It is not just a case of hiring the right people, acting for the right clients and being in the right sectors in the right economy.

'The cake is getting bigger,' says Mr Parker.

There are other, organisational factors, which may also have had an influence on growth.

Many firms have introduced billing targets or increased existing targets to help justify pay rises.

There is some evidence that firms have raised their charge-out rates.

Firms have also tinkered with their partner remuneration, often by modifying their lockstep to introduce performance-related targets and early retirement or exit routes.

There are also many more salaried partners, which has an affect on the cake mix.

Firms that have ruthlessly cut out dead wood, and insisted on high standards, will also be seeing increased turnover and profitability.

Mr Scott says a firm's true profitability can be masked in another way.

'You can keep average profits per partner up by getting rid of partners.

You have to compare the lump sum of profits with the year before,' he says.

And if firms have not managed the high growth achieved by their rivals this year, it may be an indication of having made investments from their equity, rather than taking out loans.

All firms are conscious of their bottom line and rising overheads in a toughening market.

Anne Mizzi is a freelance journalist