A number of our recent posts have focused on trends and challenges impacting the UK legal market currently. While the UK economy continues to languish in a double-dip recession with transactional activity stalled, the publication of the Legal Business 100 (subscription required) last week indicated that, at least at first glance, the UK legal industry showed a re-bound over the past year. According to the Legal Business 100, UK law firms increased revenue by 14% this year.
However, much of this growth has come in the form of merger activity as opposed to organic growth. As we discussed last month, the UK market has continued to consolidate, in the face of increased competition and challenging market conditions. This has occurred both domestically and internationally. When the contribution of revenue growth from large mergers was removed, revenue growth for the UK market was a more moderate 6%, according to Legal Business. Furthermore, profits per equity partner grew by a modest 2% over the past year, and have yet to reach pre-recession levels experienced during the economic boom.
While gross revenues and net incomes have increased to record levels, profit margins (gross profit as a percentage of revenue) still lay some way behind pre-recession highs. Although margins have re-bounded from their all-time low in 2008/09 (directly following the Lehman Brothers bankruptcy), law firms are still seeing economic pressures keep this metric low. Decline in demand, pressure on fee rates from clients, and rising costs, particularly in the form of high salaries, form the basis of this margin squeeze.
Cost Pressures Rising
The considerable reduction in demand levels which prevailed at the outset of the recession placed a far higher focus on cost efficiency for many firms. Firms struggled to produce top-line growth and placed far greater focus on reducing costs in order to stabilize profit declines. However, over the past financial year, expenses at UK firms have increased with average costs per lawyer for the UK 100 rising 4% compared with the previous year (£220K compared with £212K). US firms have experienced similar cost pressures, as observed in the U.S. market by Thomson Reuter’s Peer Monitor.
One of the likely contributors to this expense rise in the UK are increased headcounts (total lawyer numbers of the UK 100 grew by 9%, although some of this growth can be attributed to merger activity). Despite large scale redundancies occurring during 2008 and 2009 in response to reduced demand, some firms appear to have rebuilt headcount at a higher rate than work level increases. This has lead a number of firms to re-visit redundancies in the past few months in areas where capacity continues to outstrip demand.
Head of Legal Services – Corporate and Institutional Banking at The Royal Bank of Scotland (RBS), James Tsolakis, was quoted by Legal Business as saying:
“The level of fee-earner resources, notwithstanding the restructuring that has already been done, continues to exceed the volume of work that is available…I can see at least 5% of capacity being taken out of the market.”
These figures do suggest a stabilization of the market, with now two years of revenue growth being posted since the Lehman crisis. However, many expect the challenging market conditions to continue for the medium term. According to Tsolakis:
“This position is unlikely to alter until the UK and major global economies recover by demonstrating long-terms sustainable growth.”
Eversheds Chief Executive, Bryan Hughes, meanwhile, expressed to Legal Business an even more pronounced view of the limited growth potential in the UK market currently:
“It’s a massively challenging market…There’s no real growth in the economy therefore there’s no growth to latch on to, so what you’re looking for is increased market share or increased shares from your existing clients. There is an incredible amount of pricing pressure out there. It’s a capacity market: there are too many lawyers and not enough work.”
This is suggestive of a continuation of the status quo – growth will only be achievable by acquiring market share or winning a greater slice of work from existing clients (or new clients) – driving further consolidation and greater levels of competition in the market.