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Law Firm Management at the Margin

In parallel there has been a marked slowdown in some economies which in turn has impacted on levels of M&A activity affecting those firms in particular that traditionally have been strongly focused on this type of work.

There is a real danger, however, that these headline grabbing high profile factors distract attention from the more fundamental and more significant underlying trends and changes occurring in the legal market. By their nature, these trends do tend to be lower profile but their impact is not and the great risk is that they become ignored or receive less attention than they should.

The primary driver of these trends is a single, yet complex factor, namely the changing needs and expectations of clients; of course such changes have been occurring for many years but the evidence indicates that there is currently a coincidence of events that will result in their impact being of significantly greater scale over the next 3 years or so.

The impact will vary from market to market: intensifying and accelerating change in those jurisdictions that already have higher levels of competition and introducing new pressures in those jurisdictions that historically have been subject to lower levels of competition.

In the past references to clients’ needs and expectations changing and displaying greater levels of ‘sophistication’ in their purchasing were frequently seen as a euphemism for buying on price and, to a degree, there was an element of truth in this. Over the past five years or so client sophistication in purchasing has gone way beyond a focus on price although the focus on fees paid to professional advisers is as intense as ever.

Clients today are increasingly purchasing services on a markedly different basis:

  • First, they are reassessing the ‘value’ of legal services (on a case by case basis for certain work) in an ever more rigorous fashion and on this basis deciding what level of fees are appropriate. Certain work is considered by clients to be of critical strategic, competitive, financial or reputational importance and for such work clients remain relatively less concerned about fees although expect them to be based on the ‘value’ of the matter as they perceive it rather than on the basis of time on the clock or scale fees. Increasing levels of work are, however, becoming considered as commodity or lower level operational matters and as such clients are prepared to pay relatively lower fees and take advantage of the competition between the range of firms seeking such work to drive down fees still further. But even on the higher value matters (except for in a very small range of work) clients perceive there to be a reasonable choice of potential providers and will use this to keep fees under tight control. This is all occurring to a far greater extent and in a more consistent way than at any time in the past and more importantly all the indicators are that it is set to continue.
  • Secondly, clients are discriminating and differentiating between competing law firms in a way and to a level that they have not in the past. Over time clients have become more experienced at buying legal service, better at establishing what they are seeking on any particular matter or type of work, more knowledgeable about the relative capabilities and characteristics of a range of law firms and, most significantly, increasingly able and willing to select firms at a fee level they feel is appropriate, on this basis. Put quite simply they are increasingly clear about what they require and which firms are best able to meet these requirements and are in parallel willing to negotiate to ensure that the fees they pay are both in line with their perceptions of value and market rates;
  • To add to this, on the vast majority of legal services there is something of a ‘product life cycle’: new, innovative services command a premium to begin with but over time what was new and innovative initially becomes regarded as more ‘run of the mill’ and with increasing numbers of firms seen as credible providers, becomes devalued commanding lower fees in the market. In this respect the legal market is no different to any other market with new products and services commanding a premium at their time of launch but this becoming eroded over time as other competitors offer similar or even identical products and services.
The result is clients purchasing legal services on a significantly different basis from in the past, differentiating between the competent and the excellent, selecting the latter in preference to the former, and then using their negotiating strengths and the fact that they believe that there is choice to agree fee levels in line with their perception of the value of the service being provided.

In the past this approach to purchasing legal services has been most prevalent for the lowest value legal services and in a range of areas commoditisation or near commoditisation has occurred.

The downward pressure on fees has resulted in those firms unable to meet the service and pricing expectations of the market losing out on certain types of work while other firms have only managed to maintain some presence in such sectors, often at substantially reduced margins.

There have also, of course, been winners too: those firms that have restructured themselves in a way that allows them to meet both the service and pricing expectations of clients while still making good margins. This typically involves quite radical change in terms of the way services are provided (processes and procedures), the structure (gearing) of firms, the use of IT, the level of staff employed, and so on.

Successful firms have focused on building their capabilities in line with market expectations and those that have done so best are enjoying good returns on their investment.

What has until recently been mainly limited to the lower end of the legal services market is increasingly applying to mid and higher value work types (eg. Real Estate, Banking and Commercial Litigation) and clients are becoming increasingly determined to achieve lower costs for such work taking full advantage of any ‘softness’ in the market to negotiate reductions, leveraging the more aggressive (predatory?) pricing being offered by some firms (to maintain or build volume and market share) to ‘force’ pricing reductions from all providers.

This is increasingly putting significant margin pressure on an ever widening group of law firms and in particular those that are not seen as particularly exceptional or outstanding in what they offer.

Of course strong relationships can help offset or lessen the impact of downward pressure on fees but this is unlikely to provide a long-term sustainable counter force and it is unrealistic to expect this to last indefinitely.

The real risk for a very wide range of firms is that they will find themselves regarded as not fully competitive in terms of capabilities for the very highest value matters and not meeting the pricing and possibly also service expectations for much mid-value work.

The challenge for such firms is to develop and implement entirely new approaches to the way they ‘manufacture’ legal services ensuring that they can be ‘produced’ in a way that meets clients’ quality, service and price expectations (that are all likely to become even more demanding over time) while also ensuring an acceptable level of margin is made.
Put quite simply the market will, over an ever increasing range of services, determine the price that can be charged for a particular service and law firms will have to focus more and more on effectively managing the costs of producing that service taking into account the margin they wish to achieve.

In manufacturing industry and much of the service sector this, of course, has always been a management focus – it is after all the basis upon which profit (or otherwise) is generated. In professional services which traditionally have enjoyed high margins it has tended in the main to receive lesser attention.

That will now have to change with the focus on managing margins becoming as important an issue for the legal services sector as it is other sectors of the economy. This will require the development of new skills, a change in mindset, differing roles and responsibilities for partners, and the willingness to consider and if appropriate implement radically different approaches to how legal services have been ‘produced’ and delivered in the past.

The opportunities certainly exist and the winners will be those that are most adept at changing the way they operate so that they remain profitable in what will increasingly become a ‘margin’ focused sector.

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