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Large law firms perform well but feel the heat

Posted in Australasia, Leadership, Legal Profession, Uncategorized

Despite a period of patchy M&A work, scratchy demanding clients and less ‘sticky’ partners, Australia’s ten largest law firms (Big Law Australia: BLA) have recently reported record gross fees, high equity partner profits coupled with a bullish view of their future world (Alex Boxsell and Samantha Bowers reporting in AFR 16 September 2011). However, they are facing real challenges from abroad and locally; a few thoughts on all these below.

 

On the back of excellent reported results, top Australian law firms are being challenged by foreign firms entering the Australian market, as well as local mid-tier innovators - graphic by Sharon Larkan on iPad (adapted from online image - artist unknown)

Good news for a majority of the top ten Australian law firms:

  • improved gross fee income over the past year with partner teams (equity and fixed share) generating annual fee revenues above $2m
  • tightly managed expenses
  • profit margins averaging 41%
  • average top equity partner earnings in the range $1.8m to $2m

These are outstanding results by any world standards, from some of Australia’s best-run businesses. However, a more in-depth consideration of developments over the past year or two, and the published AFR performance results for Big Law Australia (BLA), seem to indicate they have been (or should be) feeling the heat from both internal and external forces – some obvious and some not so obvious:

  • After (in some cases) years of discussions or negotiations, foreign firms have bypassed BLA firms and entered the market in numbers:
    • from the UK – Clifford Chance, Alen & Overy, Norton Rose, DLA Piper and from the US – Squire Sanders, Baker McKenzie and Holman Fenwick Willan;
    • such firms have rejected the allure (and arguably bloated condition) of the large firms and in most cases taken over or teamed with smaller boutique firms;
    • these firms generally compete in the same ‘space’ as BLA firms and are certain to take a percentage of work in this already mature and over-lawyered market;
    • the foreign firms have successfully poached a number of partners from BLA firms. In one case, virtually the whole office (Minter Ellison in Perth by Squire Sanders). This has created a more competitive, cut-throat market with firms now hungrily poaching from one another to fill gaps caused by these incursions. It has also meant, contrary to assertions by some BLA leaders, that the foreign firms will quickly be regarded as having both a foreign and an Australasian character and feel;
    • These new firms offer an exciting alternative to top performing lawyers, whether at senior associate, salaried partner or equity partner level – high earnings, established world-wide networks, international work, excellent systems and IP and in many cases, good leadership and cultures.
  • Clients are increasingly calling the shots and are proving innovative in solving their legal needs; they have:
    • increased the size of internal legal teams or are using more lawyers in-house from suppliers like Advent;
    • reviewed legal panels and reduced panel sizes, in some cases bringing on board specialist smaller firms;
    • referred certain types of work to LPOs overseas, to key specialist partners in other firms and to smaller boutique firms
    • refused to countenance increased rates or large teams working on matters;
    • where appropriate insisting on fixed fees and in a majority of cases a more rigorous control of fees.
  • Smaller boutique and mid-sized firms have grown in stature; they have proved more innovative, faster moving, as well as extremely profitable. Both local business and overseas international firms have found them to be attractive alternatives to BLA firms.

As a result BLA has been forced to make signficant structural changes to both match profit shares offered by foreign firms and to try to protect their star partners from poaching;

  • with one exception, by re-jigging equity partner structures – effectively reducing equity partner numbers relative to fixed salary partner numbers. In this way they have been able to increase earnings of key performing equity partners, in some cases boosting these with bonuses to ensure levels of $1.8m to $2m are achieved. It is no coincidence that most BLA firms achieve profit payments to key partners in or around this band.
  • increasing the number of salaried or fixed share partners with sometimes 5 to 10 times multiples between top equity partner and salaried partner pay. (Only three BLA firms have only equity partners).

What does all this meant for BLA firms?

  • It seems that equity will be more tightly held by fewer partners; there will thus be fewer opportunities for fixed salary partners to progress to equity. In a meritocracy it is also going to be more challenging to progress to full equity.
  • This is sending a clear message to BLA lawyers and salaried partners – equity will be held tightly; we will pay ourselves a significant multiple above what we pay you; we can’t guarantee access to equity unless exceptional performance is achieved. How this works through in the long term will be interesting to see.
  • There could be significant cultural implications and upcoming challenges down the line –
    • fewer equity partners and many on 100% points with fixed earning partners comparing their pay/performance ratios against these equity partners. This can directly impact trust, loyalty and culture and make it easier for external predators to pick them off. Fixed earning partners will no doubt be watching carefully to see how equity partner performance is measured and how this relates to profit shares and in turn their own packages. How these matters and resultant discussions are managed will be stressful for leaders.
    • culture changes over time and is largely determined by senior leadership, in this case ever-smaller groups of 100% equity partners. If other partners come to view such structural adjustments as being driven by greed by a few and not by sound business or long term partnership benefit principles, this could irreparably change and sometimes damage a culture.

The successful large firms in Australia may have bought themselves some time in competing with foreign firms in being able to offer comparable earnings. However I suspect their leadership, cultures and equity and compensation structures (admission, progression, regression) will be severely stress-tested in coming years.

There are already signs that these developments have undermined cultures, trust and firm loyalties. If they are not very carefully strategised and managed in future there are even tougher times ahead for BLA firms. To date, as a group, they have seemed to be impervious to outside influences and competition. Things may change quickly as the heat coming from foreign firms, dynamic local innovators as well as clients plays out.