Status quo

The past ten years have brought unprecedented change to the legal profession. As we enter a new decade, Legal Business and Dublin’s McCann FitzGerald hosted a round table discussion of some of the key issues affecting firms now.

As we leave behind one of the most tumultuous decades in the history of the legal profession, the overriding message from some of the industry’s thought leaders is keep calm and carry on. At the end of 2009, Legal Business and leading Irish law firm McCann FitzGerald gathered nine legal experts together for dinner and debate at the Gherkin. We wanted to hear their views on how the legal market will shake up in the next decade, particularly while we’re still in the jaws of a global recession. The responses were assuredly unflustered; the mood was anything but pessimistic.

Turning first of all to the current transactional market, the ten participants conceded that the previous 18 months had been bleak, but believed that current signs were positive. Peter Baldwin, a corporate partner at Jones Day, pointed out that diversity of practice and geography has enabled the firm to top the charts and be well-hedged financially in the teeth of the crisis. Jones Day topped mergermarket’s global M&A table by volume for the first three quarters of 2009/10. While Baldwin admitted the tables show that deal volumes were down around 35% on what the firm was doing in 2007, and that average deal value had dropped from $500m to $100m, the fact that no single office in Jones Day’s network accounts for a significant proportion of global revenue means that the firm is not dependent on single sources of income. Similarly, because M&A is one of many practices, and Jones Day looks to keep people properly engaged on a varied diet of work, the firm is well positioned to ride the storm.

‘We think the way forward is to have as broad a diaspora of clients and geography as possible,’ Baldwin says. ‘That is the way in which you hedge activity, rather than an over-focus on any one particular centre or any one particular type of legal activity.’

McCann FitzGerald chairman John Cronin adds: ‘Irish business has been faced with examining what has happened, the reasons why it happened and what the implications are for its immediate and short- to medium-term future. All business enterprises have, as an imperative, had to review their activities so that no foundation stone, no relationship and no assumption can be left unchallenged or made exempt from vigorous scrutiny and retesting.’

Seeking power

While business models varied between the firms represented around the table, all have benefited from broadening their practice and geographical scope, all the way up to Freshfields Bruckhaus Deringer, with global revenues of £1.3bn. What was the cause of some debate, however, was which clients needed to be targeted in the new decade. Has the shake-up of the markets meant that the global investment banks are no longer the key powerbrokers?

‘Partners should not focus on selling but rather see every interaction with a client as an opportunity to develop that relationship.’
Gary Senior, Baker & McKenzie

Unsurprisingly, Clifford Chance has no plans to eschew its institutional relationships with key investment banks anytime soon, despite the impact on the firm’s profits in the past year. Corporate finance partner Jonathan Beastall says: ‘Investment banks are always going to be a big feature of the market. I think that it’s true that they are focusing on other things at the moment. Those of us that have been around a long time have seen it before, but perhaps not to this extent. But those skills don’t go away – I don’t think it’s so much a crisis as a periodic change.’

Herbert Smith corporate partner James Palmer agrees. ‘I think our revenues from investment banks have gone up in the last 12 months. That’s not pricing, that’s volume. So, I think that we still see them as incredibly important and we’re not going around saying investment banks are dead when we don’t believe it for a second.’

Herbert Smith, which mounted a successful campaign to join the ranks of the UK’s legal elite in the past decade, is in no hurry to lose traction with a client base that has taken years of blood, sweat and tears to develop. That said, Palmer is acutely aware that the firm needs to be proactive whenever there are any perceived shifts in the balance of power.

‘Who are the powerbrokers?’ he asks. ‘Well, the investment banks are still pretty critical, and I think clients who have got cash to go shopping when others can’t, as well as those that are in desperate trouble, are the big sources of work for us.’

As the only finance lawyer in a room of corporate specialists, Paul, Hastings, Janofsky & Walker’s Conor Downey is somewhat of a minority. However, he sees that his own practice area of structured finance, which was at the epicentre of the credit crunch, is where there will be real changes in the balance of power.

‘There will be new entrants into this market. We will see investors becoming a lot more active, becoming almost quasi-banks themselves.’
Conor Downey, Paul Hastings

‘Where I think there has been a shift in who the powerbrokers are is in the niche practice areas – perhaps those areas which have been most heavily blamed for contributing to the credit crunch – structured finance and real estate,’ he says. ‘I think it’s fair to say that while the investment banks have been important, in my practice area they will be less important in the future in a couple of those areas than they have been in the past. There will be new entrants into this market. We will see the investors, and in particular the hedge funds, becoming a lot more active, becoming almost quasi-banks themselves. We’ll also see some of the professional consultancies, such as hedge fund consultants and insurance consultants, eventually starting to become involved in transactions.’

Flight to quality

So how much effort should the firms put into chasing work from these emerging powerbrokers?

Baldwin argues that recent events have shown that firms can be ‘too cute’ about which clients they should target. He feels that diversity, breadth and scale of practice are what have kept firms in London in fairly decent shape in recent years.

‘Absolutely no one was able to predict two years ago who was going to be active and where the major transactions would come from,’ he says. ‘The world changed in lots of ways, and diversity has been the thing that has protected people more than anything. It goes to show that pretty much all of your business development activities, in terms of forging relationships with banks and corporates, are important, as you never know who’s going to be really valuable.’

‘Those that are good sellers of legal services have really been differentiating themselves from those that are simply good at executing the work.’
Giles Murphy, Smith & Williamson

Giles Murphy is a keen observer of law firm strategy through his position as a director in the professional practices team at Smith & Williamson. He specialises in advising law firm partnerships on financial management and is quick to follow up on the point about the pressure law firms face in developing their businesses right now.

‘Something we have observed is that, going back 18 months, there was enough work around for everyone and as long as you had your business development right then you’d get your fair share,’ Murphy says. ‘What’s happened since then is there has been quite a shift – the people that are good at business development are actually very good at selling, and a lot of people don’t like to think of themselves as sellers of legal services. But those that are good at that have really been differentiating themselves from those that are simply good at executing the work.’ He adds: ‘It’s a skillset that I don’t think law firms are particularly good at training their partners at. They invest in it, but most people join law firms because they relish the mental challenge, not because they consider themselves as salespeople.’

Unsurprisingly, the idea of lawyers being sellers of legal services is met with some consternation around the table. The oft-quoted ‘flight to quality’ is still very much in evidence, according to the majority of participants. Barclays’ group deputy general counsel Michael Shaw, who until recently was a corporate partner at Herbert Smith, believes the current market conditions will show which firms are more successful at winning instructions and why. ‘Is it about selling? Is it just because you happen to be a rather more silver-tongued salesman than one of your competitors?’ he asks. ‘Or is it the case that people are looking for the very best lawyers and there isn’t enough work around for those who aren’t quite in the top tier, but there are other people that are simply looking for value for money, that’s actually what they are really interested in?’

‘Pretty much all of your business development activities are important, as you never know who’s going to be really valuable.’
Peter Baldwin, Jones Day

Cronin says that in Dublin there is a tangible contraction of the legal market. He puts this down to the fact that there’s a huge number of lawyers that can do the work, but in difficult times ‘those firms who have always tried to recruit and retain the very best people, who have invested considerable resources in continuous in-depth training, and who have had the greatest exposure to different types of work situations – including previous downturns – are those best equipped to meet current challenges or, as the case may be, to assist clients at this time.’ This viewpoint elicits nods of approval from around the table.

‘There is a greater requirement for “real lawyers”, because of the complex issues that are being thrown up,’ Cronin adds. ‘So in some ways the top two or three law firms, despite this great pressure on fees, probably have a better shot at getting much of that work, as they are able to demonstrate their high levels of expertise, experience and know-how. You’re able to show what you’ve done and, thus, win the work or appointment and, then on the job, demonstrate that you really can produce for the client, and in this way, hopefully, enhance the relationship with the client.’

Shaw adds that in the UK the mid-tier firms are in danger of being hit hardest, as they can be caught between premium quality and greatest value.

‘There is a flight to quality because people need sophisticated advice,’ Palmer says. ‘There are more serious consequences to some of the things people are doing now, and greater risks to bear. People in those situations want to be incredibly comfortable about the advice they are getting. But, you know, there is still excess supply compared to demand in a whole lot of other areas and there is pricing pressure on those areas.’

Red letter day

Is the answer to drop fees to compete? Many firms are losing deals on price and attendees trade similar tales of woe. But Murphy asks how keenly pricing pressure is being felt by the firms present.

According to Baldwin, the extent of pricing pressure depends on how much traction the firm has in a specific jurisdiction. On the whole, pricing pressure is greatest in those jurisdictions and practices where there is the highest level of competition.

Partner Tim Jones says even Freshfields Bruckhaus Deringer, the highest-grossing law firm at the table, is feeling the pinch. ‘We budgeted for a reduction in overall demand and a reduction in pricing this year, and that’s what we have seen,’ he says. ‘That’s across most practices and geographies as well, not just M&A.’

‘We’ve harmonised our level of gearing at around 3:1, and we’re pretty determined not to automatically add people as the markets pick up.’
Tim Jones, Freshfields Bruckhaus Deringer

For these firms, contamination on pricing continues to be a major headache. Cronin gives the example of where rival firms and boutique firms are competing for similar work, thus providing company board members with an unprecedented scale of intelligence about the range of pricing options available. The result is that everyone is undercutting.

The trick, according to Baker & McKenzie’s London managing partner Gary Senior, is to understand that ever deeper discounts are not the answer for either law firms or clients. ‘Law firms need to focus on showing and delivering value,’ he says. ‘A big part of value is a strong overall relationship. Partners at law firms should not focus on selling, but rather see every interaction with a client as an opportunity to develop that relationship and, of course, if you are successful in that, then work will flow.’

Palmer agrees that the key issue surrounding cost saving and pricing pressure is delivering value. But he argues that so much of the debate at the moment about the value of billable hours is false. ‘We’re in business and we’ve got to make a return, and it’s got to stack up as a whole,’ he says. ‘We certainly have some clients who we will give significant discounts to on something because we know we are going to get a significant upside on something else; in other words, value-based billing. However, the majority of debate on the death of the hourly rate is really about lower fees, given the current cost control pressures clients are under – and which we have to recognise. Accordingly, the current debate doesn’t mean the billable hour is dead – many clients are still sticking with hourly rates if they think it will be cheaper, which makes an alternative model hard to develop.’ He adds: ‘If market activity levels remain lower, the reality is that fee pressures are likely to continue.’

‘Clients with the cash to go shopping when others can’t, as well as those that are in desperate trouble, are the big sources of work for us.’
James Palmer, Herbert Smith

Senior argues that cheap pricing is not the ultimate goal. ‘I do think there is more to it than just cheaper,’ he says. ‘It’s about what “value” actually means, and a lot of it is around relationships. I also think there is a real issue about certainty. There is no doubt that a key issue for clients, in terms of value billing, is certainty around how much a job will cost so that there are no surprises. Strong relationships between law firms and their clients are an important facilitator for fixed pricing.’

Murphy agrees, pointing out that there are very few goods, or even services, left in the world where the price is open-ended. ‘I think we’re heading towards the death of this concept that if you spend a few more hours doing something you automatically get paid for it,’ he says.

Size matters

With general counsel under increased pressure to deliver legal services at a reduced cost, a possible solution to providing value may stem from in-house legal teams becoming larger and taking on more work themselves. Certainly, the trend of the past 18 months has been for general counsel to cut back on their external providers, streamline their panels and try to get their own teams to handle as much as possible.

Barclays’ Shaw doesn’t perceive that there is a general trend for in-house teams to be expanded right now, with lawyers under pressure to reduce overheads in most organisations.

‘There has always been more partner input and direct face-time with clients in Ireland – it’s expected and many partners prefer it.’
John Cronin, McCann FitzGerald

‘It is bound to be the case that in-house legal departments – if they were calculating their hourly rate in the same sort of way – would be less expensive than the firms that are represented around this table,’ Shaw says. ‘But that will only help in relation to certain types of work. Sophisticated clients will learn to slice and dice. They are being more cautious about which work goes to which sorts of firms.’

While panels have their place and it is becoming harder for firms to win spots on them (Barclays’ own panel review in 2009 being a good example), some firms are growing weary of being on panels if they don’t deliver work. Some participants agreed that panels were fine when there was plenty of work going around, but now that the work has dried up in many areas, simply being on a barren panel could hinder the firm in seeking new business opportunities.

Baldwin says: ‘I think the panel thing is always interesting. I mean, one thing that we as a firm try quite hard to avoid is being one of many, many firms on panels, and then not getting much work and also being conflicted by clients who don’t send much traffic our way.’

Smell of success

The next key subject of debate was whether increased profitability at law firms was something that clients were particularly irked about, especially at a time when they are looking at lowering costs. As Jones points out, despite the credit crunch and subsequent economic collapse, many law firms have fared relatively well compared to other professional service industries. The question is whether clients will want their law firms to attack their cost bases to justify their fees in the medium term.

‘Law firms don’t seem to have gone through the same sort of internal pressure to become more efficient as have in-house departments,’ Beastall says. ‘However, I don’t really believe that clients are concerned about what profit firms maintain or even improve upon, provided the in-house team is seen to be driving efficiency in their business and cutting overheads by the astute use of law firms.’

‘I don’t believe that clients are concerned about what profit firms maintain, provided the in-house team is seen to be driving efficiency.’
Jonathan Beastall, Clifford Chance

But before firms congratulate themselves too much, Shaw adds a note of caution, pointing out that he feels law firms have been quite lucky so far, in that they have been relatively insulated from the worst effects of the crisis.

‘I think clients want their law firms, like any other provider, to be responsible,’ he says. ‘I think they would be upset to see their noses being rubbed in it if they were in for cost-cutting steps internally, and they thought that the lawyers were making hay.’

Lean and mean

Inevitably, efficiency questions turn to a discussion over leverage. The general consensus is that leverage will come down, but not to the extent where firms are top-heavy. The answer to reducing overheads is not simply culling associate levels. McCann FitzGerald’s Cronin points out that the pressure to contract in Dublin is different, as there have not been the same partner:solicitor ratios as in the UK. ‘There has always been more partner input and direct face-time with clients in Ireland – it’s expected and, in many cases, partners prefer it thus,’ Cronin explains. ‘There may be some reduction, but not too much. However, in firms where there are a number of salaried partners, there may be some contraction on that side.’

Freshfields’ Jones says that maintaining efficient gearing levels is essential for his firm going forward. ‘We’ve harmonised our level of gearing at around 3:1 across most of our regions and practices, and we’re pretty determined not to automatically add on more people as the markets pick up. We need to find smarter and more efficient ways of doing things,’ he notes. This attitude of maintaining the status quo and avoiding the boom and bust approach to leverage is seen by most attendees as sensible.

‘Law firms will need to work on relationships in a deep and sophisticated way that they didn’t need to do in the past.’
Michael Shaw, Barclays

Ultimately, the table agrees, the real challenge for law firms in this decade is to get themselves fighting fit and poised to make the most of opportunities that come their way. If the past decade was about rapid expansion and a glut of transactions as the world globalised, the next should be about prudence and steady business development, as opposed to boom and bust. Most agree that the markets will come back, but whether they return with the same vigour is an open question. The firms that get themselves in shape for controlled growth will be those that fare best come the next recession.

‘Although different sectors of the economy have encountered somewhat different problems,’ Cronin says, ‘there is also a recognition that companies and businesses need both their internal teams and their outside advisers to work alongside each other as they take the tough decisions required of them and their individual business situations. A culture of teamwork and mutual support is important. We work hard on that front.’

‘Law firms will need to adapt quite quickly,’ Shaw says. ‘There’s plenty of them around, and while there was so much M&A and other work around, there was no pressure on fees, there was no pressure on how you were going to deliver, there was no pressure on what the relationship entailed. In the two or three years of the boom it was a matter of getting transactions transacted. That’s all changed, I think, and it will be quite a long time before anything like that comes back. In the meantime, law firms will need to work on relationships in a deep and sophisticated way that they didn’t need to do in the past.’

Murphy’s parting shot is to warn law firms not to get too complacent. ‘I think the general feeling among the firms represented around this table is not to change too much, be it on pricing, business development or size and shape,’ he says. ‘Looking at the relative success of your firms, this would make sense. But I wonder if we all met again in five years’ time whether the picture would be different. I think there are big changes around the corner, and things will be somewhat different from where they are now.’ LB