ABSs “have potential to challenge leading law firms”

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28 March 2014

BT: telecoms giant’s arrival in the market will threaten top law firms

The involvement of big brands like BT and KPMG is evidence that alternative business structures (ABSs) have the resources and expertise to encroach on the work done by larger law firms, a top banker has predicted.

In his annual report on the shape of market for larger law firms, James Tsolakis, RBS’s head of legal services, was upbeat about prospects for the UK’s legal market but listed a number of dangers. The report followed yesterday’s RBS/NatWest survey of SME law firms.

While at the moment ABSs are mainly in the “lower-end or high volume sectors”, he suggested many are simply testing the water. “They can expand their service offering and tap into other profitable areas should they wish to in future. This seems a logical evolution and certain participants in the ABS market have aspirations to build into the mid tier market where they can service larger client.

“ABSs have the advantage of relying on lower-salaried lawyers, paralegals and support staff which may enable them to be more agile in a competitive market. And given that such big brand names as BT and KPMG are moving into the sector, they have the expertise and resources to offer more specialised services, and will ultimately encroach on the work done by bigger firms.”

Mr Tsolakis issued a stark warning against firms seeing the early signs of economic recovery as an excuse to revert to pre-recession business practices, saying the consequences “will be adverse in the extreme”.

The economy gave grounds for “cautious optimism” and it was likely more work would result. He acknowledged that the legal services market was still extremely tough for top-50 law firms, however, with average profits shrinking by 0.5%, while annual turnover rose by 6.9%.

Managing costs with today’s fee structures was clearly at fault, he said. “Therefore, law firms need to be relentless in their pursuit of margin management which is constantly under threat from both revenue and expense pressures.” Prudent management needed to extend to cash reserves too, he recommended.

A central theme of his narrative was that the shift to clients demanding more predictability around costs and the end of the billable hour was only likely to intensify. Pressure on fees was forcing law firms to consider disaggregation – breaking down a piece of work and giving parts of it to the cheapest competent person – but not enough firms were doing it.

“Presently, the majority of firms – particularly large – are reviewing but not overwhelmingly implementing disaggregation strategies. But this will need to change and will be forced upon firms by clients if the firms do not proactively adopt this principle.”

Also in the report, Mr Tsolakis predicted that more merger activity would speed changes in legal sector consolidation, including “the size and scale of firms in the top-50 as measured by turnover will continue to increase at an unprecedented rate”.

He said: “However, a danger of the healthy appetite for mergers is that poorly conceived transactions which are not value accretive may go ahead. These may not be founded on solid strategic objectives, well-formulated business plans and sound financial principles.”

Mr Tsolakis acknowledged the temptation of firms to grow through recruitment in a tough market, especially since, he predicted “it will be some time yet before firms experience a strong volume driven upswing in some core practice areas and key profitable areas of practice, notably M&A work”.

Yet a growth strategy based on “poaching instructions and clients is both high risk and expensive”, he cautioned. A preferable strategy was based on improving a firm’s market share “by developing a more focused approach to client management and relationship development”. Although the legal profession was still “relatively unsophisticated” in this area, “the lower risk, lower cost and higher returns available from capturing business from existing clients is compelling”, he said.

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