Survival is by no means certain for struggling UK law firms - PwC survey

  • Top tier outperforms whilst mid-market feels the squeeze
  • Profit per equity partner for Top 10 law firms averaged £1million, up 6.1% on 2012, while a third of law firms outside the Top 10 saw net profits of less than 20%

With many global economies on the up, some UK law firms will be well placed to take advantage - but pricing pressures, effective utilisation of fee earners and cost reduction challenges have taken such a huge toll on others that their medium term survival is at risk, according to PwC.

The latest annual survey of the Top 100 law firms shows 2013 has been a watershed year with merger activity and restructuring, among others, making it more difficult to identify and interpret trends. However, the Top 10 firms have reinforced their dominance of the UK legal market with average net profit margins now over 14 percentage points higher than the next 15 firms, up 3 points on last year.

In contrast, the survey found only a 1.5 point difference between the Top 11-25, Top 26-50 and Top 51-100 firms. Also, almost a third of firms outside the Top 10 only recorded net profits of less than 20%, with a number now close to single digit margins.

David Snell, partner and leader of the Law Firms Advisory Group, PwC said:  

“Against a challenging backdrop, 2013 could be seen as a turning point for the legal sector with the gap between best and worst performing firms widening further – and clear blue water between the Top 10 firms and the rest of the sector.

“The legal sector has come under increased scrutiny from banks and the sector’s regulator following a number of well-publicised law firm insolvencies during the year. Worryingly, with almost a third of law firms outside the Top 10 recording disappointing net profit margins, our view is that unless these firms can radically restructure their business, their short to medium term survival must be in doubt.”

Mark James, Partner PwC CI said:

'Whilst the CI market has not witnessed law firm insolvencies in the way the UK market has we have seen a number of law firm mergers and CI firms do face similar Margin challenges'.

The PwC survey notes that profit per equity partner (PEP) is another area where the top law firms outperform the market – with the Top 10 UK PEP averaging £1 million, up 6.1% from 2012 as a result of increased focus on cost reduction and tight management of headcount. But average UK fee income for the same firms was up by just 0.8%.

Conversely, average UK PEP for the Top 11-25 firms was just £448,000 (a fall from £481,000 in 2012) while the average firm fee income rose by almost 9.7%, although this was almost entirely driven by consolidation in this segment of the market. Clearly this has yet to translate into improved profitability for these larger mid-tier firms.

While a number of law firms remain heavily UK-focused, many are becoming increasingly international and manage results on a global basis – seeking to benchmark their performance against their international peers.

PwC analysis shows that, at a global level, UK firms have generally found conditions challenging. For the Top 10, global fees per fee earner increased by a modest 1.2% to £341,000. Meanwhile, the Top 11-50 firms are struggling to maintain their international networks – during 2013, average global profits per partner have fallen by almost 11%.

UK top tier firms (defined as firms with revenues in excess of £1 billion) also compare well with their US counterparts, with fees per full equity partner on average £2.91 million compared to £2.69 million. However in terms of PEP, US PEP is some 21.1% ahead of the UK average at £1.29 million. If UK top tier firms were able to achieve the same net profit margins as the US top tier, a further £126 million of profit per firm could be generated, equivalent on average to an additional £295k of PEP.

David Snell, partner and leader of the Law Firms Advisory Group PwC, said:  

“Continued focus on cost reduction and innovative delivery is required across all firms to maintain profitability in a highly competitive UK market. At the same time, we expect many firms to look carefully at their international strategy, focusing on whether there is a sustainable presence in each region of operation.

“Looking ahead and despite some encouraging signs of a pick-up in activity, it is clear firms remain concerned about continued economic uncertainty and the changing needs and behaviours of clients.

“Some clear winners and losers will emerge over the next few years as all firms strive to take market share from their rivals.”

Mark James, Partner PwC CI said:

'Although the survey results are based on responses from UK Legal firms our experience is that many of the messages from the survey are relevant to CI legal firms who face similar challenges and have similar opportunities to firms in the UK market. The results of the survey are essential reading for partners and senior staff concerned with strategic direction , profitability , performance and day to day financial management of law firms.'