The first MTT meeting of 2020 was hosted by PwC. Kate Wolstenholme, who leads PwC’s law firm advisory group and sits on its internal audit and risk committees, and Tony Hodgson, a partner in its legal consulting practice, presented the highlights of PwC’s Law Firms’ Survey 2019, “Adapting to a new world”.
The survey covers UK headquartered firms and US firms with London offices who submit their data anonymously. The results are presented by size of firm, using four bandings, determined by global revenue: Top 10; 11-25; 26-50 and 51-100.
Professional services are facing multiple challenges, including the digital revolution, new technology and the changing expectations and attitudes of the workforce. 2019 saw a sharp focus on flexible working, diversity and inclusion and upskilling the workforce to keep up with the pace of technological change.
Notwithstanding that 2019 was a challenging year economically and politically with uncertainty around Brexit, China-US tensions and geopolitical risk in the Middle East, 89% of firms achieved revenue growth, although this was slower than in previous years, with an average of 6%. None of the top 10 firms achieved double digit growth. While 63% of firms saw profits increase, margins declined, continuing the trend of increasing fee income and falling margins over the past five years. The only group that achieved higher margins in 2019 was the top 26-50 firms.
One reason for falling margins is pressure on salaries, particularly from US firms with high associate salaries. Another factor is top 10 firms recruiting ahead of demand, reducing utilisation rates.
Firms’ biggest cost is staff – fee earners and non-fee earners. And property is in second place. Although there is a greater appetite for flexible working and scope for firms to achieve higher leverage from their premises, property spend per fee earner is still significant – ranging from £20,000 per fee earner in top 10 firms to around £8,000 for top 51-100 firms.
Top 10 firms are recruiting fee earners and business support staff ahead of demand. The 11-25 group recruited fewer fee earners but saw a sharp increase in business support staff while the 26-50 group saw a reduction in headcount.
The survey compared firms’ chargeable hours with target hours. Although it is likely that firms are setting stretch targets, for the larger firms in particular, the gap is significant, reflecting the trend for larger firms to increase targets in anticipation of higher utilisation.
2019 saw a sharp focus on diversity and inclusion. Gender diversity has improved, particularly among business support staff and paralegals, but only minimal progress has been achieved at full equity partner level. However, BAME diversity is rare among full equity partners.
Global operations driving growth
For top 10 firms, international offices represented 74% of fee income and 85% of growth, with approximately half of income growth deriving from Western Europe, followed by Central and Eastern Europe. The biggest range of margins were in the Middle East where well-established firms doing well. China and Australia are proving highly profitable for well-established firms. The UK to international performance gap has narrowed to 1% for the top 10 firms, with a similar trend for the 11-25 tier.
US top tier firms are outperforming UK firms across all KPIs, with high profitability supported by year-on-year increases in chargeable rates driving utilisation rates. US firms on average charge 42% higher fees than their UK equivalents and their margins are significantly higher. This is a challenge for UK firms contemplating international expansion via US mergers.
Business support priorities – technology
The top priority in the next 12 months is improving the use of technology. Law firms are playing catch up with other sectors in implementing transformational technology and upskilling business support. Key priorities are standardising and centralising processes, improving the legal service offering and increasing the level of business partnering. Data analytics has slipped down the priorities list, notwithstanding a 25% increase in firms reporting that they employ data analysts.
Law firm IT projects have focused on core practice management systems, time and disbursement capture, HR and L&D and mobile and remote access. Planned projects focus on resource management and procurement and the next wave of implementations is likely to include client relationship management and business development systems.
Digital and emerging technologies are high on the agenda. Most firms are adopting established technologies such as mobile applications, collaboration tools and automated and semi-automated document production, and piloting emerging technologies including artificial intelligence (AI), data visualisation and smart contracts in response to client expectations. Half of top 10 firms (plus 50% piloting) and approximately a quarter of top 100 firms are currently deploying AI and 38% of firms predict that it will be the most disruptive technology over the next five years, followed by process automation, blockchain and smart contracts and data analytics.
The focus on technology has encouraged particularly the top 10 firms to recruit professionals with specialist skills, such as data analytics, strategy business innovation, digital and emerging technologies and procurement.
As technology starts to replace the chargeable hour, firms need to factor in the value of their technology investments, so pricing and compensation are key priorities. This includes managing unplanned fee write-offs. Half of top 10 firms are writing off more than 15% of their recorded fee income. This links with pricing, behaviours, setting things up at the outset of a job and negotiating within the programme if things change. The report highlights this as an opportunity for improvement.
Cybercrime is increasing and every firm surveyed experienced a security incident in 2019. The most common is phishing attacks to gain access to client funds, followed by loss or leakage of confidential information. More serious threats, such as network intrusions and denial of service incidents are less frequent, but their impact can be significant. Although 40% of firms undertook a crisis management exercise every six months, and although most firms were aware of common threats, particularly in the mid-tier, top 26-50 firms, are insufficiently prepared.
In 2019 over half the firms refinanced, with 63% increasing their facility level, and increased the funds in their capital and current accounts. Lock up continues to be a challenge, with an average of 120-130 days. Year-end lock up improved by two days in 2019 but the deficit between average lock up and year end lock up increased.
Key areas for improving lock up are KPIs and reporting (across all bands), billing and collections process redesign and system enhancements, while the top 25 firms also focused on incentivising partners to monitor their working capital metrics. However, this challenge is partly operational – waiting for transactions to close – and cultural, as partners can be protective of client relationships, and are reluctant to involve the collections function.
Consolidation and diversification are important trends, with many firms are contemplating a merger within the next two years. Larger firms in particular are looking for US mergers in order to diversify their operations. Mid-tier firms are also considering IPOs or private equity investment to fund growth and incentivise innovation and talent.
The key challenge for top 10 firms is technological change, whereas for all other bands the biggest challenges are Brexit and economic uncertainty. The top 11-25 are more concerned about the economy, technological change, maintaining margins and retaining talent, while the 26-50 are the only group that expressed concern about new entrants taking market share.
When asked to predict their future results, firms anticipated modest fee income and profit growth in the short-term with more significant improvements, particularly to margins, in 2020-21. While indications are encouraging, particularly for international operations, there is still a gap in capacity/utilisation, which could potentially be addressed by resource allocation technology.