Despite a raft of challenges from Brexit to global economic pressures, the number of UK law firms achieving UK fee income growth is at its highest since 2011, with 89 percent of Top 100 firms saw growth compared to 84 percent last year with only a third reporting growth in 2011, according to the survey.
Challenging legal sector
The Survey data reveals that actual growth rates are decelerating, from the average 2019 figure, by 2.4 percent from the previous year’s 8.3 percent, with no Top 10 firm reporting double digit growth compared to 50 percent in 2018. The average profit per full equity partner (PEP) has reached record highs across the Top 100. The survey reports a growing appetite for deal activity with some mid-tier firms focussing on IPOs and Private Equity (PE) funding. Amongst the mid-tier firms, more are reporting Brexit as the key challenge to their financial performance aspirations, whilst the Top 10 are focused on technological change. Optimism persists in the medium term, with Top 50 firms expecting profit growth to exceed fee income increases in 2020/2021. Kate Wolstenholme, leader of PwC’s law firms advisory group and editor of the Law Firms’ Survey, profit pressures continue to challenge the legal sector, with only the Top 26-50 firms bucking the trend by a marginal improvement of 0.5 percent to 24.7 percent. For Top 10 firms, profit margins have fallen for a fifth consecutive year to a low of 35.5 percent in 2019, compared to 40.0 percent in 2014.
Ms Wolstenholme explained, “With 31 October looming large, Brexit and economic uncertainty remains a significant concern, with most firms expecting only modest fee income growth in the short term with profit improvement lagging.” She added, “Our survey does show, however, that UK firms’ optimism for a brighter future hasn’t diminished, with the Top 50 expecting profit growth to exceed fee income increases during 2020/21.” Ms Wolstenholme concluded, “Firms in the Top 25 are battling an ongoing erosion in margin, but this is in part due to strategic investment as opposed to increasing staff costs which have hit margin in recent years. Although this is undoubtedly a drag at the moment, investing in system updates and innovation will enable firms to grow a more sustainable business in the long term and build market share.”
During the last year, average PEP increased, reaching record highs across all bandings. Outside of the Top 10 a significant contributor to this growth has again been equity management. The report also reveals a widening gap in performance between UK and US top tier firms, with UK global top tier margin at 36.4percent compared to a US top tier equivalent of 45.7percent - this equates to an average of £152m of profit or £317k of PEP. The 2019 Survey reflects a growing appetite for deal activity across the UK legal sector, with 57percent of Top 10 firms and 36percent in the Top 11-25 stating that mergers are somewhat likely within the next two years (2018: 40percent and 27percent respectively). For those operating at the top end in terms of market share, the focus will be on diversifying their operations, geographically and along service lines, potentially through deal/merger opportunities with international players in order to further exploit more profitable international markets, especially the US.
Despite falling utilisation and increasing spare capacity being a significant issue for several years, a number of firms have increased headcount in the current year, particularly across junior fee earner grades. Other findings include that at trainee level, firms are continuing to recruit more females than males, although female equity partner numbers have remained broadly static with no firms exceeding 20 percent in volume. BAME representation at partner level in Top 10 is flat at 7percent, while the trainee grade has grown from 19percent to 22percent. The survey states 83percent of Top 10 firms have a strategy in place to address gender and BAME imbalances across the business compared to 91percent and 82percent respectively amongst Top 11-25 firms. More than half of Top 50 firms are also focusing on disability, social mobility, and sexual orientation. However, staff turnover continues to be higher than expected across fee earner grades compared to other professional service sectors, with the exception of newly qualified staff and trainees.
The likely winners
Leon Hutchison, co-editor of PwC’s Law Firms' Survey, commented “There are a number of challenges facing UK law firms. The most pressing perhaps include finding the right markets for investment, ensuring growth is sustainable and profitable to protect margin, and building a culture that is relevant and attractive to today’s workforce. Alongside this, firms are also having to make the right choices for technology investment to capitalise on opportunities whilst managing the increasing risks of a technologically enabled world.” Mr Hutchison concluded, “The firms that build their strategies around meeting and overcoming these challenges will likely become the winners as UK law firms continue to adapt to a new world.”