Legal Market Consolidation? Look Again.

The only set of numbers not coming from the Law Society about the number and value of law firms, come from HMRC [i] essentially the statistical estimates used for VAT purposes. They have their problems[ii], but there are lessons on the shape of the profession which are, frankly, surprising.

Market consolidation?

Received wisdom is that the legal market is consolidating, but it really is worth unpacking that a little. Yes, the market overall is growing – but consolidation normally suggests fewer suppliers doing more work. This in turn would then pose problems for suppliers and buyers of their services alike. The problem is, however, that the market is growing both in volume and value terms over the long term – ie there are more firms generating more revenues.

Ah, the argument goes – ‘but not all sectors are growing – the large firms are growing faster than the small ones’. True, but the implication is that the large firms are growing at the expense of the small firms – and this is far from clear. Global pressures and opportunities mean precisely nothing to micro High Street law firms. In competition terms, there is a chain of substitutability – but frankly the span between a consumer law one man band and a global panel law firm is simply too wide now for comparisons this stretched to be meaningful.

So the next time someone says – firms have to spend £50k on marketing or market consolidation will kill them – ask them precisely why. If firms spend more it is not because of consolidation (although, yes, there may be other reasons). There are more mid market firms making more money than ever before – it’s just that the Magic Circle are – well – magic.

This is great news for vendors to leading smaller firms such as Perfect Software, DPS, Pracctice, Peapod and Quill – rumours of the death of the High St are highly misleading. The economic picture for firms with between £1-4m in sales is that since ‘98 (ie the beginning of the last Big recession) there has been an increase of between 869-1040 more firms. A firm with £4m in sales should have 8 partners or over 20 fee earners, so this is not so ‘small’ really. It is great news for consumers of law services - or should be - and if there is genuine disquiet about why law firms are not seen by clients as well as they should be, it means you really have to look harder elsewhere and stop trying to blame the weather.

Global expansion is a good thing for some, but not all.

The market appears to be ‘consolidating’ more through global expansion of the magic and silver circle firms than any significant contraction of the mid market or small firms. This is not a bad thing – someone doing well is good. Comparing their growth with others who happened to attend the same College thirty years ago and implying that these others are somehow wrong is nonsense. They may be missing out somewhere, but they almost certainly are not missing out on the opportunity to be on the panel to do Smith Kline’s Brazilian IP work from their 8 strong regency brass name plate in Bury.

There is a scrap, as there always has been, between the silver circle firms punching above their weight and using technology to do so, but this is not ‘consolidation’ - it is normal hostilities or intra-industry rivalry. For vendors to very large firms like Elite and Aderant, however, there is always the dichotomy of whether to embed more deeply with 25 clients or spread the risk to 250. Stretching to do both is only getting harder, especially as it increases the risk of someone in the top 25 doing something for themselves that works and spawning another credible competitor in due course in their heartland.

Micro firm market contraction is not a problem.

There is contraction both in numbers and value among the very very small part of the market. The VAT definition of this is £0-49k (effectively sub registration thresholds). These are usually small office/home office (SOHO) one man bands. At best they are retiring or ‘life-style’ solicitors stepping back to run a few favours for a handful of long standing clients – probably doing less than 1 day per week in harness. At worst they unfocused, unsupported generalists and the largest source of claims on the indemnity funds. There are 1045 fewer of them now than on 1998. Bear in mind that any self respecting individual solicitor/fee earner should be aiming at minimum billings per year of £150k, and probably over £250k (each) and you get a picture of both the size of these firms and the likely service sector they focus on. The market changing to have fewer micro firms and losing c3.6% market share in relative terms among these micro firms overall is no bad thing.

The numbers in SOHO firms probably also disguise a different trend whereby the rise in capable individuals running micro practices could well be growing, whereas the regulatory framework is stamping out high risk generalists in low growth sectors. The micro sector should be declining more than it is in relative terms – firms with £100-250k sales (ie a full timer 'going for it') grew overall since ’98 by 3% - ie there are 2.2-2.9k more of them now than 10 year ago. This suggests a growing market for experienced sole practitioners for whom the SaaS and cloud based systems from Legal IT vendors will be a God send. Reducing barriers to market entry through reduced or negligible set up costs, and enabling sole practitioners to compete with other specialist teams with comparable facilities will be a growing niche within this an addressable market of 17.6-19k individuals.

So Keep Calm and Carry On

The global race continues and is good news for those that can hack it up there.

The mid-market is growing and will continue to do so irrespective of the legal services noise around franchises and ABSs. The example to watch here is actually the Connect2Law solution – similar versions of it remains alive and kicking even in the much more consolidated accountancy sector. The acquisition of teams and firms to build scale and competitiveness will continue, and frankly would have done with or without the Legal Services Act.

Allegedly franchises (whether ABS driven or not) will consolidate the market, especially among small firms; but there is a problem with this. Law firms tend to be distributed more along supply lines than demand ones. In essence they tend to be sited near courts, not clients. The logistical scale economies behind franchised dentists, opticians and other distributed professional service providers simply do not have as much sway with law firms. And make no mistake, franchise margins can be very tight and if scale economies are not there, few succeed. It would also mean at least 3 of them succeeding on the level of firm take up they themselves project to begin to erode the number of 'firms' overall in the small and medium size categories. We'll see.

The other basic challenges we already know, and frankly have little or nothing to do with ‘consolidation’. Consumer work on the High St is not a legal services market, and hasn’t been for some time now – it is an insurance services market. The Legal Aid market is unsustainable in its current form for basic inefficiency reasons, not contraction. Ironically good firms coping with systemic governmental confusion have no option but to automate or die. The insurance led (ATE and BTE) sectors will get tougher still, and frankly the disruption of the wills and probate market is both inevitable and already well progressed.

Even the (real) sole practitioner market is growing (up 527 firms since 98). The small firm market is growing. There are 2305 more firms making £100-249k a year now than in '98 and over 1500 more firms making £250-£1m. That it’s not growing as fast as Allen & Overy is neither here nor there. So - apologies for raining on the impressive and noisy parade around legal services currently. But the HMRC statistics simply do not back up the hype.

[i] Source: Office for National Statistics: UK Business: Activity, Size & Location Reports 1998-2011

[ii] Rebasing of SIC codes in 2007 appears to have had a significant effect on the number of firms included within the definition; adjustment for this has been made, but it inevitably clouds the precision required around the height of the recessionary impact in 08 to some degree.