London's Survival Lessons for Legal Market Downturn

Paul Lippe

10-22-2008

As travelers have noted since time immemorial, the best way to enrich your perspective on your own culture is to step outside it and visit someone else's. I spent last week in London (home of four of the six biggest law firms in the world), talking to clients and law firms. I'll offer some observations and predictions on the legal market worldwide based on what's happening in the U.K.

Given the credit crunch, and the various interventions by governments, central banks, shareholders and investors, six factors are likely to have a significant negative effect on demand for legal services:

1. There will be downward pressure on executive compensation. Since law firm compensation is highly correlated with the pay of the most highly paid folks in clients, this will have a dampening effect.

2. There will be dramatically less deal origination in most categories of synthetic or derivative securities, which are highly complex and generate commensurate legal fees.

3. There will be dramatically fewer mergers and acquisitions without leverage to support private equity returns.

4. The overall recession will dampen economic activity, and, therefore, client demand across sectors.

5. Many of the largest financial institutions are likely to face 20 to 25 percent headcount and budget cuts across the board. As such, it's highly unlikely that they'll hold either legal budgets or law firm spending sacrosanct.

6. There will be less overall tolerance of risk, and, therefore, greater harmonization/standardization of terms and practices.

While there will be countervailing factors such as the growth of hedge funds, restructuring, litigation and bankruptcy, the net effect of the above is likely to be the greatest year-to-year decline in law firm revenues that anyone practicing today has experienced in their lifetime. Whatever the most extreme forecast you've seen about the decline from 2008 to 2009, you should double it.

The trends above will result in the following effects:

1. The Humbling Effect. As one law firm partner in New York said to me, the impact of the financial meltdown has been to undermine many of the key assumptions that underlie the whole legal market. As law firms see their marquee clients struggle and even disappear, they will take a while to find a new model of the world that they are comfortable with.

2. The Wile E. Coyote Effect. Most of us remember the iconic Road Runner cartoons, where Wile E. Coyote sprints after the Road Runner, and often goes off the cliff and soars into space, propelled forward by his own momentum for a bit until running out of gas and plunging to earth. Restructuring deals are generating tremendous demand today for legal work, making it very tricky for firms to figure out if that demand is a blip or a harbinger of things to come. Because the restructuring will drive demand for about six months, and then the factors described above will kick in, it is very difficult to plan.

3. The London Effect. London firms will continue to gain market share relative to New York, because all the relative strengths of the London firms -- more effective use of size, better global management and integration, greater innovation and more stable partnership structures -- will become even more relevant in this market, even as they wrestle with greater dependence on the financial services industry.

4. The (Missing) Rate Hike Effect. Law firms that typically boost rates 4 to 8 percent at the beginning of the year will realize that big price hikes would be in very bad form in the current environment, and that a small 2 to 3 percent boost is probably not worth the hassle. Wise firms will eschew rate increases, and use this time of anxiety for both clients and firms to engage in a conversation with clients on delivering value, managing costs, and increasing "share of wallet." They will thereby learn faster and gain market share. Over the next 60 days, clients will increasingly insist that law firms focus on just that -- the smart firms will open the conversation with their clients before their clients impose it on them.

5. The Financial Engineering Effect. I will return to this topic in a subsequent post, but as the saying goes, "we have seen this movie before." When reality starts to lag behind expectations, aggressive management can always find ways to make the numbers for four to six quarters through various forms of financial engineering. When the telecom bubble burst in the early '00s, lots of smart companies acknowledged that they had stretched their numbers to keep pace with WorldCom, and they couldn't understand how WorldCom had been doing what they were doing. The answer of course was that WorldCom was engaged in world class financial engineering, pulling in revenues all over the map. No law firm management team will want to be seen as underperforming its peers and will feel tremendous pressure to meet or exceed expectations, but don't be surprised if those firms who show surprisingly good numbers for '08 end up in trouble by the end of '09.

Paul Lippe is a founder and chief executive officer of Legal OnRamp.

This article first appeared on The Am Law Daily blog on AmericanLawyer.com.