Below is an excerpt of Barbarians at the Gate: The Invasion of Regional Legal Markets and How Mid-sized Firms Should Respond. The full report is available on the ALM Intelligence website. 

Rising competition has been a major discussion in the legal industry over the past decade. Most of that conversation, at least recently, has been focused on the competition flowing from new competitors such as alternative service providers and from the increased insourcing of in-house legal teams. The data on law firms’ geographic expansion over the past two decades suggests there is a third important source driving increased competition on law firms – notably other law firms (see Figure 1).

Rising Competition on Local Firms

As the number of firms in a market increases, the level of competition also increases. Leading local firms compete with new entrants in a wide range of areas. Most obviously, they compete for clients and legal talent. The increasing competitive pressure on local firms in these areas is relatively easy to see.

Partners at local firms complain that it is increasingly difficult to win client work. “Part of the difficulty”, a partner at a leading Houston based law firm told ALM Intelligence, “is that clients have gotten more sophisticated over the past couple years, but the other part of the problem is that there are just so many more firms to compete with these days.” This partner’s comments are understandable – Houston has seen 46 NLJ 250 market entries since 2001.

One of the biggest risks for incumbent law firms is losing a good client. Leading local firms typically have long standing relationships with locally based clients. New entrants often have the expressed goal of disrupting these cozy relationships. Kirkland & Ellis’ current expansion into Boston, for example, is widely believed to be connected to the firm’s desire to expand its business with Bain Capital. If Kirkland succeeds, it will come at the cost of leading local firms who currently represent Bain in their high value mergers and acquisition engagements, most notably Ropes & Gray. Such expansion serves multiple goals for new entrants. Winning new work brings revenue and, hopefully, enhanced profitability. When marquee brands are involved – like Bain Capital – the firm’s brand, as a leading provider, also stands to gain. There are also competitive advantages. Expanding into new markets may weaken rivals, enhancing the firm’s ability to attract talent and new clients.

On the talent side, leading local law firms face similar risks. New entrants often destabilize local talent markets. “As firms expand their geographic footprints, they will, inherently, be faced with navigating the lateral talent market in unfamiliar locations, routinely hiring a team from one, or more, peer firms”, notes Michael Ellenhorn, the Co-Founder & General Counsel at Decipher, a firm that provides intelligence and advice to law firms on lateral hiring. Ellenhorn observes that these initial hires “often create a chain reaction of lateral ‘musical chairs’ as the firms that lose talent need to replace lost capability, productivity and revenue”. This process, naturally, upsets the status quo.

Many of the cities which have seen the most market entries have also seen the largest number of lateral partner moves. In fact, eight of the top 10 markets for lateral hires since 2001 are also included in the list of the top 10 markets for law firm market entries over the same period (see Figure 2). In many markets, leading local firms have been net losers from increased lateral hiring. In San Francisco, for example, leading local firms have seen 13 percent more departures than additions since 2001. In Los Angeles, local firms have fared significantly worse, seeing 55 percent more departures.

Beyond the obvious points of competition related to legal talent and client engagements are areas that are less evident but still equally important. Law firms compete for real estate, for non-lawyer talent and for a wide range of other goods and services that are essential for the proper functioning of a law firm. Jennifer Scalzi, the CEO and Founder of Calibrate Legal, an executive search firm that specializes on non-lawyer business services positions, told ALM Intelligence that “the data on law firm market entries mirrors what we are seeing in the law firm business services talent market”. She notes that demand for marketing and business development professionals in Houston and Boston, two markets which have seen large numbers of market entries, have increased dramatically over the past several years.

The Houston Market: The Impacts of Increasing Competition on Local Firms’ Market Share

The Houston market provides a useful case study on the impact of increased competition on local law firms due to market entries from national and international firms.

In 2001, the Houston market was, in many respects, a typical local legal market. Despite being host to a large number of law firms, Houston was largely dominated by eight firms. These firms accounted for 66 percent of Houston’s total lawyer headcount. They were also largely local firms. Vinson & Elkins, for example had 50 percent of its total lawyers in Houston and 80 percent of its lawyers in Texas. Fulbright & Jaworski, Baker Botts, Andrews Kurth, Bracewell, Locke Liddell, Haynes and Boone, and Winstead were also, largely, local firms. Each had a majority of their lawyers in Texas, large Houston offices, and offices in other key Texas business centers (see Figure 3). While each firm had unique areas of specialty, most of these firms had maintained a strong, leading position in the Houston market for well over a decade.

Since 2001, Houston’s leading firms have seen their market invaded by a wide range of national and international law firms. Houston hosted 34 NLJ 250 firms in 2001. Over the 16 years which followed, the local market saw 46 additional market entries, increasing the total number of firms in the Houston market to 80. This represents a 135 percent increase in the number of NLJ 250 law firms which local firms had to compete with (see Figure 3).

Importantly, the fresh entrants into the Houston market included a wide range of new competitors (see Figure 3). This included large global firms such as Hogan Lovells, DLA Piper and Norton Rose. It also included highly profitable “bet the company” firms such as Kirkland & Ellis and Latham & Watkins. The range of firms entering a market matters, as each firm competes for different types of engagements and for various levels of talent. Each firm also brings different strengths which local firms will have to compete against.

The large global law firms which entered Houston offered clients and prospective lateral hires something local firms could not – a global platform. When DLA Piper entered the Houston market in 2008, the firm had over 2,000 lawyers outside of the United States, spread across 44 offices. In contrast, Vinson & Elkins, the most globalized of Houston’s leading firms at the time, had just 82 lawyers abroad. Houston’s other leading firms had even more limited international capabilities, averaging only 24 foreign lawyers and two international offices.

It is difficult to measure the exact impact which the disparity in international capabilities between local and global firms had on the Houston market. Houston is home to large globally diversified energy companies. These clients and the lawyers that served them were targeted by the global firms, which expanded into the Houston market. In the lateral markets, global firms fared well. Global firms such as Baker McKenzie, Orrick, Morgan Lewis, Hogan Lovells, Jones Day, and Greenberg Traurig have all hired aggressively in Houston, often from leading local firms. Combined global firms account for over 150 lateral partner hires in Houston since 2001, adding a total of 116 new local partners after departures at those firms are taken into account (see Figure 4).

The entrance of Kirkland & Ellis, Latham & Watkins, and Simpson Thacher put a different kind of pressure on local firms. These highly profitable firms were able to use their above average partner compensation as a weapon in the lateral partner hiring markets to secure some of Houston’s most sought after partners.

In 2001, Houston’s leading firms had an average profit per equity partner (PPP) of $550,000. Vinson & Elkins, the region’s most profitable firm by a wide margin, had a PPP of $695,000. In contrast, in 2001, Kirkland & Ellis and Simpson Thacher, two firms which would enter the Houston market, had a PPP of over $1.5 million. Latham’s PPP of $1 million, while lower than the other two firms, was still 91 percent higher than the average of the eight leading local firms.

The disparity in profitably between Houston’s leading local firms and the higher profitability new entrants matters. Research on the retention rates of lateral hires by Hugh Simons and Paola Cecchi-Dimeglio, featured in the October 2017 edition of The American Lawyer, revealed that firms with higher profitability are more successful at retaining partners (see Figure 4).

In Houston, the disparity in profitably between leading local firms and new entrants allowed expanding firms to target high earning partners, in key practices, at the largest local firms. Kirkland & Ellis, for example, has lured several partners specializing in mergers and acquisitions and capital markets from Vinson & Elkins since 2012. In total, highly profitable firms, with PPPs of over $1 million, have added 21 partners in the Houston market though lateral hires (see Figure 4).

Altogether, Houston’s eight leading firms have lost 390 partners to lateral departures in Houston since 2001. Even after adjusting those losses to account for lateral hires that these firm engaged in, leading local firms lost a net total of 101 partners in the Houston market since 2001. These departures, combined with slower growth due to the increased competitive pressure, has resulted in significant headcount reductions at all eight leading firms (see Figure 3). Vinson & Elkins’ Houston office lost 155 lawyers, including partners and associates, between 2001 and 2017. Fulbright & Jaworski, which merged with Norton Rose in 2013, is 83 lawyers smaller in Houston. In total, Houston’s leading firms have lost nearly 500 local lawyers since 2001, reducing their share of the Houston market from 66 percent in 2001 to 40 percent in 2017.

Beyond Houston: The Impact of “Market Invasion” On Local Firms

The experience of local firms in Houston is not unique. In fact, it’s relatively ordinary. In most markets which have seen a significant number of market entries, local firms have seen significant headcount reductions, resulting in the loss of local market share.

In San Francisco, leading local firms have struggled as national and international firms have poured in. The San Francisco market has seen 47 market entries by NLJ 250 firms since 2001. In the same period, three leading local firms have gone bankrupt. This includes Brobeck Phleger, Heller Ehrman and Thelen Reid. Of the remaining firms which could have been considered a market leader in 2001 (those firms with 100 or more lawyers in San Francisco), only one has seen an increase in local headcount. Latham & Watkins has increased its headcount in San Francisco from 157 lawyers, in 2001, to 206 in 2017. The other five firms have lost 300 lawyers in total, reducing their headcount, on average, by 31 percent.

The Boston market reveals similar trends. Boston has seen 26 market entries since 2001. Since then, two leading firms have gone bankrupt. Of the firms with more than 150 lawyers located in Boston in 2001, only one has seen an increase in local headcount. The remaining six firms have seen a combined loss of over 500 local lawyers.

A wider look at the US market reveals that every major legal market in the United States has seen an increase in the number of NLJ 250 firms and a decrease in the market share of the leading five firms, measured by headcount (see Figure 4). The data shows that the correlation between the two figures – the increase in the number of firms and the decrease in market share of leading firms – is relatively strong. As the number of competitors increases, the market share of leading firms decrease correspondingly.

Nicholas-Bruch - EditedNicholas Bruch is a Senior Analyst at ALM Legal Intelligence. His experience includes advising law firms and law departments in developing and developed markets on issues related to strategy, business development, market intelligence, and operations. He can be reached by Email, Twitter, or LinkedIn.