Perched at the very top of the UK legal market sit five law firms known as the “Magic Circle.” The commonly held wisdom about these firms, at least until recently, was that they had built an impenetrable position as the leading firms for complex high-value legal services in their home market. While these firms still enjoy prestigious reputations, this market position appears less certain than it did in years past. US firms have invaded their home market, increasing competition for clients and talent.
ALM’s recently released Global 100 dataset provides new evidence that this pressure is intensifying and beginning to have an impact on Magic Circle firms. Steady investment in London by US firms over the past decade is beginning to pay off. Am Law firms are growing more quickly and gaining traction in key markets such as mergers and acquisitions. Additionally, the gap in profitability between the Magic Circle and elite US firms has widened, giving US firms a key advantage in the battle for talent. The challenge for the once-dominant Magic Circle is how to respond to this increasing pressure.
The UK’s Magic Circle
The “Magic Circle” label emerged in the mid 1990s. The five firms have not changed over the past 20 years: Allen & Overy, Clifford Chance, Freshfields, Linklaters, and Slaughter and May. A generation ago, these firms were broadly understood to lead the UK market in numbers of large corporate clients served, transactions capabilities, and volume of cross-border work. These firms were among the largest in London, ranging from 200 to 400 lawyers each in 1990.
The group has become less cohesive over the past two decades. All five firms remain London-based, highly profitable, and highly regarded for complex cross-border legal services. The similarities, however, end there.
Over the past two decades, the Magic Circle has separated into two broad groups: Slaughter and May and the remaining four (see table above). Slaughter and May, which was similarly sized to the other Magic Circle firms in the early 1990s, is now much smaller. At 500 lawyers and $750 million in revenue, Slaughter and May is 75% smaller than its peers in headcount and 60% smaller in revenue. Additionally, the firm is significantly less global, with 90% of its lawyers in London and only a handful of offices outside the UK. What Slaughter lacks in scale and global coverage, however, it makes up in profitability. Slaughter’s average profits per equity partner (PPP) of $3.6 million is 75% higher than its peers and among the highest of any law firm across the world.
While the other four firms have remained largely similar to each other, they have increasingly differentiated. Financially, Freshfields and Linklaters enjoy significantly higher profit margins and profits per equity partner. Geographically, all four firms continue to have a strong UK presence, with more than 800 lawyers in their home country. Beyond the UK, however, some differences exist. Allen & Overy’s presence in 31 countries makes the firm’s global network much larger than its peers. Clifford Chance is also more global, with 71% abroad.
The differences between these four firms, which have only emerged in the past decade, suggest a strategic divide within the Magic Circle. Freshfields and Linklaters are focused on maintaining high profitability. Allen & Overy and Clifford Chance, on the other hand, are betting that a greater focus on global coverage will strengthen their long-term position. This is partly a response to increasing globalization of the Magic Circle’s core client base. But it is also a response to the invasion of the UK legal market by globalized US law firms.
Changing Market Conditions: The US Invasion
In 2000, Am Law firms collectively had approximately 2,000 lawyers in the UK, predominantly in London. A decade and half later, that number has increased by 250%, to more than 7,000 lawyers. The most visible reason for this increase is mergers between US and UK firms, such as the ones that created DLA Piper and Hogan Lovells. A less visible, but no less important, component of the change has been the slow and steady expansion of highly profitable US firms into London. Of the 5,000 lawyers from US firms added over the past 15 years in the UK, 40% have come from firms with PPP of less than $1.5 million. The remaining 60% has come from higher-profitability firms with a PPP more similar to the Magic Circle’s $2 million average (see table below).
According to the most recent data, 28 Am Law firms with PPP over $2 million operate in London, with a cumulative headcount of more than 2,300 lawyers. In many cases, these firms represent direct competition to the Magic Circle for talent and client engagements. Many US firms – White & Case, Cravath, and Skadden to name a few – have made strong inroads into the mergers and acquisitions market, long considered the Magic Circle’s home turf. These successes should be a warning to Magic Circle firms that US firms are cable of stealing market share.
Can the Magic Circle Defend Their Home Turf?
Elite UK firms have many advantages. Foremost among them, in the face of this onslaught, is maintaining their longstanding reputations with clients and talent. True, Magic Circle firms still enjoy a significant advantage in terms of UK headcount, particularly when compared against elite US firms. The Magic Circle average approximately 800 lawyers in the UK, more than twice as many as any US firm with a PPP over $2 million (see table below). This scale allows them to offer a wider and deeper range of services, a key differentiator for large clients.
But while US firms lag behind the Magic Circle in scale, they enjoy two key benefits: higher profitability and US coverage. Elite US firms are significantly more profitable than the Magic Circle, due in part to higher billing rates in the US. Kirkland & Ellis, for example, has 142 lawyers in London and a PPP of $3.6 million, or 80% higher than the Magic Circle average. Simpson Thacher, Skadden, and Cleary all have more than 100 lawyers in London and a PPP of more than $3 million. The high profitability of these firms, combined with their more flexible compensation systems, provides them with a significant advantage in poaching the best talent. This has allowed these firms to grow quickly. Simpson has added 60 lawyers in London since 2010. Latham has added more than 100 London-based lawyers in that time frame.
The increasing pressure put on the Magic Circle by US firms raises an important question: How should elite UK firms respond? Some have suggested that the Magic Circle should invade the US market in the same way that US firms did in the UK. It may be too late for that. The US invasion into London began more than a decade ago and is only now picking up steam. Even if such a move were possible, it’s not clear if the Magic Circle could afford such a gamble. Due to their relatively lower profitability, Magic Circle firms would need to compensate US hires at levels above that of their UK lawyers. Such a move could create financial strain, weakening their positions elsewhere. A merger between a Magic Circle firm and an elite US firm could be another possible solution. Many elite New York firms reported lower profitability last year, suggesting that some may be looking for a change in strategy.
Regardless of whether Magic Circle firms choose to enter the US, they face the same situation. Their market has been invaded by competitors with equal capability but higher profitability. A change in strategy will almost certainly be needed to address the problem this creates.
ALM Intelligence Notes:
- Leaving China: Cadwalder is the latest firm to close its offices in China. Another sign of international firm’s difficulties in the world’s largest economy.
- Mega-Merger Watch: CMS, Oslwang and Nabarro are said to discussing a potential three way merger that could shake up the UK legal market.
- The Global 100: ALM’s report on the world’s largest 100 law firms reveals that the legal industry continues to grow and identifies some key markets international firms are watching closely.
Nicholas 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 at NBruch@ALM.com.