The recently released Am Law 200 figures reveal that the Second Hundred, as the Am Law 101 to 200 firms have come to be known, had a very difficult year. Some performed well, but most are struggling. The question is, Why?

The Second Hundred, which cumulatively accounted for over $20 billion in revenue in 2016, includes a broad range of midsized firms. Within this group of 100 law firms are midsized national players, regional firms, highly prestigious specialist firms, and even a few local law firms whose operations are largely limited to their home state. So what, if anything, could be ailing such a diverse range of firms?

The prevailing narrative on the Second Hundred is that they are being squeezed by larger firms. Midsized firms, so it is argued, simply cannot compete with the scale and brands of their larger competitors. The Am Law 200 data shows this story is only half true. Midsized firms are being outpaced by larger firms in many markets. But several types of smaller firms are bucking the trend.

Interestingly, many of the most successful firms in the Second Hundred share a similar characteristic. Many of these firms have chosen to focus on sections of the legal market where competition is less fierce. Larger firms would be wise to take notice of these trends. Competition is growing at the top of the Am Law rankings.

The Second Hundred at a Glance

Seen as a whole, the Second Hundred had a very difficult 2016. After controlling for changes in the composition of the Second Hundred group, revenue grew by an average of 0.4%. This figure is significantly lower than the 4.6% growth rate the Am Law 100 reported this year. It is also represents a sharp slowdown from last year, when the Second Hundred reported a year-on-year growth rate of 2.0%. Seen together, these data points show that firms within the Second Hundred are not only growing more slowly but also losing market share to their larger brethren at the top of the Am Law rankings.

Beyond the averages, firm level performance paints an even more worrying picture. More than a third of firms within the Second Hundred reported declines in revenue, and 61% of firms reported a slowdown in revenue growth from the prior year (see graph above).

On the profitability side, things were not much better. Forty-four percent of firms within the Second Hundred reported declines in profits per lawyer. Profits per equity partner (PPP) performance was slightly better. Only a third of firms saw declines in PPP, but that is only because firms were, on average, shedding equity partners faster than they were shedding profits.

Taken together, these figures show that for nearly half of midsized firms, growth has evaporated and profits are declining. But not all firms performed equally, of course. Nearly a quarter of firms reported strong revenue growth, defined as 5% or more. Nearly a third reported strong PPP growth. Analyzing which firms performed best – and worst – provides some telling intelligence on why so many Second Hundred firms underperformed.

Midsized Firms Are Struggling Where Competition Is Fiercest

The firms that are struggling most have something in common: they tend to be in the most competitive sections of the legal market.

New York is home to the largest number of Am Law 200 firms. Thirty-nine Am Law firms are based in New York, and 141 have a physical presence in the region. This, combined with other trends such as the number of laterals and large clients in the region, makes New York the most competitive legal market in the US.

Tellingly, smaller firms in New York underperformed their larger peers by a wide margin. Forty-seven percent of New York-based Second Hundred firms reported revenue declines last year. In contrast, only 17% of New York-based Am Law 100 firms reported declines (see graph below). Similar trends were seen in other highly competitive markets like the Midwest, the Southeast, and the West Coast. This data suggests that lack of scale is part of the explanation of why Second Hundred firms are, on average, underperforming.

In the past decade, many markets – such as New York, Chicago, Houston, and Boston – have been invaded by larger firms with national or global capabilities. This process has injected new competition into these markets. The Am Law data shows that midsized firms are clearly struggling with this transition and have yet to find a successful strategy to compete with the larger firms.

Midsized Firms Are Performing Well in Certain Markets

One group of firms within the Second Hundred that performed well in 2016 was local firms. These firms, which have 90% or more of their lawyers within their home state, were among the strongest performers within the Second Hundred. As a group, they even outperformed the national firms within the Am Law 200. Initially, this seems odd. The vast majority of these firms sit at the bottom of the Second Hundred. Their lack of scale should be limiting their growth prospects. A look at the competitive dynamics these firms face, however, helps explain why these firms are bucking the trend.

Segmenting the Am Law 200 firms by service offering reveals three broad groups: elite transaction firms, specialist firms, and “full-service” firms. The vast majority of the Am Law 200 fall into the full-service category. In fact, more than 80% of Am Law firms market themselves as “full-service.” Within this segment there are four broad groups: international, national, regional, and local firms.

The Am Law data reveals that nearly half of elite transaction firms saw strong revenue growth this year (see graph above). Forty percent of specialist firms saw equally strong growth. Within the full-service segment, however, there was a wide range of performance. International and local firms did well, while national and regional firms underperformed. Among the national group, only 16% grew strongly. Smaller national firms – those within the Second Hundred – did particularly poorly, with 41% reporting year-on-year revenue declines.

The poor performance of national firms, and particularly smaller national firms, can be attributed to the high levels of competition within the full-service segment of the legal market. One-hundred-sixty Am Law firms compete within this segment for talent and clients. National firms, and particularly smaller national firms, have little to differentiate themselves with among this group. The global firms’ vast scale and global capabilities are attractive to the largest clients. Local firms, on the other hand, are a natural choice for smaller regional clients who appreciate a familiar face and an advisor who knows their market. National firms, by contrast, are stuck in between, with no natural client base.

Differentiate or Die

The lesson in this year’s Am Law 200 data is not that smaller firms are underperforming. While this is true, the success of local firms suggests scale is only part of the story. The real lesson is that firms that lack differentiation are suffering. Specializing in a particular service range or client type appears to be a successful strategy for limiting competition. This lesson should resonate far beyond the Second Hundred. ALM Intelligence’s analysis of this year’s Am Law 100 data revealed that pressure is mounting on larger firms. These firms should look to some of their smaller peers for how to manage these difficult times.

ALM Intelligence Notes:

  • Behind the Numbers: an interview with ALM Intelligence’s Senior Analyst Nick Bruch on what the Am Law 200.
  • The 2017 Am Law 200: complete coverage on the Am Law 200 from The American Lawyer.
  • Intelligence in Your Inbox: Subscribe to the ALM Intelligence Analysts Brief, featuring the latest thinking from our analysts, delivered straight to your inbox each week.

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.