Earthquake or glacier?

Grant Thornton’s Head of Professional Practices, Roger Zair, gives us his ‘geographical’ take on the post-Clementi world as he asks whether the moves afoot are more akin to an earthquake or a glacier. Either way, it’s a must read article for all those plotting a successful future.

Sometimes change can be like a glacier, moving only inches at a time. One view of the government's proposals for reform of legal services falls firmly in this camp.

Since Sir David Clementi started the process, we've had his wide-ranging consultation, then the draft proposals, followed by the period for comment: then, after a pause for preparation, came the White Paper with its own comment period, in turn leading to the draft Legal Services Bill on which the joint parliamentary committee reported this July.

Still to come is the process by which the draft legislation makes its way through parliament on to the statute book. This will be followed by the setting-up of the Legal Services Board, and in turn the LSB will authorise front-line regulators, which will then issue their own rule books.

A lengthy process! And while it's possible that law firms will have the detailed road map of a post-Clementi world during 2008, it may well slip beyond that date.
So it's a glacier: or is it really an earthquake?

Because irrespective of the pace of legislative and regulatory process, there's some pretty explosive change going on behind the scenes - which may have an earthquake's impact on law firms.

The epicentre of this earthquake is the opening-up of law firms to external investors –
what Sir David Clementi described as "alternative business structures". This means that, when the legislation is in place, law firms can be owned by non-lawyers. For the consumer market, this means the possibility of a trusted mass-market brand name providing legal services. The Co-op has shown most interest recently, although the phrase "Tesco law" is still used as shorthand for this proposition.

Clearly, if one of the big brands moved into legal services there could be a massive impact on high street law firms. These firms should be thinking hard about their competitive response if such powerful new entrants start to take the market seriously.
A number of firms have been developing their response for some time. Improving processes comes high on the list, because if clients' perception is that their instructions are carried out promptly and efficiently then that, coupled with price competitiveness and transparency, is a good start to a defensive strategy.

The strategy can't just be about process and price, however, it has to include marketing and brand as well. Firms with foresight have been looking carefully at their marketing and branding. In some cases this has led to a decision to "unbundle" the firm and to establish different brands for different aspects of the business. This can work well when the firm is providing distinct services each with their own channels to market, because it provides clarity of focus which may not have been there previously.

It may also highlight, however, that the firm is carrying out several activities which are "sub-scale" - the volumes are not high enough to support the infrastructure required, on a stand-alone basis. So "bundling" can follow on naturally from "unbundling", as firms recognise that they have to put parts of their business together to achieve the critical mass required. This is not the same as a conventional merger, because the business drivers will have been identified far more clearly: provided the execution is effective, building volume by a bundling strategy should have much to offer.

This requires management's thinking to be clear and the implementation to be agile - not qualities which are generally viewed as widespread. However, high street firms will have to change rapidly or face terminal decline if the big brands enter the market. There is no doubt that life will become even tougher, as the investment required in IT, systems, marketing, and brand becomes ever higher.

Firms which find this prospect daunting may decide that the time is right to make a graceful exit, and look to sell their practice to one of the new entrants. History shows that this can happen, as with the estate agents who sold to the building societies and insurance companies in the late 1980s. Corporate purchasers, however, are now likely to have more highly-developed policies for acquisition. They will have done in-depth research, know their market, be clear on what they are looking for, and be very selective.

Highly efficient processes, well-developed systems, scaleable operations will be at the top of their shopping list. So only the firms which have anticipated these needs will be attractive. There may be some scope for franchise-type arrangements, but the big brands are so aware of reputational risk that their degree of operational control may not be very different to an outright acquisition.

The opportunities and threats are different for firms which operate in the corporate market and with high net worth private clients. So much of the press coverage has been in terms of "Tesco law" that they may feel largely unaffected. But the earthquake is already starting to rumble! A few firms are already viewing themselves as investment propositions once the legislative and regulatory framework is in place. So there is the prospect of law firms doing a stock market flotation and becoming a quoted company, or teaming up with private equity investors - in other professional service sectors this has already happened.

This is a demanding route to follow, as few law firms are close to having a "plc culture", but is definitely under consideration in some quarters. The key here is making the growth story, which the law firms put to investors, sufficiently attractive.
Investors will want to know that the money raised (which they are investing as risk capital) is to be applied in a way which generates a good rate of return - and paying out retiring partners may not qualify!

As with any investment proposition, the key will be the business plan: what are the prospects, what return will be generated on the investment, what will the return to shareholders be? Demonstrating that a firm has quality management that can deliver what is set out in the business plan will be essential to getting investors' support.
Initially at least, it's likely that only a few firms will take this third-party investor route. That has been the pattern in other professional service sectors, such as property services and accounting.

The earthquake tremors will still spread, because the effect of the new third-party investment will be to accelerate the pace of change. Those firms with new investors will press ahead with their plans, may well want to gain market share quickly with aggressive pricing: the recruitment market is likely to heat up, as the best lawyers receive tempting offers. In response, other firms will look again at the possibility of merger to gain advantages of scale and get the people resources before it's too late.

So although it may seem glacial now, the seismic shocks are going to come. The law firm market in five years time will look very different to how it does today.

Roger Zair
Head of Professional Practices
Grant Thornton UK LLP
Roger.C.Zair@gtuk.com

Published on: 25-09-2006