In this article SSQ’s head of research, Dustin Foo, discusses the challenges UK mid-tier firms face, their responses, and the outlook for this area of the market.
The “squeezed middle” has been used by economists and politicians alike to describe the struggles of middle-income earners with cost-of-living increases and tax rises. In the context of the London legal recruitment market the same term could easily be used to describe the group of UK firms operating below the top ranks of the London elite .
The somewhat arbitrary but nonetheless recognisable group making up the UK mid-tier would include Addleshaw Goddard, Eversheds, Pinsent Masons, Berwin Leighton Paisner, Stephenson Harwood and CMS Cameron McKenna, Nabarro and Olswang (now combining). A second set of firms – including Bird & Bird, Osborne Clarke, Taylor Wessing, Holman Fenwick & Willan and Watson Farley & Williams – has developed differently, along more sector-focused lines, but have much in common with the earlier group. Perhaps their most defining characteristic in the recruitment context is that many of their leading partners represent attractive targets for both US firms and UK rivals.
The “squeezed middle” is also squeezed from other directions. Smaller London commercial firms and emerging regional players such as DWF offer increasingly viable options for lower midmarket work and clients. Direct competition from the legal services offerings of the Big 4 accountancy giants – temporarily banished following the Enron and Worldcom scandals, but having reappeared on the scene thanks to the alternative business structures allowed by the Legal Services Act 2007 – is now very much on the horizon. The largest of these, PwC Legal, generated revenues of just under £60m in 2015-2016, a 24% increase. These operations, combining globally recognised brands with massive resources in technology, management and finance, represent perhaps the most serious challengers to the UK mid-tier.
This crucible of intense competition has resulted in some of the most significant structural changes in the London legal market – not at the level of the magic circle, which have remained in their current shape for the last decade, but amongst the tiers below. The mergers or combinations of Hogan & Hartson and Lovells, King & Wood Mallesons and SJ Berwin, Herbert Smith and Freehills, Ashurst and Blake Dawson, and more recently Gowlings and Wragge Lawrence Graham, have distinctly changed the London legal landscape, erasing historic names and bringing in more aggressive management from foreign partners. As this article goes to press, two more major mergers/combinations have resulted in Eversheds Sutherland and CMS Cameron McKenna Nabarro Olswang. Few would bet against further consolidation in the short to medium term. But, while the aftermath of the financial crisis has added urgency to the process of seeking merger partners it has diminished merger options at the same time, as US merger partners in particular looked carefully at profitability and practice synergies.
The squeezed middle responds
Yet, far from withering away, most of the “squeezed middle” firms have increased their key financials, as well as headcount, beyond those achieved at the height of the pre-credit crunch boom. In contrast, at least two high-profile mergers or tie-ups bear testimony to the difficulties of integrating transformative change, with the Blake Dawson merger arguably having contributed to Ashurst’s woes, and even most prominently, SJ Berwin’s tie-up with King & Wood Mallesons regarded by most observers as a strategic misjudgement that significantly contributed to the collapse of the firm.
What are the reasons for this seeming paradox? One is simply that mid-tier firms operate in an area of the market that meets the needs of many clients and the career and financial aspirations of many lawyers. But the mid-tier has also proved itself quicker to adapt to market realities than the biggest beasts of the UK legal elite. A case in point is its move away from traditional lockstep partner remuneration, a process the “squeezed middle” adopted well in advance of the magic circle. By 2007, 16 of the top 20 UK firms had adopted modified lockstep remuneration systems. This remains the case today, with all firms researched operating either full merit based remuneration or a modified/managed lockstep (see table B for more specific details). The last decade has seen further increases in the merit elements at most firms not already operating a full merit system; more active lockstep management (equity gates, moving partners up and down the lockstep, etc); and increases in top equity at over half of this group to £1m or over. In most cases the spread from the top to bottom of equity has also increased.
These steps have enhanced the mid-tier’s ability to attract and retain strong performers. Also important has been an increasing trend towards developing practices in particular industries and sectors. (Interestingly, firms noted for sector-focused practices, such as CMS, Taylor Wessing and Watson Farley show significantly fewer partner exits than the average.) Over the last few years, firms that once promoted full service offerings have placed increasing emphasis on their strongest sectors, Berwin Leighton Paisner, for instance, positioning itself as a market-leader in real estate and Pinsent Masons concentrating on a tight group of key sectors including energy, infrastructure, and technology.
The so-called “squeezed middle” has demonstrated that well-managed firms can succeed even in the crowded conditions of the mid-market. The CMS-Nabarro-Olswang merger, in particular, also shows that transformative mergers are possible and that the assiduous search for merger partners can be a worthwhile exercise. Nonetheless, intense competition in the mid-market, against peer firms and an increasing range of rivals, will continue to squeeze the UK mid-tier for the foreseeable future. In recruitment terms, this area of the market is arguably the battleground where the movement of stronger partners towards better-managed firms, combining clear strategic vision with the ability to capitalise upon sector and client strengths and to make astute recruitment and investment decisions, may be most clearly demonstrated. This group of firms offers significant opportunities both to recruit from and to recruit for.
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