Many readers will be familiar with the concept of ‘peak oil’, the idea that world oil production, although currently at unprecedented levels, has in fact reached (or passed, by some calculations) its peak; there are no new major reserves to be found, and all the large fields are steadily running down.
The theory of ‘peak oil’ has had to be, but it set me wondering whether, from a recruiters’ point of view, the lateral partner market has in fact reached, and passed, its peak, both in terms of revenue and, possibly, activity too.
In contrast to peak oil, this is nothing to do with dwindling reserves – there are more partners than ever – but is the result of changes to the structure of the market which may mean that recruiters who, in 2007, had ‘never had it so good’, may never have it so good again.
Let me explain. In 1993, Clifford Chance, the UK’s largest firm had just over 1,000 lawyers and a revenue of £210m, compared to 2,500 lawyers and revenue of in excess of £1bn these days, reflecting a huge expansion in the sector as a whole. Back then, very few partners moved around, whereas now, as we know, this is pretty commonplace, with 400-500 partners moving in London alone during the course of an average year.
The sector has also become significantly more profitable. Profits per Equity Partner (PEP), the headline measure of law firm success, at Clifford Chance in 1993 was estimated to be £256,000, while this year is reckoned to be £1.1m, a fourfold increase. (This, by the way, compares to a 1.63-times increase in real prices over the same period. Lawyers done good…)
Recruiters have been some of the main beneficiaries of both the growth in the number of lateral partner moves and the massive increases in PEP, simply because they benefit a) from activity and b) because their own compensation is based on a partner’s first year’s remuneration, usually 25-30% of that amount.
So, a partner earning £300k – quite modest by today’s BigLaw standards – can bag the recruiter £75k. Place an average partner at Clifford Chance now and, assuming no discount or fee cap, you’d get £250k+. Back in 1993, you’d be looking at a much slimmer pay-packet – £64k.
But alongside lateral partner hiring as the main method of law firm growth sits merger. In fact, the sector has been gently consolidating for as long as partners have been moving around. While it is difficult to say whether the pace of merger is quickening, it seems fairly steady, and as it continues, the number of major players in the market declines.
Ah, you might say, as big names get swallowed up, other firms come through. Names such as Plexus, Minster, Optima and many more were unknown in the Top100 until very recently. But these firms are outliers; in the most fertile territory for recruiters – the UK mid-tier – the party is coming to an end, if only they knew it.
The mid-tier represents a unique opportunity for recruiters because the quality of firms is such that they act both as ‘feeder clubs’ (using a football analogy) for larger firms, and as pastures for partners exiting big firms.
But just as in football, the distance between the big clubs and the rest is widening year on year. Back in 1993, the 100th firm in the Top100 had a PEP of £79k (firm No.99 was at £180k…), a ratio of 3.2:1 compared to the top firm. Last year, this ratio was 7.9:1. That is consolidation, writ large.
Firms in the middle, the mid-tier, have an invidious task; they are forced to play a game of catch-up with the big firms but have smaller firms nipping at their heels. The nature of work at the top of the game, and the middle of the game, is such that top-end finance and corporate work (£1bn+ M&A, for instance) is pretty much reserved to a very small group of firms and seems pretty much unassailable (leaving aside the threat from US firms, which I’ll come onto). In the mid-tier, however, the work is usually less groundbreaking, less complex, far more vulnerable to firms lower down the food chain muscling in, and, at the other end, to the big firms cherry-picking the cream of mid-tier work which they often undertake at a loss to use up spare capacity or to win promising clients.
The mid-tier firms are caught between a rock and a hard place; they have to distort their own compensation systems to hold on to their good players against a background of fairly flat revenues. In fact one could say with some justification that the mid-tier firms as a group are at the sharp end of the net oversupply of legal services in the market. Cue major partnership restructurings, as we have seen, and of course merger.
So what does this have to do with recruiters?
Well, look at it this way. If a 500-lawyer firm does, say, 10 pieces of lateral partner recruitment in a year, does that mean that a 1,000-lawyer firm will do 20? Not usually. In fact, as we go up the food-chain, we see that the larger firms do less partner recruitment than the chasing pack. The Magic Circle has by far the greatest number of partners and yet does virtually no lateral hiring compared to some of the fast-growth mid-tier firms. And as the chasing pack becomes smaller via steady consolidation, there are fewer hires around to be had. Mid-tier firms merging (usually together) simply create a bigger mid-tier firm, which some analysts believe doesn’t really get them anywhere.
Partners falling out of merger will most often go to firms below them which pay less, often considerably less (how else do they manage to operate more effective business models than the firms above them?).
So, as the mid-tier shrinks, the number of partners earning mid-tier rates shrinks accordingly.
Not only that, but there is a persuasive piece of thinking in the legal market at present that law firm partners may well be at peak-earnings themselves, give or take minor rises in the future.
Partner compensation has grown out of all proportion to economic growth, as we have seen in the figures above. This has largely been down to international expansion, but new, highly-remunerative sources of work (such as privatisation and leveraged finance) grew out of the world boom in the 90s and 00s. As we are all painfully aware, this has flattened out, and may be entering a period of relative stagnation. Firms simply cannot charge the amount of money they have been charging clients for the last 20 years; there is not the work around, and there are multiple pressures on fees. Absent another privatisation-boom or the invention of another financial bubble-machine, whizzy new work on which you can charge top-end fees will be difficult to come by, and mechanisms such as Legal Process Outsourcing will act to concentrate profits in the hands of an ever-smaller group of partners. One could even argue we have reached the ‘Bespoke Peak’, beyond which the amount of unique, and hence uniquely profitable, work around will continue to decline. This is certainly the thesis of Richard Susskind’s highly-persuasive book ‘The End Of Lawyers?’.
So with the vast majority of partners perhaps at peak-earnings themselves, and fewer chunky mid-tier firms trying to play catch up with the big boys, there will be less, not more, partner lateral hiring in the upper echelons of the UK legal profession in future.
The spanner in the works of this theory, of course, is the US expansion into the UK. US firms are inveterate lateral-hirers, often building an office from nothing by a burst of lateral hiring (the so-called “shake ‘n’ bake” strategy) which delights recruiters, not least because the urgency to grow quickly often allows them to place partners they might otherwise find challenging to help.
But the advent of the US-UK merger – a predicted “tidal-wave” according to some – may kybosh that revenue gravy-train. Starting-up from the ground followed by organic growth is an incredibly expensive way to build critical mass and can simply run out of steam; merger gets bulk quickly. Yes, there will be fallout from some partners who either don’t want to be part of the new firm or are surplus to requirements, but they often find their fall from grace results in a large drop in remuneration, which doesn’t benefit the recruiter.
Certainly it is my view that current US firm hiring policy cannot continue indefinitely. According to my own research, some US firms have an attrition rate in partner recruitment of up to 75% over five years, a strategy which is uneconomic and surely unsustainable.
To sum up, we can point to a number of factors which, taken together, may indicate that we have passed the glory days of lateral partner recruitment.
First, the flattening of revenues across the market as a whole will mean profits stagnate, meaning aggregate remuneration stagnates (however it is shared out, that is to say PEP may keep rising but the numbers earning average PEP or more will fall), meaning recruiter fees plateau. Second, big firms recruit less, not more, than smaller firms, and those smaller firms are recruiting partners for less money. Third, the change in strategy of US firms from lateral hire to merger suggests a pattern of less ardent lateral hiring on their part, and while US firms tend to ‘surge-hire’ at the beginning of their campaign in London, the level of hiring drops off markedly once they get to a certain size.
Recruiters should reassure themselves that there will still be plenty of activity in the market for them to get their teeth into, but a large recruitment company wanting to enter the market for the first time, or perhaps looking to acquire an established legal recruiter (itself quite a barmy idea, in my humble opinion…) should take a pause and consider whether this is a wise move. In other sectors, a pattern of falling activity and flattening revenue, not to mention strong competition, would make any company think twice, but then law tends to have a kind of ‘gold rush fever’ effect on players from out-of-sector.
If I am right, and the partner lateral recruitment market is indeed past its peak, future prospects can only be slightly disappointing.