Performance: slowing revenue growth and rising costs saw law firms ill-prepared for a crisis

In common with many sectors, law firms were caught by surprise when the pandemic hit the UK in March 2020. Many went into the pandemic with slowing revenue growth and high cost bases, a tough starting point to face down a once-in-a-generation crisis.

The majority of UK law firms have a March or April year end, so we can now access information on their performance and financial strength for the year to the end of March/April 2020 of the top 50 firms, just as the pandemic started significantly to impact everyone’s lives.

It is worth noting the size of the UK legal market. The top 50 firms generated revenue of £19.5bn up from £18.7bn the previous year. While this was an increase of 4.3%, it was the second lowest annual increase in the last seven years. Clifford Chance reported the highest revenue, at £1.8bn, with another four firms also generating over £1bn. On average revenue was £390m with Browne Jacobson coming in at number 50 with £81m of revenue.

Had the revenue increase seen in the previous year continued - and there was plenty of anecdotal evidence to suggest it could - we would now be announcing the top 50 law firms had generated perhaps over £20bn of revenue. While the UK’s move into lockdown may have been towards the end of the firms’ financial years, the immediate and sudden impact on revenue is clear.

However, the case is not the same for costs. While revenue can cease almost immediately, the majority of costs for law firms, such as property and people, take time to change. A total of over 94,000 lawyers and support staff worked in the top 50 law firms in 2019/20, up from just under 90,000 the previous year, an increase of 5.2% (or 5.8% in relation to lawyers), while overall staff costs increased by 7.6%.

These staff costs accounted for 43% of turnover, up from 41%, with an average cost per employee standing at £77,300, up from £75,000.

Consequently, operating profit margin fell from 32.0% to below 30.0% at 29.8%, the lowest level and biggest movement in the last seven years. While these changes might seem small, this reduction in operating profit resulted in £430m less profit being earned by the top 50 firms. It is also not the way many law firms would have chosen to enter the most challenging conditions most had ever witnessed.

This reduced profit was shared by an increased number of partners (number of members up 2.9%). As a result, the average profit per member fell from £511,000 last year to £496,000, a reversal of increases in the last three consecutive years.

The pandemic has had a profound impact on society, all of our lives and the business world. An analysis of the top 50 law firms’ accounts for 2019/20 suggested that law firms were not immune. Many had to respond with unprecedented steps to protect their businesses. While the first half of their subsequent financial year was challenging, there is evidence to suggest they recovered quickly and the second half was much better. Whether that was sufficient to bring law firm performance back on track, or whether some firms will have suffered permanent damage remains to be seen.

DISCLAIMER
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.