Wolstenholme: Law firms now face some headwinds
The largest UK law firms have enjoyed a “bumper” year of income and profits but staff turnover is spiking despite an “unprecedented” rise in their pay, new research has found.
It also found ever growing concern and spending on cyber-risk.
The 31st annual PwC survey of the top 100 law firms recorded that a large number of firms have reported “bumper increases and record fee income, profits and PEP”.
Almost 90% of firms increased fee income, whilst 65% saw a rise in profits, with most practice areas performing strongly.
“There have been high levels of M&A activity, and other areas have also seen strong activity levels, including arbitration, employment, refinancing, restructuring and insolvency.”
Average fee income growth among the top 10 firms was 8.5% – double the rate of 2021 – to £1.2bn, while their profit grew by 9.2% to an average of £505m: “While profit growth has halved from 2021, which was an unusually exceptional year, this is still a strong result.”
The next tier down, of the firms ranked 11 to 25, saw fees and profit grow by 5.8% and 3% to £394m and £130m respectively – most of their growth came from international operations, whereas for the top 10 it was relatively even between UK and international offices.
Average net profit margins for the top 50 all increased to levels “not experienced for a number of years”: 39% for the top 10, their highest since 2015; 29% for the top 11-25 firms, their best since 2009; and 27% for the top 26-50 firms, a 12-year high.
Profit per full equity partner also hit records, reaching £1.4m for the top 10 (up 10%), £868,000 among the top 11-25 (13%), £650,000 for the top 26-50 (26%) and £464,000 for the top 51-100 (4%). With full equity partner headcount remaining fairly flat, “this PEP performance is representative of underlying increases in profit”.
Over 90% of the top 100 predicted an increase in fee income in the next two financial years, although confidence over profits was a little more muted.
PwC found the four key areas that firms thought could affect their future financial performance were shortage of talent, cyber-risk, macroeconomic uncertainty, and inability to recover costs through pricing.
“Since the end of the final lockdown of the pandemic, partners and fee-earners have been on the move, more so than at any time in the last two years. The war for talent, coupled with a shortage of supply exacerbated by the so-called ‘Great Resignation’, have caused eye-watering staff cost inflation.”
Staff turnover has risen almost across the board; across those with one-to-two years’ post-qualification experience, it was 17% among top 10 firms and 28% in top 26-50 firms.
But PwC warned that ever-increasing remuneration levels – which were impacting on profitability – were “not sustainable as a long-term solution”.
It continued: “Furthermore, as a new generation comes through, other factors are becoming equally if not more important. Therefore, law firms need to prioritise their strategy towards areas including work life balance, the hybrid or remote working model and their ESG [environmental, social and governance] policies, all of which are increasingly valued by staff today.”
At the same time, the trend last year was for a fall in chargeable hours, described as “an intentional reigning in of unsustainable levels of busyness for some”.
Staff costs increases were offset to some extent by reductions in the property costs, as firms have reduced their space by an average of 13% due to hybrid working, while marketing and business development spend was “not yet back at pre-pandemic levels”.
Spending on cyber-risk has risen by at least 50% across the top 100, but PwC predicted that it may have to increase further – the top 10 firms are pumping £5m a year into it.
With 77% of the top 100 reporting phishing attacks, cyber-spend as a percentage of fee income increased from 0.33% to 0.46%. Seven in 10 experienced cyber-incidents unintentionally caused by staff, while 8% suffered an incident caused by “a malicious insider” at least once.
The report went on: “With high levels of inflation and the cost-of-living crisis continuing to put pressure on salary demands, the ability to keep recovering cost inflation through pricing will be a challenge, especially as clients look to manage their cost base through difficult times…
“Firms may need to look beyond pricing – e.g. through taking out non-core costs, improving the operating model and leveraging technology innovation.”
PwC said the Covid focus on improving lock-up, “with a ‘cash drive’ mentality which saw collections prioritised”, has dissipated to some extent, with most many firms seeing “a significant deterioration in their year-end total lock-up statistics”.
For the first time, the report investigated firms’ approach to ESG – a quarter of firms have a formal policy in place, with a similar proportion closing in on one.
Most firms expected the key impacts to be on travel policies, selection of suppliers, recruitment and organisation strategy; in the top 10 firms, the most common ESG targets dealt with greenhouse gas emissions, and gender and race/ethnicity representation rates.
Kate Wolstenholme, leader of PwC’s law firms advisory group, commented: “Despite a very strong year, law firms now face some headwinds from continuing macroeconomic and geopolitical uncertainty, with high inflation, tightening of credit markets and the energy crisis creating a shift in business confidence…
“But with some market players now focusing on expansion into adjacent service lines, successful firms will maintain a strategic growth mindset to avoid compromising mid- to long-term ambitions.”
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