Last Tuesday, 22 September, at 13:30 GMT the Northern hemisphere had Autumn Equinox as the sun was directly above the equator and day and night had precisely equal length. From then onwards the days are getting shorter and there will be increasingly longer periods of darkness. Also since the last couple of days, politicians started talking of a ‘second wave’ and are openly discussing the possibility of a second lockdown. Meanwhile businesses are suffering and support among the population is diminishing. It seems as if from several perspectives we are entering into the night.
After the lockdowns ended, politicians and business leaders were sort of hopeful that there would be a reasonably fast V-shaped recovery. The graph - based on data compiled by Goldman Sachs - seems to justify that optimism. Until summer the global economy recovered pretty quick and as people went on holiday the trend somewhat slowed down.
Now that we are facing the serious prospect of a second wave and people are urged to work from home again and lockdowns cannot be ruled out, the mood quickly starts to deteriorate. The graph below is illustrative for the grim new reality. In April, after most restrictions had been lifted, the aviation industry projected to be back at 80% of pre-pandemic levels by the end of the year (red line). Until end of August they seemed to be reasonably on track (black line). Now, faced with the new reality the expectation is the industry will be at just 40% of pre-pandemic levels (blue line) by the end of the year. Many other industries are making similar downward adjustments to their outlook.
How this will affect legal spend
Corporate clients represent over 80% of all legal spend, the remainder being government related and private individuals. So if businesses are facing strong headwind, how will this influence their legal budget? I have had several one-to-one conversations with General Counsel over the past three weeks and the pattern seems to be fairly consistent: companies are in full cost-saving mode. On average companies spend 0.5% of total revenue on legal (looking at it from the cost perspective: large companies spend typically <2% of their total cost on legal). Even though legal does not count for much of the cost (and potential savings), GC’s tell me that they have to contribute like all other departments and potentially even a bit more. None of the GC’s I spoke was happy about this at the time. It is fair to assume that legal budgets will go down. Certain things will be postponed or not done at all (the nice to have) for other mandates there will be an increased pressure on price and a tendency to ‘push work down’ to less expensive law firms in a lower tier or to an Alternative Legal Service Provider.
What impact does this have on law firm revenue?
There is no escaping, law firm clients will start scrutinizing their budgets. Most law firms that operate in the upper segment of the legal market sailed pretty smooth through the first few months of the crisis, reporting equal or better numbers compared to 2019 (which for most has been one of the best years in recent history). This may, after an initial shock, have created some misguided sense of optimism. Most law firms who initially cut partner payments had reinstalled them by start of summer. There seems to be cautious optimism in the business of law.
In the weeks and months to come, darkness will descend upon us. The economic outlook is grim and legal budgets are under pressure. The impact will be felt differently across different legal markets. In western-Europe national legal markets are small as compared to the US or China. Needing a minimum of 3-5 high-end law firms in a smaller market, the tier-1 law firms have to rely for a large part of their revenue on bread-and-butter type of work. There simply is not that much strategic work around. This is exactly where the problems will soon arise.
As illustrated in the TGO Value Matrix© strategic matters and bread-and-butter matters each have completely different pricing dynamics. Even through times of severe economic crisis corporate clients are prepared to spend on lawyers that can have a significant positive impact on their bottom-line. Lawyers that contribute to the business opportunity will not face pressure on price. On the contrary, in bet-the-farm situations money will be no consideration. It is results that count.
How different it is, as it comes to the bread-and-butter matters that count for about 60% of western-European tier-1 law firm revenue. These are the matters for which high-end law firms are overqualified. This type of matters could equally well be dealt with by mid-tier firms that are far less expensive. Which is great news for mid-tier firms but not so great for the tier-1. If a tier-1 law firm would lose 10% of the bread-and-butter work (either in volume or in revenue after discounts), this would cause revenue to drop by about 5% and, everything else equal, reduce profit by 12,5%. That’s something to think about when drafting the 2021 budget and strategy.
Fortunately there are a number of strategies to mitigate these effects. We are happy to discuss.