Adventure of Strategy

The prospect of non-lawyers being allowed to own businesses that dispense legal services in England & Wales is leading to a comprehensive re-examination of how one values a law firm. I wrote an article on this topic on this blog nearly four years ago in January 2006 (see How Much is a Law Firm Really Worth?) There are a range of others that have also written in this area, varying from those that paint an exuberantly optimistic picture, to the likes of that doyen of law firm strategy and management, Prof Stephen Mayson, who like me takes a FAR more pragmatic and sober view.

The simple fact, according to Stephen in a keynote address to a seminar organized by the Solicitors Regulation Authority recently, is that lawyers are overpaid if one evaluates their compensation together with the return on [financial] capital and the cost of labour. Those that believe that external investors are going to pay them a large cheque for their firm so that they can "waltz off, retire, play golf, go yachting ...." are deluding themselves.

The basis for this is that if one views a business in conventional terms, which is what any sensible external investor should do, then the business needs to :

• Provide a decent return on the financial capital invested relative to alternative investments available (i.e. provide a 'return on capital.')

• Pay the firm's owners a salary comparable to what they would earn elsewhere or, put differently, what it would cost to employ others to deliver the substantive professional services to clients and to manage the firm (i.e. provide a 'return on labour.')

• Provide a return over and above that, as a profit that can be returned to shareholders as a dividend. This is the part that will be of most interest to external investors and in the case of most firms .... it simply isn't there. In calculating net profit, partner/owner return on labour is reckoned at zero. If all the "profit" is required to compensate partners/owners at a level that is competitive in the market, then the real profitability of the firm is .... well .... also zero. At least from the prospective of an external investor.

The really interesting impacts that might result from the Legal Services Act will not be caused by external investors injecting capital into law firms as we know them and understand them. Far more interesting will be if the opportunity for non-lawyer ownership creates entirely new and different business models that (a) provide a decent return on capital AND (b) provide competitive compensation for all senior talent whether owners or not AND IN ADDITION (c) provide a decent return over and above that too. That kind of innovation could easily have a domino effect in legal services across the world, fundamentally transforming the way that legal services are delivered to clients.

One thing is very sure: this will not involve an income model that simply relies on "rate x hours."