Measuring Success in Law Firm Mergers

There seems to be no decrease in law firm enthusiasm for mergers, despite continuing turbulent times.  According to Hildebrandt Institute’s MergerWatch, law firm mergers jumped by 67 percent in 2011, and are expected to rise again in 2012.  Certainly activity in the first half of the year seems to point to another busy year.

However, it has always been difficult to get any hard evidence of how successful merger strategies are in practice.  My own informal study of publicly available information is that whilst mergers are often successful in assisting with the achievement of an over-arching strategic objective (such as the need to gain access to new geographical locations, or new service lines, or to raise the profile of a brand), it is much more difficult to demonstrate success on the bottom line and many firms seem to have a period of a few years where profits remain in the doldrums for a few years post-merger.  In many ways this is not entirely surprising, as it is in the nature of businesses which essentially sell professional time that scale does not necessarily equal greater profit.   If you accept David Maister’s well known formula, which says profit per partner (PEP) is a function of utilization X charge-out rate X leverage X margin, then none of these are likely to be significantly impacted by a merger.  Few mergers fundamentally change the ratio of partners to fee earners, or enable big hikes in charge-out rates.  It is true to say that there are a degree of cost synergy savings in some mergers with the elimination of back-office duplication, but these tend to be relatively modest and are often offset in the early years by the additional costs of the integration exercise itself.  The best mergers do lead to an increase in combined revenues, but turning it into an increase in PEP is a much greater challenge.

A good example of this is likely to be Clyde & Co¸ which has achieved the phenomenal achievement of a 36% hike in revenue (to £287 million) so far this year, following its merger with Barlow Lyde & Gilbert in November 2011.  This makes it currently the fastest revenue growing firm in the UK top 50, and even when the revenue contribution from Barlows is stripped out, like-for-like revenues at Clydes grew 17% - impressive growth by any standards.  It appears that a lot of the growth has come from the firm’s non-UK operations, which seems to suggest that the course of internationalisation that they have embarked upon is resulting in a rapidly increasing market share - so clearly Clydes’ strategy is working in that regard. 

However, there is likely to be a lull before that translates into increased partner earnings, if indeed it does so. Profits have not yet been announced by Clydes but whilst absolute profit is expected to have increased at the group, PEP is widely expected to have declined over the same period, perhaps by 10%.  This reflects the relatively high costs of opening new offices, and having to place a relatively high proportion of senior people there in advance of the work flows.  Despite this, Clydes certainly seem to be happy to stick with the expansionist plan - earlier this week they announced new office openings set to happen in Sydney and Perth, which is an indicator that they are happy to bear a short term dip in personal earnings to achieve a longer term strategic objective.

The prospects of Clydes recovering any temporary loss of PEP seem to me to be very good in the medium term, as newer international offices gain scale and the proportionate costs of supporting them and the integration effort reduces.  However, it would in my view be misguided to think that the PEP will ever increase at anything like the same rate as the revenue line, unless there is a fundamental rethink of the basic principles of running a law firm, so that Maister’s formula is truly challenged (perhaps for example, by following the bold steps of Riverview Law, and breaking the direct linkage between hours worked and the bill levied).

So by what measure should we measure the success of a law firm merger?  That is a long and complex question. There are, as I said, many things which can indeed by achieved by a merger – brand awareness, geographical footprint, sector expertise, and sometimes even just the protection of a market share which is likely to be eroded if a firm isn’t seem to be moving forwards and developing.  However, if the number one strategic aim of a merger is an increase in PEP, then that is quite a tough nut to crack.