Editor’s Note: This post is written by the chairman of Seyfarth Shaw.
By Stephen Poor, Chairman, Seyfarth Shaw
Growth continues to elude Big Law. As demand for services of external firms remains flat, the competition for clients and revenue only intensifies. One vital sign of competitiveness in the legal services space — albeit one that requires some interpretation — is the pace of mergers in the industry.
Relying on Altman Weil’s running MergerLine tally, the New York Times DealBook recently reported that 2015 saw the most robust year ever for law firm mergers. The report cites 91 mergers, up from the previous high of 88 in the prior year. According to Altman Weil, this level of merger activity reflects a “strategy to acquire new business” in a largely flat demand environment. In other words, inorganic growth.
Fairfax Associates, in a report published in Big Law Business, provides a slightly different take: by questioning how we define “mergers.” Through an analysis that excludes deals involving five or fewer lawyers, Fairfax contends that merger mania actually cooled in 2015. Concluding that the real 2015 numbers are roughly half of those reported in the Altman Weil survey, the authors note that 2015 activity levels actually resembled 2011-2012 levels and were relatively lower than what we saw in 2013-2014. At the same time, Fairfax noted that 2015 saw an uptick in mergers involving 100 lawyers or more, with two of the six such deals involving Dentons.
The Fairfax analysis strikes me as a more meaningful approximation of the industry’s merger activity. Deals involving five or fewer lawyers are more akin to lateral moves than true mergers. Assuming that the merger mania has slowed a bit (with the caveat around the newly emerging mega-merger), it is worth speculating as to why that might be the case.
One theory could be that a relative cooldown simply reflects a cyclical adjustment in the industry. With the frenzied activity of the past few years, perhaps the bulk of the tie-ups that were destined to occur have, in fact, occurred — and the industry is left digesting the cumulative results.
I think that is a partial explanation at best. A fuller theory must account for the fact that the ground beneath Big Law has shifted in a very real way. For many decades, a reliable backdrop of rising demand meant evergreen opportunity for growth: capturing new market share was a simple question of making sure headcount kept pace with the overall growth in demand. In that environment, mergers presented a viable and speedy “strategy to acquire new business.”
Putting aside the early movers, I think most mergers over the past ten years or so — no matter how the strategy was articulated—were fueled by this simple proposition. Size, in fact, mattered.
The challenges of buying growth in the New Normal
We no longer exist in that world of rising demand. Can Big Law continue to buy market share in much the same way as before? While the crystal ball is a bit murky, I think that signs point to “no.”
The trend of flat demand for legal services is most likely here to stay. In the face of growing law department capabilities and the increasing threat from new entrants, demand for Big Law is arguably contracting. Perhaps most importantly, the way buyers look at the acquisition of legal services has fundamentally changed.
At one point, size was a material factor in reputation and in the perceived quality of services expected (if not always delivered). Sophisticated buyers, however, are now arming themselves with a complete arsenal — new mindsets to evaluate and articulate their unique needs differently, new skillsets in law department operations and legal services procurement, and new tools to measure the overall fit, effectiveness, and quality of each player in the legal supply chain.
All this means that buyers are no longer fettered to old proxy measures like reputation or size. Rather, they are making far more nuanced judgments and far more robust decisions about their suppliers of legal services. As a result, the industry’s erstwhile reliance on reputation is waning; with it, the significance of size will diminish.
Mergers live on — but will look and feel different
Nevertheless, inorganic growth will continue to be a key lever in our industry. Simply witness the sustained pace of lateral hiring in the industry. The watchword, however, should be smart growth — not a pell-mell rush toward size, driven by a misplaced belief that size is what is valued in the marketplace.
Instead, each firm in this environment must focus on targeted growth that reflects their unique strategic positioning in the marketplace. Such efforts can only be based on a deep understanding of the needs of the purchasers and an honest evaluation of any gaps within the firm’s service delivery platform — always working from the perspective of the client.
Given these pressures, I believe mergers will face an increasingly high bar for success, and increasingly, I think mergers will fall into one of three frameworks.
- Mega-mergers here to stay: I believe we will continue to see a small trickle of massive deals intended to drive inorganic growth into new geographic regions. Firms that have already started down this path are essentially committed to the vision of a massive global presence — they will most likely be compelled to finish the path. As Fairfax reported, 2015 merger activity bore out this narrative.
- The long sunset on the merger of equals: Amidst growing dispersion in law firm performance, a number of firms are contemplating the unpleasant prospect of irrelevance. These firms tend to lack true differentiators in practice- or industry-specific expertise; in lieu of a protracted effort to develop a unique value proposition, these firms are likely to seek salvation through tie-ups.
For some such tie-ups, the combination of fading firms may afford the breathing room necessary to reconfigure service delivery profiles to create a new whole that is more than the sum of its parts. Being neither fish nor fowl, however, such firms face the difficult challenge of organizational soul-searching, followed by an equally harrowing search for the right partner, most likely under intense scrutiny by the growing business-of-law media and by the market itself.
Certainly, these challenges do not preclude success; for most such tie-ups, however, I believe it simply delays the inevitable day of reckoning.
- The rise of the lopsided acquisition: In recent years, I believe we have seen an uptick in deals that are far closer to the nature of an acquisition than a merger—where a dominant firm picks up a failing, or at least flailing, firm. Increasingly, we also see firms decline to assume entire balance sheets, opting instead for something akin to an asset purchase of a smaller remnant of the target firm.
Where the dominant firm’s decision-making takes into account the type of gap analysis discussed above and finds that the pieces fit their strategic position in the marketplace, there is a real opportunity to accelerate its strategic positioning in the marketplace. Without this commitment to strategic thinking, the undiscerning attempt to buy market share is unlikely to create real economic value.
As the world changes around Big Law, the way in which firms think about merger activity is evolving. Those firms that are applying a new lens to better understand a shifting landscape will be better equipped to spot opportunities. In turn, those firms will continue to break away from the pack. For firms simply trying to bulk up for the sake of bulking up, I think their mileage may vary. Ultimately, the success or failure of a merger of any flavor is only determined in one way: with the client as the final arbiter and the firm’s bottom line as a scoreboard without asterisks.
For more essays from Stephen Poor (@stephen_poor) and Seyfarth on change in the legal industry, visit Rethink the Practice.