History repeats as Big Four accounting firms pose threat to Big Law

After more than a decade on the sidelines, major accounting firms are again using their size, skills and geographic spread to target the changing legal services market, write Eric Chin and Warren Riddell.

The recent acquisition of former King & Wood Mallesons managing partners Tony O’Malley and Tim Blue by PwC Legal clearly signals the professional service giant’s intent on building its legal capability. This is the same Big Four firm that did not fully retreat from the legal arena, as did its peers, when Sarbanes-Oxley was introduced in 2002.

History of accounting firms’ excursion into law
The concept of multidisciplinary practice first appeared in Europe when tax accountants and lawyers were allowed to practice in partnership. Germany’s multidisciplinary firm Rödl & Partner embodies this shift in Europe. By the mid-1990s, the then Big Six accounting firms, operating under cohesive global brands, made a concerted effort to build their legal capabilities. To circumvent the barricades rule, they entered into network arrangements or Swiss vereins (associations) with local law firms.

As the accounting firms were first among the professions to globalise, their legal practices were more geographically fluid, and not limited by local practice and ethics rules like their law firm competitors. By the start of the 2000s, the Big Five (as they had become) firms’ legal practices were the largest in the world by headcount and were posing a major threat to law firms. To be clear, the accounting firms competed actively in the mid-market segment, winning legal work from their audit or consulting clients at the expense of local law firms. The response from law firms was generally passive indifference, although the American Bar Association did establish the Commission on Multidisciplinary Practice to scrutinise the accounting firms’ incursion into law.

Using publicly reported data from 2002, we have analysed the Big Five accounting firms’ legal practices and compared them against the then five largest law firms. This was the year before all the accountants, except PwC, offloaded their legal practices.

This analysis reveals that:
• in less than a decade, Andersen Legal was the largest law firm by headcount
• Klegal was the most globalised law firm, having a legal practice in 60 countries
• the global legal landscape was dominated by the Big Five accounting firms.

The numbers illustrate the ease with which the Big Five firms grew their legal practices, having the comparative advantage of global brands and global platforms. This was, of course, halted by the demise of Arthur Andersen and the consequential Sarbanes-Oxley legislation. As a result, by 2003 all but PwC (through its associated firm, Landwell, in the United Kingdom) had retreated from the legal market. This begs the question: what would have happened if Sarbanes-Oxley had not been introduced? The accounting firms would almost certainly have dominated global business law today, as very few law firms, other than Baker & McKenzie, had at that time as substantial a global footprint.

Shifting legal landscape
Fast-forward more than a decade and the legal landscape has changed. One fundamental difference is the rise of the general counsel and the increased sophistication in how clients buy and use legal services, irreversibly shifting relationships from a seller’s to a buyer’s market. Globalisation of trade is now commonplace and digital commerce has removed the jurisdictional boundaries that constrained many enterprises. As a response to this trend, we have witnessed major trans-Atlantic amalgamations to create firms such as DLA Piper, Norton Rose Fulbright, Hogan Lovells and Dentons. As the tectonic plates of the global economy shift from West to East, this refocusing of capital and commerce has also given birth to Sino-Western amalgamations such as King & Wood Mallesons and Dacheng Dentons. As a result, the big law firms have a wider geographic reach and a larger battalion of lawyers to serve their clients’ increasingly international business needs.

In 2013, Beaton introduced the NewLaw neologism. This new business model is the antithesis of the traditional law firm and sees clients increasingly accepting the new alternatives to the supply of legal services. Outsourcing started in the 1980s with information technology services and opened the way for back-office services in the 1990s and knowledge process outsourcing in the 2000s. These trends led to the creation of legal process outsourcers such as Exigent, Pangea3, Elevate and others. The 2010s saw the rise of crowdsourcing, new technology and new processes, making NewLaw firms such as Axiom, Riverview Law, Keystone Law, AdventBalance and Bespoke Law viable alternatives for general counsel.

The result is that, increasingly, traditional law firms are being squeezed from different parts of the market. Historically, law firms were built on the opacity and knowledge asymmetry of law, but this barrier to entry and defence of fee levels is being eroded in this age of Big Data, in which knowledge is liberalised, commoditised and readily accessible. This is an irreversible movement that will continue to change the legal landscape. Research (see chart below) conducted by Beaton Research + Consulting reveals client satisfaction increases as the number of practice groups used by a client from the same firm increases.

This makes economic sense as clients consolidate their spending with fewer providers to enable them to flex their buying muscle and reduce their own administrative burden. We also know that clients’ issues are rarely partitioned into a single area of expertise. In this digital and globalising market, issues are increasingly multifaceted and complex, requiring a greater understanding of both industry and business than was previously the case, irrespective of whether it is law, accounting, tax or other professional services. Lawyers may find the next point difficult to accept, but the accountants have often been ahead of lawyers in understanding the business context of issues. As one client said to us: why is it that my accountant asks to come to my office, but I am expected to go to my lawyer’s office?

The evidence indicates that for clients with complex issues to solve, multi-disciplinary firms will have a distinct advantage over generalist, single-discipline firms – be they lawyers or accountants. Boutique firms are different to the extent they can demonstrate both exceptional specialist expertise in specifically identified industries – where they will usually give a multidisciplinary firm a run for its money.

Big Four back in Big Law land
In July 2001, New South Wales legal service practitioners were the first in the world to be permitted to incorporate. In 2007, we saw the first listing of a law firm on the Australian Stock Exchange and in January 2012 the UK issued the first alternative business structure (ABS) licences. These changes made multidisciplinary practices a possibility in the UK and Australia. In January 2014, PwC Legal gained an ABS licence, followed by KPMG Legal in October 2014 and then EY Law in December 2014.

Using publicly reported data, we have analysed the current size of the Big Four’s legal practices and compared them against the largest law firms in 2014 (see chart below).

Currently, the largest law firms are more than twice the size of the Big Four firms. Among the Big Four, PwC Legal is the largest with 2400 lawyers. This can be attributed to the fact that it was the only Big Four firm not to fully divest its legal practice at the turn of the millennium.

All the Big Four firms have announced their legal ambitions and are resolute about taking a more considered approach to growth and in which areas of law to compete. This does not mask the fact that they still have the comparative advantage of their geographic spread, an existing back-office infrastructure, and deep and recognised industry knowledge and contacts. They are also well positioned in the emerging markets of Asia and Africa, where price will be more important than brand loyalty. Inevitably, the Big Four’s legal practices will grow globally as they expand into other jurisdictions. One other change in the past decade that is also a threat to law firms has been the Big Four’s significant growth in the private client market; this will provide them with another area of focus to cross-sell their legal services to emerging privately owned enterprises.

Strategies to compete against the encroaching Big Four
Developing competitive strategies in this market will be crucial for law firms. Below is some guidance as to how we believe law firms can combat the growth of the Big Four law practices. The diagram below summarises the competitive landscape and how clients perceive your points of differentiation relative to the Big Four and other very large firms in the legal industry.

From this graphic the following immediate strategies can be developed:

• Defend your existing advantages (highlighted in green) in areas such as ‘ease of doing business’, ‘caring about clients’ and ‘cost consciousness’, and ideally improve upon them to demonstrate the difference in the market.

• Attack where there is open ground (highlighted in blue) to take a leading point of differentiation, such as ‘excellent communication’, ‘reliability’ and critically ‘understanding your business/industry’. From our research, it is this last point that can have the most dramatic impact on a firm’s relative competitive positioning.

Below are three key takeaways from the work we have undertaken over the past few years:

1. Be relevant to your client
Clients perceive professional expertise as having three equal components: ‘technical expertise’, ‘industry experience’ and ‘understanding of their business’. Too many firms – lawyers and engineers are the main perpetrators of this – believe that technical expertise is sufficient to be relevant. Accountants, by contrast, have long understood the need for real industry and business expertise to be differentiated and that technical expertise is merely a ticket to the game.

In other words, clients want their service providers to be able to ‘stand in their shoes’ when addressing the problems of their business in their industry. This idea is not new; Clayton Christensen from the Harvard Business School christened this the ‘job-to-be-done’ theory, which states that clients buy a product or service to solve problems that arise in their day-to-day lives. The ability to demonstrate an understanding of the ‘job’ (or business and industry) differentiates the firm from the pack.

2. Client service: Great service equates to repeat purchase
Firms that consistently outperform on client service are likely to see higher repeat purchase intentions. Typically in cross-professions analysis, law firms tend to outperform the other professions (accounting included) on client service. The top three most important drivers of client service performance are ‘ease of doing business with’, ‘cost consciousness’ and ‘commerciality of advice’. This means practitioners that consistently demonstrate these attributes stand to benefit. Generally, clients are time poor and do not want to switch their professional service provider and retrain a new advisor. Do not give them a reason to switch through poor service.

3. Be responsive to change
We do not advocate growth without purpose, but growth into new areas of practice, or industry specialisations or even geography, are valid strategies. Clients’ needs change and to be able to retain key accounts may require a strategic change to the firm. This usually requires investment and a trade-off with other priorities. Organic growth is usually too slow a response to changing demand patterns; hence lateral hiring, team grabs or even mergers and acquisitions have become increasingly common. We find that beyond the strategic logic, cultural affinity is the key to making a merger or team grab work. Like a marriage, the two parties need to come together with the ‘right mentality’ to build something more than the previous entities individually could achieve.

We recently issued a white paper looking at the importance of brand purpose in law firms. The paper identified a key aspect of how clients now regard their legal provider, and it comes down to shared values. There is a binary relationship between ‘what a firm stands for’ (internally) and ‘what a firm is known for’ (externally). This is where mid-sized and smaller firms have an edge over the big firms – their identity is easier to define.

Eric Chin is an associate at Beaton Capital and Warren Riddell is a partner at Beaton Capital. Beaton Capital is a leading corporate advisory firm based in Australia and Hong Kong that provides strategic, M&A and debt advice to professional services firms globally.
www.beatoncapital.com