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The Biggest Challenges Facing the Legal Profession in 2016

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About The Author

Chris Bridges (Executive Editor)

Chris is an IT and Data Protection solicitor at a top 20 full service firm and the founder of Keep Calm Talk Law. He also contributes to Computers and Law and other sector specific publications.

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We have now published updated articles for 2018 and 2019. See "The Biggest Challenges Facing the Legal Profession in 2018" and "The Biggest Challenges Facing the Legal Profession in 2019".

Every year, hopeful lawyers are expected to demonstrate commercial awareness, and a key part of this is to understand the market law firms operate in; particularly so for the vast majority that will train in private practice.

If you want to impress recruiters, you need to show that you have a firm grasp of the challenges facing their business, and how these challenges might affect how they operate. This article covers three issues I foresee as significant challenges facing law firms going forward: fixed fees, market consolidation and the rise of the Big 4. Whilst these will be relevant to varying degrees for the firms you are applying to, an understanding of challenges facing competitors can be equally useful.

Fixed Fees

Despite the fact that the economy is well and truly back on the up, downward pressure on solicitor’s fees is still very real, in turn placing pressure on solicitors’ traditional methods of business planning.

As with other professional services, legal services have in times gone by been billed by the hour, with a fee earners hourly rate, in theory, being set on a very simplistic formula: a third for salary, a third for overheads and a third to either put away or withdraw as profit.

However, over the years firms have come under increasing pressure to consider other fee models such as fixed fee, which force a firm’s hand to take on some of the client’s risk. According to PwC, between 2014 and 2015 alone fixed fee arrangements as a proportion of the total rose:

  • in top 25-50 firms, from 21% to 32%; and
  • in top 51-100 from 26% to 38%.

Whilst these pressures are nothing new, there have been developments this year with regards to fixed fees which every aspiring lawyer should be aware of in 2016 and beyond.

Developments in Litigation Costing

Early last year the Master of the Rolls placed an indefinite freeze on the increase of guideline hourly rates (GHRs), which have not increased since 2010. In that same period, total inflation has been 19.77%. GHRs are currently used to determine a fair award of costs; thus if firms charge more than the relevant GHR, the client will not be able to recover the difference from the other side.

However, since 28 January 2016, the date of Lord Jackson’s IPA Lecture this has somewhat paled into insignificance.

In 2009, Lord Jackson’s “Review of Civil Litigation Costs" final report recommended fixed recoverable fees in all fast-track cases (less than £25,000), and contemplated a move towards fixed fees in multi-track cases (more than £25,000). Since, fixed fees have only been implemented in personal injury fast-track cases and intellectual property claims with a value of less than £500,000 in the IP Enterprise Court.

However, in Jackson’s January 2016 lecture, he spoke openly about pushing on with the introduction of fixed fees in all fast-track and the lower value multi-track claims (less than £250,000), and even further once these have been adjusted to by the profession.

If you are looking for detail, I strongly advise you read Lord Jackson’s Lecture which is very easy to follow. His ‘costs grid’ determining the applicable fixed fee for particular stages in claims up to £250,000 can be found at page 13.

Whilst Jackson talks about a greater chance of ‘acceptance’ by the profession now than in 2009, he does note:

I suggest that a senior judge who doesn’t mind being pilloried (preferably not me again) should actually draw up the scheme.

Clearly then, he acknowledges this will be no easy ride for the profession.

Before I go on to discuss the problems the profession faces with fixed costs, it should be noted that Lord Jackson’s proposals would not affect the amount that can be charged, only the amount that can be recovered, as with GHRs. A firm can still charge the full value of the hours spent on the matter based upon on hourly rates, and the client can pay the shortfall out of its own pocket, if that is what has been agreed.

Therefore, whilst difficult conversations with clients about why the court did not think the fees incurred were proportionate to the claim at hand have always been a risk with costs management, fixed fees will likely reduce the amount recoverable making these conversations that much more difficult.

Whilst experienced courts users will be aware of this, and are perhaps happy to pay a premium for the firm they consider to be the best, the reduction in recoverable fees will almost certainly lead to downward pressure on costs from the less experienced court users or those with shallower pockets.

Therefore, the courts only awarding fixed costs does not mean lawyers will be forced to start billing on a fixed fee basis, per se, but it certainly adds to the pressure to do so. We should therefore reflect on what fixed fees mean for the profession.

Allocation of Risk

The fundamental difficulty with fixed fee arrangements is straight forward. For all but the most simplistic transactions it is very difficult to determine how many hours a matter will take or how complicated it might get (the more complicated it is a greater proportion of time will be spent by a fee earner with a higher hourly rate).

For routine non-contentious tasks such as a will, a contract review or a run of the mill conveyance, and the most simplistic (typically low value) contentious claims, experience will tell a department how much it will cost. Even these can throw curve balls, which may or may not balance out with those matters that take less time than the average.

For corporate transactions of any size and higher value contentious claims it becomes increasingly difficult to put even a best guess on how much time each stage will take. Typically, a firm will not know how much document review will be needed during due diligence and disclosure within a reasonable margin until the day on which the documents are produced.

By providing these services on a fixed fee basis, a firm may be taking a substantial portion of the client’s risk. Go over the estimate on which the fixed fee was based and the matter will start cutting into the final third: profit.

It is by no means unreasonable for a client to want fixed fees; how else can they decide with a degree of certainty whether incurring the fees makes commercial sense?

Traditionally law firms have provided ballpark fee estimates, or tightly defined fee estimates which price the expected and expressly exclude the unexpected. Regardless of the type of estimate, they make business planning difficult, particularly for those smaller clients with limited cash flow where a few thousand or even a few hundred pounds can be a determining factor. How would you feel if you asked a builder to build a house, he quoted £300,000 but at completion invoiced you £500,000? Depending on your liquidity, it could put you close to financial ruin.

So what is the difference? Short of being clairvoyant, it is extremely difficult for lawyers to predict what might emerge during the course of a large transaction or a significant dispute. On the flipside, to take the example above, a builder should be able to calculate with some degree of certainty what materials and labour will be needed, and the price of these is unlikely to change significantly over the course of a year. It is unlikely a builder will take the risk of precarious site conditions, for instance, without a proper ground survey being conducted.

However, could lawyers not fix fees at a median for the size of matter being taken on, and offset ‘overspends’ of time against ‘underspends’ of time? With top 26-50 firms having an average net profit of 24.5%, and top 51-100 firms 21.2%, could they not afford to take a little more risk? To put this in context, the average profit margin for the services industries in the UK is significantly lower at 18.5%.

Arguably, yes, law firms could take on more risk where they have healthy profit margins, but only with significant buffer, and buffer typically comes with size. However, this is a catch 22 situation; the smaller client, who traditionally would have gone to the smaller firm, may not be turning to the larger firm that can provide commoditised services at a fraction of the cost on a fixed fee basis. This leads to the second significant challenge for the legal profession in 2016 and beyond: market consolidation.

Market Consolidation

On 9 February 2016, it came out that Olswang, a firm that has never merged since its foundation in 1981, is on the market for a merger. Whilst it is currently possible to known the reasons behind the decision, this may well serve as a sign of the times.

Whilst there was a decline in merger activity in 2014, this may be a misleading trend as the UK emerges from the 2008/2009 recessions. Indeed, in the Law Society’s Annual survey 2014/15, the most commonly cited issue to have the biggest impact on law firms over the next ten years was competition and in a Managing Partner survey of the UK’s top-200 firms, 95% expect merger activity ahead. Many firms may feel obliged to consolidate in order to avoid being priced out of the market.

With an increasing pinch on legal fees and the constant rise of the in-house solicitor unbundling legal services, this is unsurprising. Not only do firms need greater financial buffers to take on fixed fee work, they need to make up for downward pressure on fees and therefore profitability by cutting costs elsewhere. Invariably, this will mean cutting overheads wherever possible; the only alternative would be to cut fee earner payroll, which is an extremely unattractive option in the fight for talent with salaries continuing to hike, particularly in the city. Cutting overheads without service being affected, for many firms, will mean economies of scale through merger.

However, mergers do not happen overnight. According to Managing Partner, two thirds of merger discussions fail. Firms must be able to gel otherwise hook-ups can end in disaster. Finding the correct merger partner that both parties can foresee integrating with takes significant time, and possibly significant lost revenue, depending how involved fee earning partners become.

The Rise of the Big 4

Competitiveness is becoming all the more important for city firms given the rise of the “Big 4” accountancy practices in the legal services market. For those unaware, the Big 4 include Deloitte, PricewaterhouseCoopers (PwC), KPMG and Ernst & Young. The threat is becoming very real, with PwC’s global legal services leading aiming to be in the top 20 by 2019 and The Law Society in its January 2016 report warning that “the implications of the Big 4 accountancy firms offering legal services should not be underestimated”, with the uptake of alternative business structures becoming a global trend.

The Big 4 are able to target areas that complement their bread and butter audit and consultancy services, for instance tax, compliance and corporate due diligence, making business development a walk in the park. As their reputations rise, more and more large corporates may seek to consolidate their audit, consulting and legal panels.

To make matters worse for law firms, the Big 4 are not short on cash to invest in world-class fee earners. PwC’s UK member firm alone has a turnover of £2.6 billion, compared to Clifford Chance, the largest UK registered firm, with a worldwide turnover of £1.4 billion. You only need to watch the legal press’ lateral hire pages to see this in action.

Small Claims Cap & Personal Injury

A bonus fourth challenge facing the legal profession in 2016, for which I refer you to a distinct Keep Calm Talk Law article.

In the November 2015 spending review, the Chancellor pledged to raise the small claims limit from £1,000 to £5,000 while axing soft tissue and whiplash cash pay-outs completely. This is likely to have a significant impact on the personal injury landscape, drastically reducing the number of claims personal injury firms can compete for.

Rather than reinventing the wheel here, I refer you to Samuel Cuthbert’s (Private Law Editor) article on Keep Calm Talk Law earlier this year, ‘Ill conceived with disingenuous motivations: personal injury reform’, for an analysis on this reform’s impact. This is a must read for any hopeful personal injury lawyer, or for that matter, any hopeful lawyer aspiring to join a firm which relies significantly on its personal injury revenue.

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Tagged: Commercial Awareness, Legal Business, Legal Careers

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