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How Do Smaller Firms Compete Against Larger Firms
Hello, and welcome to “Whiteboard Wednesday.” Today I’m going to explain how smaller law firms compete against larger law firms.
So let’s get started. So today I’m going to explain how smaller law firms, for example, U.S. law firms, can compete against larger law firms, like UK Magic Circle firms. Because often students don’t quite understand how that works. How do U.S. law firms pay more? How do they challenge enormous, well-established UK firms? And that’s hopefully what I’m going to explain. So let’s start off with some of the questions that I get asked. So how do smaller U.S. firms compete with larger firms? Reportedly, why do U.S. firms pay more, and why don’t UK firms just match when we look at salaries? So let’s have an idea of why that might be. Let’s go through this.
So imagine this is the legal market. A bit basic, I know, but stay with me. So let’s identify where U.S. law firms operate in this market, in the UK market. Essentially they operate at this level, okay, doing really high-value work, and it’s high-margin work, so the fees are quite high. The charge-out rates are high, but equally they’re quite small relatively. So maybe 100 lawyers, 150, 200 lawyers, something like that, so they’re operating at this level. So high-margin, low-volume work in many cases.
So where are the Magic Circle firms? Because we know that Magic Circle firms compete against U.S. law firms and smaller firms. Of course they do. But ultimately, they’re much bigger so they’re taking up a bigger share of the market. So let’s have a look. Okay, so they’re probably operating somewhere like this. So yes, they’re doing the high-value work, but not exclusively, and that’s one of the key differences. They’re also doing some work that might be more mid-market work, okay? So if we think about the charge-out rate, because this is the key concepts here.
So if you’re doing really high-value work, it’s complex, it’s difficult. It might be a really complex cross-border M and A deal, which you charge a lot for. So if you’re doing this type of work…let’s have a notional figure. Let’s say this is something like $500 an hour for an associate.
Okay, so let’s say that’s the market rate for this high-value work. But that’s not going to be the market rate of the more mid-market work, so this might not be a particularly complex M and A transaction. This might be one UK company buying another UK company. Not as difficult, not as complex, in which case you can’t charge as much for it. So you might find that at this level, this type of work your charge-out rate is going to be less, okay? So let’s say this is $250 an hour. So let’s have a think about how that works over the course of a year. So let’s say an associate in one of these firms, and also operating here, are working the same number of hours per year, let’s say it’s 2,000 hours.
Okay, so if you’re working 2,000 hours and your charge-out rate is $500 an hour, you’re bringing in a million, okay? But let’s say you’re working the same number of hours and your charge-out rate is less.
Okay, so then you might be bringing in half a million, okay? And often one of the misconceptions in the market is U.S. law firms pay more because you work more hours. It’s not the case, it’s to do with the type of work that you’re doing. U.S. law firms really, and elite law firms, do this high-margin work exclusively, and that’s not necessarily the case with some of the bigger firms. What do you find that some lawyers in Magic Circle firms are also doing this work, but ultimately because they’re much bigger there’s a convergence, okay? So let’s say this type of charge-out rate for an associate means that…
An NQ salary for a U.S. associate, an NQ salary can be 120,000 pounds a year or more. But what happens here with the UK firm, there has to be some kind of convergence. It has to meet in the middle. So you might find that that salary is then something like 90k per year, which explains the gap, okay? Because they can’t really pay everyone the same a the U.S. firms and the people doing this type of work – so it actually meets in the middle somewhere. That is why the U.S. law firms pay more, and it’s also an explanation as to why UK law firms simply don’t match.
Because the value of the work is different. It would put enormous strains on the profitability of the big UK firms. So hopefully that, kind of, explains how this works. It’s nothing to do with the number of hours that you work. As we’ve seen, it’s actually to do with the type of work that you’re doing. And with elite firms, smaller firms, they’re exclusively doing the high-value work, and that’s not necessarily the case elsewhere.
Okay, so I hope that explains. Hope you found it useful. If you have any questions just type them below, and I will see you next time for “Whiteboard Wednesday.” Thank you very much for watching.