“History doesn’t repeat itself, but it often rhymes.” Usually attributed to Mark Twain, this quote might well describe the past few decades for middle market commercial law firms. We have moved from one “existential threat” to another, and so far, as a class at least, they have survived them all. But will that continue? Consider briefly the (relatively) recent history:
- In 1985 Steve Brill and The American Lawyer began publishing their “Top 50” (later 100, then 200) law firm financial rankings, arguably triggering material change in industry dynamics. For the first time, lawyers could readily compare their own firms’ performances with those of other firms. This became a (gradual) trigger for increased lateral movement in the industry, and pressure on lower performing firms trying to keep their top people in the ranks. For some, this meant mid-market firms were inevitably doomed. Some failed, and some continue to do so, but as a class, these firms continue strong.
- The late 1980’s and into the 1990’s saw a rise in law firm combinations, a trend which also continues strong today. Despite headline-making big firm combinations, most “mergers” in the legal industry were, and are, acquisitions of smaller firms (usually much smaller) by larger firms. And on queue, a group of pundits and consultants made names for themselves predicting the end of midsize law firms. They were wrong – but left a bad taste for consultants that lingered for years.
- The “coming of the accounting firms” in the late 1990’s was the next coming crisis for the middle-class law firms. This ended, of course, with the Enron debacle and the collapse of Arthur Anderson. The accounting world pulled away from law, at least in the US. The middle market firm survived unscathed.
- The Great Financial Collapse of the 2009-2010 period next threatened the mid-market. The pressure was on everyone, but with major Wall Street firms undercutting mid-market firms everywhere for middle market deal work, many wondered about the ability of these firms to survive. They did, of course.
- Covid came and threatened everyone, but all assumed the “rich firms” would survive. Most mid-size firms pulled in their reins as much as possible. Coming out of Covid, mid-size firms found themselves under a talent siege, with big firms routinely offering their younger lawyers $50-100,000+ more to jump ship. Many did, and midsize firms were forced to pay more to keep people. They lost good talent, but they are still here. And some of the talent has returned – the grass isn’t always greener.
The middle market has proven remarkably resilient. But through all of this, the relative position of the middle market has changed. For most of the past 15 years at least, we have seen a major divergence of economic performance between “Big Law” and the Middle Market. While Big Law revenue per lawyer and profits per equity partner have grown dramatically, significantly outpacing inflation, mid-market firms have basically kept pace with inflation (though they have done a little better the last couple of years.). This has created a major economic separation between Big Law and the mid-market.
Today we face the next “existential crisis”. Several forces are in play, and all are exacerbated by the economic gap noted above:
- AI is rapidly changing law, a trend that will only accelerate. It will not be enough just to buy a few off-the-shelf products and say, “we’re an AI powered firm.” The successful firms will need to learn how to truly incorporate AI in their practices, build its use into their culture and think radically differently about how they operate their firms. The implications for pricing, compensation, training and development and everything else are significant. But beyond that, there is a cost and capabilities component here. Don’t put it past the rich deal firms to build new bespoke AI-powered tools designed to capture much of the work that currently flows to mid-market firms for better pricing. What if the cost differential between big-law and the mid-market shrinks or disappears, allowing big law to price to capture market share?
- Talent demands are changing, and the future is unclear. The need for “trusted advisors” and high-judgement senior lawyers is likely to continue, but where will the supply of those folks come from if the pipeline of high-end younger lawyers is constricted by AI-driven efficiencies? Will the middle market be able grow the next generation and keep the key people it has?
- Add in the wild card of Private Equity and outside capital generally, and the question marks grow for the middle market. So far, only a few deals have been consummated, and most of the activity has focused on specialty (such as PI) and generally smaller firms. Most mid-market firm leaders report little interest in the concept, and the investors have not yet presented a compelling case (to most). But the amount of capital available and interested in the space is huge, and the business case will likely appeal to some. It’s possible the ultimate business case will include giving the firm the capital to fully capture the benefits of AI, in addition to providing material financial benefits to the people the firm needs to keep. It would only take one or two high-profile commercial firm deals to open the gates to more activity.
- We also can’t rule out the reemergence of interest in the middle market from major accounting and other professional service firms. Some of these are already well-positioned to capture the benefits of AI and have significant capital of their own to back the entry. Combine those attributes with significant brand power, and you have a potentially compelling market story.
Will these new dynamics truly prove an “existential threat” to the middle market? Most likely not. However, they are significant enough to force middle market firms to rethink how they do – basically everything. It is no longer enough to say “we’ll be OK if we just do a X, Y and Z.” The successful middle market firms of the future will be those who rebuild their business models for success in the new world. This will mean changes to governance, to practice, to pricing and client relationships, to compensation models, and to talent acquisition, management, development and engagement, among other things. “We’ve always done it this way” will no longer be an acceptable objection to new approaches. Inertia-burdened cultures will be particularly pressed, and survival for them might involve some difficult decisions.
The conditions we see are unlikely to be an existential threat to the middle market generally, but they could well be an existential threat to more than a few middle market firms. As in past crises, we will see some firms who simply can’t change enough to survive. There have been a few material law firm failures already in the last few months. There will be more, and there will be the hidden dissolutions that pose as “mergers” of firms, with acquiring firms taking advantage of weakness to acquire talent, revenue and clients. Many middle market partnerships don’t want to be acquired – until they have no choice. The better path, as always, is to assure you have control over your own destiny. As leaders, be prepared to embrace material change. More importantly, prepare your partnerships for change – before specific change is forced upon you.
Middle-market firms as a class will likely survive – make sure your own firm can be one of them!
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