With rising competition and discerning buyers, it has never been more difficult for U.K. firms to increase or maintain their profit per equity partner (PEP). This pressure continues to plague firms, which are all too aware that a strong PEP figure helps them to attract and retain the best talent.

Across the U.K. top 50, average PEP remained largely static last year at £750,000. This represented no more than a 0.2 percentage point rise to 4.3 percent, and compares to 12 percent growth back in 2016-17.

Yet while there are a variety of ways a firm can look to boost PEP, the most efficient mechanism is perhaps more straightforward than firms currently think.

Revenue per lawyer

The most talked-about path to increase PEP is to focus on increasing revenue per lawyer (RPL). Firms can seek to achieve this growth in a variety of ways. This includes increasing worked hours and utilisation rates or realisation rates. While these levers can all boost a firm's RPL, the most potent lever is to simply increase rates. Increasing prices – which most often means increasing hourly rates – is the most rapid and straightforward path to increasing RPL.

During the last five years, average RPL across the U.K. top 50 has increased by 13 percent. Although having the appearance of a promising trend, this is counteracted by the fact that the rate of this growth has slowed. In fact, last year, average RPL across the top 50 firms grew by just 1 percent, marking the second successive year of slower growth.

An obvious reason behind this slowdown is the combination of headcount growth (with total footprint across the top 50 increasing by 8.5 percent last year) and sluggish revenue growth. Collectively, the former suggests that U.K. firms are experiencing a demand in legal services, while the latter indicates that this demand is not translating into meaningful revenue growth.

Reasons for this are varied. One possible explanation is client pushback towards rate increases. Firms don't have the same pricing power they once did. If the pricing power is weaker, it means firms could be doing the same amount of work (i.e. there is still the demand side) but it's not there on the revenue side. The growth in alternative fee arrangements and dwindling legal spend across in-house legal teams illustrate this.

Alternatively, another possible explanation is that the demand side is still there, but law firms are not capturing this demand – someone else is. This points towards wider changes that are currently occurring within the U.K. legal market, namely the increasing presence of alternative legal service providers and other market disruptors such as the Big Four. The vendor landscape has changed and as it has done so, it has fundamentally reshaped the options that clients now have.

U.K. firms appear to be being pressurised on the RPL side, which is consequently impacting upon PEP growth. Clients are pushing back, there are alternatives and there is more competition. This has led to difficulties in increasing rates and keeping utilisation high. This demonstrates the ongoing difficulties for firms in keeping RPL marching up at a rapid pace both in the now and also in the future as the legal landscape continues to evolve.

Cost per lawyer

The next path to higher PEP is to reduce costs. However, across the U.K. top 50, average cost per lawyer (CPL) has increased by 8 percent since 2014. This growth has derived from, among other things, associate salary increases, process improvements and aggressive lateral hiring activity. International growth has also played a part, with a number of firms increasing real estate overheads through the addition of international offices.

Encouragingly, last year marked the third successive year in which average CPL growth across the U.K. top 50 has slowed – an indication of the efficiency measures some UK firms have put in place to reduce their cost base. This includes investment in technology, low-cost service centres and office consolidation and withdrawal in unprofitable locations.

Even though CPL growth appears to be slowing, the figure is nonetheless still growing and for as long as it grows, it will continue to act as a drag upon PEP. A potentially worrying trend across the U.K. top 50 is the 8 percent growth rate of CPL during the last five years, in comparison to 13 percent RPL growth across the same period. Firms will want to make sure that the possibility of CPL growth outpacing RPL growth does not begin to present itself. It also raises ongoing questions over sustainability, particularly in the approach of firms in the lateral hiring market, in addition to associate pay hikes and higher headcounts.

Leverage reduction

The last path to boost a firm's PEP is to increase the firm's leverage, by either hiring more associates or shifting the structure of the partnership to include more non-equity partners and fewer equity partners.

The U.K. top 50 have complied with this to some extent, with the number of associates and non-equity partners increasing by 22 percent and 6 percent respectively. However, across the same period, the number of equity partners has grown by 12 percent. This has impacted upon overall leverage, which since 2014 has reduced by 3 percent. For the top 50 as a whole, leverage currently stands at 6.0 percent.

This trend continued into last year, with the number of associates and non-equity partners both increasing along with the number of equity partners. This continued to act as an impediment upon overall leverage, which declined by 2 percent. This decline, together with RPL slowdown and CPL growth, have collectively contributed to a subsequent slowdown in PEP.

Which is best?

Of the mechanisms relied upon to improve PEP, firms should arguably be placing greater emphasis on increasing leverage – certainly more than they currently are. As mentioned, seeking to rely on the alternative levers of RPL and CPL is likely to prove difficult. In the case of RPL, ongoing barriers include competition from market disruptors and shifts in demand share, while unavoidable investment in technology is one of a number of obstacles currently impacting upon the growth in costs.

Although increasing leverage has obstacles of its own, these can be more easily overcome than through seeking to overcome the obstacles associated with RPL and CPL. On the other side of the Atlantic, U.S. firms are currently ahead of the game, with a number already making use of leverage by tweaking their partnership models toward one of increased non-equity partners, while at the same time keeping equity ranks static. During the last five years, the total number of equity partners across the Am Law 100 has increased by just 2 percent, with the number of non-equity partners growing by 13 percent. This, together with a 9 percent increase in associate leverage, has contributed to a 19 percent uptick in PEP.

With firms needing to grow PEP to be competitive in the lateral hiring market for partner talent, increased leverage may be one of the few mechanisms firms now have that can easily be relied upon.

For a detailed breakdown of profit per equity partner (PEP) figures across the U.K.'s top 50 firms, as well as revenue, headcount and leverage figures see the full rankings available through ALM Intelligence's Legal Compass.