1、Equity Research Global ServicesFebruary 7, 2019 Timothy McHugh, CFA+1 312 364 8229 HYPERLINK mailto:tmchugh tmchughSignificant Changes to Legal Industry Creating New Growth Opportunities Trevor Romeo, CFA+1 312 801 7854 HYPERLINK mailto:tromeo tromeoPlease refer to important disclosures on pages 30

2、and 31. Analyst certification is on page 30. William Blair or an affiliate does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. This report

3、is not intended to provide personal investment advice. The opinions and recommendations herein do not take into account individual client circumstances, objectives, or needs and are not intended as recommendations of particular securities, financial instruments, or strategies to particular clients.

4、The recipient of this report must make its own independent decisions regarding any securities or financial instruments mentioned herein. Pace of Change in Legal Sector Is AcceleratingOur report from January 2011 titled Legal Services: Spending Pressure and New Regulations Creating Growth Opportuniti

5、es for Ancillary Providers argued that the legal services industry would see significant changes as a result of new regulations, alternative business models, new competitors, technology advancements, increased visibility to billing rates and spending at corporate legal departments, and spending pres

6、sure from corporate general counsels. Changes to the industry have admittedly been modest thus far. In general, law firms continue to perform well under their traditional operating and billing models. Still, we have seen growing signs during the last one to two years that the legal industry is begin

7、ning to undergo significant changes.In this report, we provide an overview of todays legal services industry, review the key challenges facing law firms, and discuss the reasons why the industry is changing. We then spend the bulk of the report looking closely at 10 changes/trends that we see occurr

8、ing in the legal services and technology sector. We highlight specific companies and contracts in each section that demonstrate the trends. The 10 changes/trends that we discuss are as follows:On-demand labor platforms are growingLarge-scale outsourcing/managed services are becoming more common 3. C

9、ontract management is gaining traction4. Intellectual property management is changing 5. Alternative law firms are emergingBig Four accounting firms are becoming more important competitorsAI, natural language processing, and automation are not just buzzwordsElectronic discovery technology is focused

10、 on the cloud and end-to-end solutions 9. Electronic discovery services continues to consolidate10. Court reporting and legal support is consolidatingThe size of the legal industry means that its transformation could create significant growth opportunities for numerous companies. Consistent with tha

11、t, we see a significant amount of capital flowing into alternative legal services providers and legal technology companies. We identify throughout this report more than $10 billion of investment in this sector by financial sponsors during the last few years. There is a limited set of investable ways

12、 right now for public equity investors to meaningfully participate in the trends outlined in this report, but these trends are somewhat relevant for some information services companies (e.g., Thomson Reuters TRI $52.88, Clarivate Analytics, RELX Group RELX $22.37, Wolters Kluwer WKL-AMS 55.30), tech

13、nology companies, and consulting firms (e.g., FTI Technology FCN $68.20; Market Perform). We also expect that there will be more investable assets in the future. We thus believe that public equity investors should monitor the changes taking place in the legal sector.Overview of the Legal Services In

14、dustryBefore we address how the legal industry is changing, we believe it is helpful to provide an overview of the sector. The legal services industry is very large. The U.S. legal services industry is estimated to generate $290 billion in annual revenue. There are about 50,000 law firms in the Unit

15、ed States, so the industry is highly fragmented. The top 20 law firms generated about 5% of the industrys global revenue. Large firms include Kirkland & Ellis, Latham & Watkins, Baker McKenzie, DLA Piper, and Skadden (Skadden, Arps, Slate, Meagher & Flom). The market share of large law firms is smal

16、l even when we look at only revenue from the top 100 law firms. The following exhibit illustrates the market share of the top 20 law firms in 2017. While the law firms shown below provide a broad set of services, many smaller law firms specialize in specific areas of law, such as criminal law, corpo

17、rate law, family and estate law, patent law, real estate law, securities law, or tax law.Global Law Firms 2017 Market Share of Top 20 Firms Firm Share of Top 100 Share of Global Market Kirkland & Ellis 2.99% 0.37% Latham & Watkins 2.89% 0.36% Baker McKenzie 2.74% 0.34% DLA Piper 2.49% 0.31% Skadden,

18、 Arps, Slate, Meagher & Flom 2.44% 0.30% Dentons 2.23% 0.28% Clifford Chance 1.97% 0.25% Sidley Austin 1.92% 0.24% Hogan Lovells 1.92% 0.24% Allen & Overy 1.91% 0.24% Morgan, Lewis & Bockius 1.89% 0.24% Linklaters 1.85% 0.23% Jones Day 1.85% 0.23% Norton Rose Fulbright 1.85% 0.23% Freshfields Bruckh

19、aus Deringer 1.71% 0.21% White & Case 1.70% 0.21% Gibson, Dunn & Crutcher 1.55% 0.19% Ropes & Gray 1.51% 0.19% Greenberg Traurig 1.39% 0.17% CMS 1.38% 0.17% Source: The American Lawyer Global 100 In addition to external spending, corporations spend a significant amount on their internal legal depart

20、ments. The exhibit below shows the results of an annual survey by the Corporate Legal Operations Consortium (CLOC). Internal staff represents almost 40% of the legal budget for corporations, and most large corporations are spending almost $200 million in total on legal services (external and interna

21、l).Corporate Legal Departments Various Metrics Based on 2017 CLOC Survey Small Companies Revenue Midsize Companies Revenue Large Companies Revenue $10 billion Average Total Legal Spend ($ in millions) $5 $40 $185 Average External Spend ($ in millions) $3 $25 $115 Average Internal Spend ($ in million

22、s) $2 $15 $70 Average Legal Spend as % of Revenue 1.24% 1.24% 0.55% Average Lawyer Headcount 9 41 188 Average Legal Ops Headcount 1 6 21 Source: Corporate Legal Operations Consortium After including $160 billion of spending within corporate legal departments, Thomson Reuters estimates that the total

23、 U.S. legal services market is close to $450 billion. The United States is the most litigious country globally (accounting for about half of the global market), but the legal industry is still large outside the United States. The Business Research Company estimates that the global legal services mar

24、ket was $849 billion in 2017 and is expected to grow to over $1 trillion by 2021.Geographic Breakdown of Legal Services Industry by Market Value Asia-Pacific 8.4%Rest of World 10.5%Europe 31.6%United States 49.4% Source: Market Research Industry Continues to GrowThe legal services industry has consi

25、stently grown during the last few decades because of the growth in litigation and regulations and strong capital markets activity. According to Statista, the U.S. legal services industry has grown at a low-single- digit rate in most years since 2009, with a compound annual growth rate (CAGR) of 2.2%

26、 from 2009 to 2018, as shown in the first exhibit below. Statistas forecast assumes that 2% growth in the United States continues in 2019.$350$300$250Legal Services Industry Revenue in the United States ($ in billions) $278$283$288$294$245$237$240$248$253$257$268$273-3%1%3%2%2%4%2%2%2%2%2%15%10%$200

27、5%$150$1000%$50$020082009201020112012201320142015201620172018E2019E-5%U.S. RevenueGrowth %Source: Statista $1,200$1,000$800$600$400$200$0Legal Services Industry Global Market Value $968$1,011$886$925$815$849$724$747$7863%5%4%4%4%4%5%4%($ in billions) 201320142015201620172018E2019E2020E2021E10%9%8%7%

28、6%5%4%3%2%1%0%Global RevenueGrowth %Source: Statista Consistent with the data above, the number of lawyers in the United States has grown at a low-single-digit pace. The exhibit below illustrates growth in the total U.S. labor force for legal service professionals (i.e., active attorneys) since 2000

29、, according to the American Bar Association. The number of attorneys has grown between 0% and 3% in each year since 2000, with growth of 0.9% in 2016, 1.8% in 2017, and 0.2% in 2018.Number of Active Attorneys in the United States (unit in thousands) 1,3391,6001,4001,2001,00080060040020002000 2001 20

30、02 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018Source: American Bar Association. While the overall legal industry appears to be growing at a low-single-digit pace, revenue growth has been stronger than that for large law firms. The exhibit below shows the most rece

31、nt revenue growth rates disclosed by the top 20 law firms. HBR Consultings Law Department Survey notes that 81% of companies that it surveyed saw an increase in their legal needs in 2018, and total legal spending grew 5% year-over-year. The Citi (C $63.89) Hildebrandt Client Advisory Survey of the t

32、op 50 law firms showed 6% revenue growth, 4% bill rate growth, and 3% demand growth in the first nine months of 2018.Global Law Firms 2017 Revenue Revenue Equity Revenue Profits Firm Revenue Growth Lawyers per Lawyer Partners per Partner per Partner Kirkland & Ellis $3,165 19% 1,997 $1.585 388 $8.16

33、 $4.701 Latham & Watkins $3,064 9% 2,436 $1.258 477 $6.42 $3.246 Baker McKenzie $2,900 9% 4,723 $0.614 701 $4.14 $1.440 DLA Piper $2,634 7% 3,609 $0.730 404 $6.52 $1.757 Skadden, Arps, Slate, Meagher & Flom $2,582 3% 1,784 $1.447 361 $7.15 $3.471 Dentons $2,360 7% 8,658 $0.273 1,474 $1.60 $0.541 Cli

34、fford Chance $2,092 0% 2,174 $0.962 392 $5.34 $2.140 Sidley Austin $2,036 6% 1,873 $1.087 343 $5.94 $2.260 Hogan Lovells $2,036 6% 2,685 $0.758 556 $3.66 $1.283 Allen & Overy $2,028 4% 2,293 $0.884 389 $5.21 $2.214 Morgan, Lewis & Bockius $2,001 8% 1,943 $1.030 717 $2.79 $1.368 Linklaters $2,057 5%

35、2,305 $0.892 440 $4.68 $2.077 Jones Day $1,959 -1% 2,513 $0.780 948 $2.07 $1.009 Norton Rose Fulbright $1,958 16% 3,339 $0.586 714 $2.74 $0.860 Freshfields Bruckhaus Deringer $1,894 10% 1,955 $0.969 392 $4.83 $2.354 White & Case $1,804 11% 2,039 $0.885 319 $5.66 $2.260 Gibson, Dunn & Crutcher $1,643

36、 2% 1,275 $1.288 313 $5.25 $3.240 Ropes & Gray $1,597 8% 1,162 $1.374 259 $6.17 $2.315 Greenberg Traurig $1,477 7% 1,944 $0.760 298 $4.96 $1.634 CMS $1,531 31% 3,558 $0.430 598 $2.56 $0.775 Total/Average $42,820 8% $0.930 $4.792 $2.047 Sources: Company documents, AmLaw, and various internet sources

37、Litigation spending at large corporations also increased in 2018. After several years of decline, litigation spending by large corporations grew 2% in 2017 and 9% in 2018, according to BTI Consulting. BTIs research does not encompass the entire corporate landscape (it is based on a survey of large c

38、ompanies with at least $1 billion in revenue), and it reflects only one aspect of legal spending (litigation), but it provides some insight into the litigation spending tendencies of the largest companies. According to BTIs report, complex litigation and investigations drove stronger growth in spend

39、ing in 2018.Litigation Industry Litigation Spending by Large Companies in the United States ($ in billions) $22.3$21.5$21.4$20.9$20.6$20.2$19.7$19.4$19.4$22.5$22.0$21.5$21.0$20.5$20.0$19.5$19.0$18.5$18.0$17.5201120122013201420152016201720182019ENote: BTI research includes large companies with at lea

40、st $1 billion in revenue Source: The BTI Consulting Group Lastly, we note that large information and software providers are sustaining steady, albeit modest, growth. Thomson Reuters, Wolters Kluwer, and RELX are the dominant providers of information solutions for the legal industry. After the sale o

41、f its financials and risk segment to Blackstone, we note roughly 50% of Thomson Reuters revenue is generated by law firms and corporate legal departments. These three businesses have strong market positions, subscription business models, and high renewal rates. As shown in the exhibits below, while

42、revenue growth is not particularly high, each of these companies is steadily growing revenue, helped by growth in software and analytical solutions. At its investor day in December 2018, Thomson Reuters said that it expected its legal professionals segment to grow at a 3%-4% pace during the next few

43、 years, with lower growth in legal research solutions and faster growth in software solutions.Legal Information Services Industry Year-Over-Year Organic Revenue Growth 5%3%1%8%6%4%2%0%-2%-4%-6%Wolters Kluwer Legal Services (Governance, Risk & Compliance Segment)Wolters Kluwer Legal & Regulatory Segm

44、entThomson Reuters Legal Segment1Q152Q153Q154Q151Q162Q163Q164Q161Q172Q173Q174Q171Q182Q183Q18Source: Company documents RELX PLC Year-Over-Year Organic Revenue Growth of Legal Segment 2%2%2%2%2%1%1%3%2%2%1%1%0%1H152H151H162H161H172H171H18Source: Company documents Pressure on Traditional Business Model

45、 and RevenueThe trends mentioned above suggest that the legal industry, particularly the top end of the sector, is healthy and growing. On the surface, large law firms are seeing strong growth and high revenue per partner. Most law firms also continue to enjoy a relatively stable business model and

46、pricing environment. We believe, however, that there are a variety of pressures building on this industry. We highlight eight factors in the section below.First, corporate legal departments are being run more like a business. CLOC frequently uses the exhibit shown below in its materials to summarize

47、 how the approach to running corporate legal departments has changed. In the past, the cost of legal services was accepted by corporations and individuals as a sunk cost of the legal process that they cannot control. We believe this is no longer the case. We believe this change is partly reflected i

48、n the growth of legal operations professionals within large corporations. We note that attendance at CLOCs annual industry conference jumped from 500 people in 2016 to 1,000 in 2017 and 2,000 in 2018. The Association for Corporate Counsel (ACC) also has seen significant growth in its legal operation

49、s group during the last few years. As we showed earlier, legal spending often represents about 1% of revenue for companies.Companies are recognizing that this is an important part of expense management. We also believe that some corporations are increasingly trying to use their legal operations as a

50、 competitive advantage, i.e., the efficiency of reviewing new sales contracts, patent and trademark management, and risk analysis.Changes in the Legal Department Pre-1990Focus on Risk Management Fewer complex issuesServe as manager of outside counsel with limited cost pressure1990Mid 2000sStrategic

51、Insights More complex, regulated, international issues Heavy use of outside counsel with some sensitivity to costMid-2000sToday Trusted Advisor Highly complex issues - both legal and business Strategic use of outside counsel with emphasis on cost control Source: Corporate Legal Operations Consortium

52、 (CLOC) Second, alternative pricing arrangements continue to become more common. Fixed fee arrangements were common throughout the legal profession in the 1950s and 1960s, but since then the traditional business model in the legal services industry has been governed by the use of billable hours (or

53、time and materials billings). Per-hour billing is the preferred method of billing when the length of project or assignment is unpredictable, which is often the case in litigation. However, it also creates an incentive for service providers to be inefficientthe longer it takes a law firm to complete

54、a project, the more revenue it generates. The use of value-based billing, in which fees are established based on the value of the particular service to the client and what the client is willing to pay, is growing. One of the leaders in this trend has been Cisco, which requires all of its outside att

55、orneys to work under two alternative billing arrangements: routine work is bid out at a fixed fee and more complex matters are billed out based on a monthly fee and a potential incentive fee. Microsoft (MSFT $106.03; Outperform) announced in mid-2017 that it planned to have 90% of its outside counse

56、l work priced on a fixed-fee basis by 2019.GlaxoSmithKline (GSK-LON 15.48) employs fixed-fee reverse auctions for any legal matters with anticipated costs over$250,000. Only 3% of the outside legal spending at GlaxoSmithKline came under an alternative billing arrangement in 2003, but that number inc

57、reased to 68% by 2011 and 84% by 2015. Shell (RDSB-LON 24.89) announced in late 2016 that it was shifting all of its legal spending to alternative fee arrangements. Lastly, large companies such as Toyota (7203-TKS 6703.00), Accenture (ACN $157.16; Outperform), eBay (EBAY $35.48), and Oracle (ORCL $5

58、1.26; Market Perform) are known to actively use reverse auctions to procure legal services.Third, data and pricing transparency is increasing. Risk aversion throughout the legal sector and fragmented decision-making about the use of outside legal services historically meant that there was relatively

59、 limited scrutiny of legal spending, at least relative to what we see in most other parts of the professional services sector. The global recession forced many executives and general counsels to start scrutinizing their budgets and demand more value from legal service providers. Given thispressure,

60、we are seeing growth in tools and services that provide increased visibility to corporations with regard to their legal spending. We believe that corporations are increasingly embracing legal spend management software to provide greater visibility into their legal spending and automate invoice recon