Small and mighty

small and mightyThe government may want to hand out criminal legal aid contracts to fewer, bigger firms, but smaller practices with lower overhead costs are arguably in a better position to survive the planned 17.5 per cent cuts, argues David Gilmore.

  •  A version of this article appeared in Solicitors Journal, November 12, 2013

There are around 1,600 law firms providing legal aid services in the crime category, according to the Ministry of Justice’s Transforming Legal Aid consultation. It is often stated by many commentators that this is far too high a number.

Everyone agrees that there isn’t as much work as there used to be. Crime, according to the Home Office, is falling although many practitioners say that this is because the police prefer to issue cautions rather than charge people for cases which are deemed not to be very serious. The fall in demand for criminal legal advice has led some to question whether we really need so many firms, especially small ones.

There are many stakeholders who take the view that market consolidation must happen.

The Ministry of Justice would prefer to deal with a much smaller number of larger firms in order to reduce transaction costs. The Big Firms Group, an alliance of larger crime law firms, is naturally very keen for the number of providers to fall. Even the Law Society have controversially come out in favour of market consolidation.

In ‘Transforming Legal Aid: Next Steps,’ at Para. 3.35, the Ministry of Justice states:

“We note that an indicative analysis set out in a report by Otterburn and Ling, supplied by the Law Society in response to previous consultation, suggested that three hypothetical organisations operating across the proposed CJS procurement areas would have a better chance of sustaining their business after a 17.5% reduction in fees, if they have an annual turnover in excess of around £1m (including VAT ).”

At Para. 229, the paper again refers to the work carried out by Otterburn and Ling:

“With regard to the proposed reduction in administrative fees by 17.5%, we acknowledged in the April 2013 consultation paper that the current provider base would not be able to sustain such a fee reduction without some form of market restructuring and consolidation. Some providers have indicated they would be able to sustain such a fee reduction if they had enough work in order to exploit economies of scale. The Otterburn report provided by the Law Society in its response supports this view. If it is possible to deliver the same quality legal aid services as now at 17.5% below the current price, the Government believes that it is self-evident that the current system is not delivering the best value for money for the taxpayer.”

The clear implication here is that larger firms are in a better position to survive because of economies of scale. This all seems like common sense. As a firm grows, it is able to achieve economies of scale through lower costs. Therefore it would seem obvious that firms that achieve turnover in excess of £1m are better placed to withstand a cut in remuneration of 17.5 per cent.

Doubtful theory
However, in the world of criminal legal aid, as of 2013, it is highly doubtful whether the theory of economies of scale actually applies.

It should be noted that the references to Ling and Otterburn by the Ministry of Justice were apparently taken out of context. Andrew Otterburn has written to the Ministry to clarify that their view was that fees of in excess of £1m were needed as under the previous proposals the contract values were too small relative to the number of custody suites and courts being covered to be financially viable. Their comments should not be applied to say that larger firms will find it easier to sustain cuts.

There is evidence though to demonstrate that smaller firms may be more profitable than larger firms. In 2009, the National Audit Office (NAO) instructed GfK NoP, one of the country’s largest polling/survey companies to carry out a survey of criminal legal aid firms. According to the report published: “The NAO wanted to evaluate current working practices on criminal legal aid, aspects of the way the LSC administers the criminal legal aid fund, and the impact of fee changes on firms.”

In the report’s conclusions, among other things, it is stated that: “Larger firms [those with 13 to 40 solicitors] tended to experience the lowest profit margins from criminal legal aid work… Higher overhead costs and less specialism in criminal legal aid work among larger firms may have accounted for this difference.”

I feel certain from experience that the higher overhead costs is the explanation. This is our experience from visiting hundreds of law firms over the past 13 years.

Smaller firms can be more viable than larger firms because in contrast to the ministry’s view, diseconomies of scale are more likely to apply to crime law firms as they grow. A larger firm will often spend a greater proportion of its income on expensive overheads such as software, training and premises compared with a sole practitioner or smaller firm.

Prudent choices
There is an element of choice when it comes to the cost of purchasing ancillary services. Smaller firms tend to be especially prudent when purchasing ancillary services.

Up until a few years ago, CPD training was mainly quite expensive across almost all recognised training providers. Now, many prefer to purchase very low cost webinars or attend free CPD accredited seminars offered by non-training organisations such as barristers’ chambers and software companies. I am not suggesting that purchasing very low cost training is necessarily desirable but many will see such decisions as inevitable in a future low-cost landscape.

Some are questioning whether they can afford time recording or case management software.

Typically, when rented, the licence charge per user is around £55 per user per month. Some have attempted to get by through using very low cost Access database or even an Excel spreadsheet. We know from experience of building databases and spreadsheets for law firms that it is possible to meet all of the current Legal Aid Agency contractual I.T. requirements by using these very low cost alternatives. Despite this, I do not think that using spreadsheets or Access databases is the future.

Valuable management information reports generated by case management systems should justify the investment. I believe that the market price for case management software will likely fall as demand for software reduces following a reduction in the number of firms operating.

Larger law firms also usually have good or very good premises. In order to accommodate significant numbers of staff and because of a desire to attract high quality staff, such firms often do not economise on the quality of their premises.

Further, larger firms often prefer to be based in a central but expensive part of the city. For example, Tuckers Solicitors have offices in central London, Manchester and Birmingham. Small firms are happy to operate from the suburbs.

Crossing over to the Bar, barristers chambers are examining their overheads as the legal aid cuts start to bite. Tooks Chambers was dissolved in October as they could not continue to make work their traditional model work of charging tenants a fee equivalent to 22% of their income. However, this chambers plans to resurrect itself as a smaller lower cost virtual chambers using free open source software. There are other large sets of chambers rumoured to be in trouble.

Small and viable
So, the market is showing us that being small does not mean being unviable. This is why we have so many crime law firms operating in the market.

Despite the economics, the government is keen on removing viable small firms. They want to remove small firms from the duty solicitor equation by distorting the market through only contracting with larger entities. They have not made their mind up how many firms should get duty solicitor contracts but the next steps consultation paper suggests that following on from the research carried out by Ling and Otterburn, a starting point is to consider offering no more than 570 duty solicitor contracts.

It appears likely that the only way in which a small firm can survive is by joining a consortium. Own solicitor contracts can only keep firms going for a limited amount of time. It is this modus operandi which frightens sole practitioners more than pay cuts.

Creating and managing consortia is an incredibly difficult task. Along with Matthew Howgate and Vicky Ling, I advised multiple citizens advice bureaux in 2010 about consortia.

The 2010 debt-with-housing contracts made the employment of housing litigators mandatory, forcing bureaux to either employ solicitors or to enter into consortium arrangements with Shelter or firms in private practice. We found that it was very challenging to agree on a set of ‘membership rules’.

I am sure that sole practitioners and small crime firms will struggle with consortia. They will find it hard to match up with firms that work in very similar ways. They will struggle to agree on a set of ‘membership rules’ in the knowledge that just one participant could bring down the whole consortium. They will find it challenging to overcome potential stumbling blocks such as work allocation, electronic working, audits and so on.

So, which firms will survive the 17.5% pay cut? Geography plays a part given that nationalising the fees means that the London and South East practitioners are disproportionately affected. However, I would not be surprised if the Ministry of Justice performs a U-turn and reverts to regional fees.

But putting to one side the geography issue, it is the small firms that will find it easiest to survive if these draconian cuts are implemented. Small firms also have the added advantage that it is easier, quicker and cheaper for them to adapt to changing market conditions. They will just need to consort if they wish to retain duty solicitor work.

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