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Managing Partner Forum Boutique and Small Firms

The Path to Survival August 2015

Contents

• Central theme

• Biggest business changes ever seen

• Everything up for grabs

• No one is safe

• What will happen to law firms

• And how fast

• Examples of business model disruption

• IBM Watson

• Clip on cancer patients

• Visit Harvard Law School website

• Why is this happening so fast now?

• What might change in legal practice, given these changes?

• Analysis of legal market

• Possible strategies to survive

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Central Theme – How Do Law Firms Survive and Prosper?

We are in the early stages of the most significant changes to businesses of all kinds we have ever seen in human history

These changes have, are and will affect how we work, where we work and how we live our lives

The legal profession is grappling with all the changes that come from now participating in a fully competitive market

On top of these changes are all the digital transformations to business models that are sweeping the world

How much of these changes will impact law firms – and how fast?

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Examples of Business Model Disruption

• The impact of Seek, Realestate.com and Carsales.com on Fairfax

• Google driverless car

• Google Loon

• Google wallet

• Tesla electric cars

• Tesla batteries

• Netflix

• iBooks

• Bitcoin

• Apple music

• Apple iPad and iPhone

• Airbnb

• Uber

• Drones

• Internet of things

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Waves of Digital Disruption

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1995+

Music Photography Video Rental …

2010+

Print Media TV Travel HR …

2015+

Banking Healthcare Automotive Retail Education Telco Legal?? …

2020+ All safe havens will be subject to digital disruption …

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No One Is Safe

Average Company Lifespan on S&P 500 Index

• Technology

• All the world’s media and information is online

• Mobile devices can access this information and anyone anywhere at anytime

• Cloud computing puts a super computer in your pocket

• Focus on problems that need solving

• Unutilised capacity - examples

• Cars

• Houses

• House roofs

• House walls

• People

• Lower cost

• Better service

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Drivers of Business Model Changes

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• Fairfax 20% • REA 18 times • Seek 5 times • Carsales 2.5 times

• Google driverless car has now done over one million miles with limited issues in USA

• If this takes off - what does that do to the:

• Ownership of cars

• Taxi industry

• Car insurance business

• Car repair business

• Spare parts business

• Design of roads/bridges

• Apparently we would only need 15% of the cars in the world

• Car park industry

• Climate change debate

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Google Loon – 4G broadband to remote areas globally

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Electric Cars

• Tesla’s all-wheel drive Model S P85D is capable of running on autopilot by using cameras and ultrasonic sensors to read speed limits, monitor other cars on the road and park automatically

• 25% running and maintenance costs compared to petrol engines • Even less cost if tap into your own solar energy • Very quiet and very smooth • Faster than Ferrari – in “insane” mode • No pollution • What does this do to the oil industry? • What does this do to the petrol station operators?

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Batteries that capture solar energy

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Batteries that capture solar energy

• House roofs sprayed with photovoltaic cells that turn the roof into a solar capture engine

• Walls made of Tesla batteries that capture this energy • Energy used to

• Recharge electric car batteries • Power the house • Arbitrage peak and off-peak tariffs

• What does this do to the power generation and distribution businesses?

• What does this do to coal powered generation pollution?

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People on Mars

There are no boundaries to some people’s imagination

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Goodbye Foxtel as we Know it?

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Goodbye Book Publishers and Retailers?

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Bitcoin is an innovative payment network and a new kind of money – driven by an amazing platform called blockchain

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Is Killing the Notebook

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Internet Anytime Anywhere

How iPhone Changed the World

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• 45 million tracks • $10 per month • Available on any device anywhere

• What did a CD with 10 tracks on it used to cost?

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The Day is Coming When No-one Will Buy Physical CDs

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Factors Driving Growth of Uber

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They are not looking for Great Ideas

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They are looking for Great Problems (that need solving)

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The Rise of the Chief Digital Officer

Ief Digital Officer

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Drones

• The solar-drones, which can reportedly stay airborne for five years, would act as movable wireless access points

• Drones could allow businesses to deliver products to customers without having to send a driver

• Huge, expensive news helicopters might not be the standard for much longer. Drones equipped with cameras can fly lower and into smaller areas than larger manned aircraft

• Large-scale farmers utilize aerial views from drones to monitor crop growth • Drone-aided search and rescue missions have been adopted by law enforcement across

the country • Rio is trialling drones in a number of mining applications in remote locations • Drones are monitoring infrastructure such as power facilities, ports and pipelines

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Internet of Things

• Factories — data from different types of equipment used to improve line efficiency • Cities—video, cell-phone data, and sensors used to monitor traffic and optimize flow • Retail—payment and item-detection systems linked for automatic checkout • Work sites—worker- and machinery-location data used to avoid accidents • Vehicles—equipment-usage data used in presales analytics and insurance underwriting • Agriculture—multiple sensor systems used to improve farm management • Outside—inventory levels monitored at various stages of the supply chain

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IBM Watson

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Why is This Happening So Fast Now?

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Start teaching your kids to code

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Who thinks law firms will be immune from all these forces at work?

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Who thinks

This is a now issue?

This is 5 years away?

This is 10 years plus away?

This is 20 years plus away?

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What Might Change in Legal Practice, Given These Technologies?

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% of revenue Great Good OK ?

Revenue 100 100 100 100

Lawyer Rem 20 25 25 25

Overheads 30 35 40 >45

Margin 50+ 40 35 <30

Leverage 4 3.7 3.4 <3

Utilisation 80+ 75 65 <55

Fee multiple 4+ 3.8 3.5 <3

Leverage under attack Fee rates under attack

Work volumes declining Margins declining

What Might Change in Legal Practice, Given These Technologies?

• Work that can be done by a machine – will be eventually:

• Discovery in litigation

• Already happening

• Due diligence in M&A

• Already happening

• Routine commodity type work – leases, mortgages etc

• Already happening

• ROSS Intelligence, which is making headlines for its novel application of the IBM Watson machine learning platform to legal research, has been hard at work training the system to understand law

• Legal OnRamp Uses IBM Watson to Analyse Contracts - today

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What Might Change in Legal Practice, Given These Technologies?

• This means that law firms:

• Leverage ratios will drop to below 2 over time

• Will increasingly focus on the high value work – which will never be replaced by a robot

• Will need to build a different pricing system for value added work

• Will need to slash their costs

• Employment costs will drop to below 20% of revenue as leverage drops

• Overhead costs will be dramatically reduced

• Premises costs for major law firms are nearly 10% of revenue

• Accenture’s premises costs are .7% - 15 times lower

• People will be able to work anywhere

• Partners will be on the tools full-time – as are strategy consulting firms

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Analysis of Legal Market

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So what do we do about this?

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Top 10 Firm National Market Shares – Top 4 Firms

Market Share % 1st 2nd 3rd 4th

B&F 16 15 14 12

Corporate 13 12 12 11

Tax 21 16 16 16

Competition 20 14 11 9

Construction 18 14 12 11

Property 13 13 12 12

PELG 20 17 12 11

IP 16 13 13 10

Technology 19 13 11 10

Litigation 19 13 11 10

Workplace R 23 17 13 11

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0.0%

10.0%

20.0%

400 900 1,400

FIR

M M

AR

KE

T S

HA

RE

%

PROFITABILITY PPEP $000

Relationship Between Market Share and Profitability

Total Legal Market Size

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Practice Group Revenue

$Mill Biggest 9 Firms Next 45 Firms Total Market

Banking & Finance 460 319 779

Competition 112 68 180

Construction 214 238 452

Corp Advisory 872 497 1389

General Litigation 605 951 1556

IP 155 102 257

Planning 151 134 285

Property 192 289 481

Tax 162 77 239

Technology 77 79 157

Workplace Relations 223 249 472

Other 0 144 144

Total 3223 3147 6370

Number of Firms with Scale – Out of 45 Firms

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Practice Group Market Share > 10% > 5%

Banking & Finance 1 4

Competition 1 5

Construction 0 9

Corp Advisory 1 6

General Litigation 0 5

IP 2 5

Planning 2 6

Property 1 6

Tax 2 5

Technology 2 4

Workplace Relations 1 5

Total 0 5

What Does This Data Tell Us?

• The legal market below the top 10 is very fragmented

• Many of the top 10 firms have achieved a 20% market share in specific practice groups – and have been in that position for generations

• There are only 1 or 2 firms in the next 50 that have a market share of 10% in each practice group

• There is no firm that has a 10% market share across all practice groups

• This market will need to consolidate – because:

• The long term winners have significant market shares

• This scale gives financial power to invest in technology, systems and people

• This scale usually produces greater quality

• This greater quality attracts both clients and lawyers – which fuels the virtuous circle

• You only need to look at all other professional services businesses globally to see what has happened over the past 20 years

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What Does This Data Tell Us?

• There are a number of areas of potential increased focus:

• Employment law - $500 mill national market

• The top 10 firms will exit this market over the next 5 to 10 years

• Who could become a $100 mill national powerhouse in this market?

• Litigation - $1.5 bn national market

• There will always be room for good litigators

• Who could become a $150 mill powerhouse in this market?

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What Does This Data Tell Us?

• There are a number of areas of potential increased focus:

• Employment law - $500 mill national market

• The top 10 firms will exit this market over the next 5 to 10 years

• Who could become a $100 mill powerhouse in this market?

• Litigation - $1.5 bn national market

• There will always be room for good litigators

• Who could become a $150 mill powerhouse in this market?

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Then there is a different equity structure

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Slater & Gordon (A$/share) S&P/ASX 200 (indexed)

A$/share (indexed to Slater & Gordon)

Possible Strategies to Survive

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Strategies to survive

• Focus in the few areas you can win and build scale – at a segment level

• Extreme examples:

• Wachtell Lipton – Major M&A and litigation

• Quinn Emmanuel - Litigation

• Consolidate to build scale

• Become totally client centric – easy to say – very hard to do

• What are the most pressing problems my clients need help with?

• Focus on building a great culture

• Drive down costs

• Cost of production

• Overheads

• As every other business has been forced to do in the past 10 years

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Good Luck

Contact Details

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John Colvin Principal

E: jcolvin@johncolvin.com.au M: +61 409 183 174 S: +61 2 8823 3485 Level 36, Governor Phillip Tower 1 Farrer Place, Sydney NSW 2000, Australia

Sandra Heinig Senior Associate

E: sh@johncolvin.com.au M: +61 416 731 897 S: +61 2 8823 3485 D: +61 2 8823 3487 Level 36, Governor Phillip Tower 1 Farrer Place, Sydney NSW 2000, Australia

Sian O’Shaughnessy Research Analyst

E: sian@johncolvin.com.au D: +61 2 8823 3485 Level 36, Governor Phillip Tower 1 Farrer Place, Sydney NSW 2000, Australia