Business & Practice

Envisioning Profits, Law Firms Find Tough Market in China, Study Says

March 17, 2015, 9:28 PM

This January, while traveling in London, Fried, Frank, Harris, Shriver & Jacobson’s chairman David Greenwald sent an email to everyone explaining the firm’s decision to “substantially downsize” its Hong Kong and Shanghai offices.

“Our growth potential in Asia was not sufficiently attractive,” Greenwald wrote, "... (Not) without significant additional investment.”

A forthcoming U.C. Berkeley study focused on mainland China suggests that nearly all foreign law firms find it difficult to build a profitable practice there, thanks to fierce competition and strong government regulation.

Torn between the long term growth prospects in Asia and the cost of building a practice, the study found many international law firms stagnate in mainland China: The median office size is 11 lawyers and more than 80 percent of firms interviewed for the study said their office accounts for less than 5 percent of overall firm revenue.

As one Shanghai-based lawyer quoted in the study put it: “If you come in here expecting to make a lot of money, you ought to understand almost no one is making money.”

Entitled, “ The Outpost Office: How International Law Firms Approach The China Market ,” the U.C. Berkeley-based authors, Rachel Stern, an assistant professor of law and political science, and Su Li, a statistician of empirical legal studies, obtained data on 174 international law firm registered with the Chinese Ministry of Justice in 2012 to create one of the most comprehensive snapshots to date of the Chinese legal market.

The data is culled from 90 interviews that Stern and Li conducted between 2013 and 2014, primarily with lawyers at international law firms, but also in-house counsel at Chinese state-owned enterprises, legal recruiters and others. They asked a set of ten questions about billing, competition and other topics.

There’s plenty of rich data about how the legal landscape in mainland China has evolved and the current state of affairs. From the study:

  • An average of 12 international law firms opened a new office in China each year between 1992 and 2012.

  • During that 20-year period, only 25 law firms exited China because of a change of strategy.

  • An average of seven international law firms closed their China practices per year, 55 percent of these exits can be traced to mergers or bankruptcy.

  • In 2012, there were 81 U.S. law firms, 19 British law firms, 15 Japanese law firms, 9 German law firms, 7 Australian and 7 French.

It also notes the rapid growth of Chinese law firms, of which there are more than 19,000. In 2002, no Chinese firm had more than 200 lawyers, but by earlier this year, Dacheng had 3,200 lawyers. It used a swiss verein to combine with Dentons to form a law firm with an estimated 6,600 lawyers — the largest in the world.

Many Chinese law firms also started opening offices overseas within the last five years and, the authors note, “In Chinese legal circles, it is now debatable whether any quality difference separates international law firms from the top tier of Chinese law firms.”

The study identified two primary strategies among international firms building a Chinese practice: Many Anglo-American firms seek to develop expertise in a practice area, such as intellectual property. By contrast, the “vast majority of firms from Europe, Asia and Latin America” view their niche as handling work that originates in their home region.

The study contains rich anecdotal data, such as the fact that many lawyers — comfortable in their anonymity — offered unsolicited rationales for why it is ok for their office to lose money. One lawyer estimated that most Chinese practices would be “lucky” to hit $600,000 in revenue per lawyer.

More than 60 percent of all international law firms in mainland China have six to 19 lawyers; having 20 lawyers ranks a firm among the top eight in size.

The authors also conducted a regression analysis that identified a strong correlation between the size of a mainland China office and the number of years present. The law firm’s global reach, as measured by number of offices outside China, also correlated positively with size. A third variable that positively correlated with office size was how many lawyers with a Chinese last name were employed in the office — an admittedly crude measure of localization. Thus, years present in China, global reach and lawyers with Chinese-sounding names appear to help an international firm grow the size of its Chinese practice.

The authors conclude the following: “The common experience of stagnation following initial excitement about market entry illustrates the strength of hype, the constraints of partnership, and the ongoing power of the Chinese state to shape the legal services market,” the study concludes. “The rarity of exit reflects perceptions that a China presence is a valuable symbol of global commitment and a worthwhile bet on future growth.”

As Stern told me in an interview, “What would be ideal is if all these law firms are making lots and lots of money there, and just expanding in China, but this is not the case.”

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