In the mid 1990s, a number of major American law firms aggressively entered the London market, focussing on corporate/M&A and banking & finance work. Their tactic? Aggressive poaching of talent from major English firms, particularly the ‘magic circle’. The English majors were stunned. The legal market in England & Wales changed forever.

There was no mystery behind the decision to enter London and compete. Sure, the multinational clients of American firms had ‘requested’ a local presence in England & Wales.

But it’s also a very attractive market. The value of the legal sector in E & W is about £20 billion. About 3 per cent (say 300 firms) of the 9,700 law firms share £10 billion. Get in there with the right business model and the profit would flow. They were right.

The repercussions of the American entry into England & Wales are still being felt. Partners in American firms still enjoy a higher PEP relative to English law firms. The Americans dominate cross-border deals in Europe. 

And working for an American firm is a very attractive proposition for young, talented partners in major English firms. Sound familiar? The same thing is about to happen in Australia. Competition. Globalisation. Profit. The same dynamics that have fuelled the market in London have now arrived here.

The news that Allen & Overy have decided to set up here – and the way they have done it - is a sobering reality check for major Australian firms. To cherry-pick some of Clayton Utz top talent in the way they have is a painful reminder that Australia is now very much part of the fight for supremacy between the world’s global law firms. Those that adapt to the new reality can continue to succeed, but only if they make some hard decisions. Those that choose to ignore reality will pay a significant price.

The entry of Allen & Overy, Norton Rose and DLA Piper into the Australian market has forever altered the landscape for local major firms. More of these firms will arrive here and they will probably use A & O’s entry strategy, as well. Large Australian firms will now have to compete with global powerhouses, in Australia. It’s a big reality check, but any major Australian law firm that assumes that it’s ‘business as usual’ will be making a grave error in strategic thinking.

The truth, laid bare this week, is that local reputations mean nothing. If a major international firm wants your best people, there’s a good chance they will succeed. If they seek business here, there’s a good chance that they will get a fair share. This represents a direct threat to the income that the top local firms have been able to rely on, year on year, for the last 25 years. It means that the current model used by major law firms to deliver client services may not be sustainable in the medium to long term. Accepting this new operating environment is the first key step that law firm leadership must take, before planning a response.

Where do the global firms have an advantage? The advantage they have is not technical expertise. As the senior partner of Allen & Overy has been saying, Australian lawyers are high quality. No, the advantage lies in terms of geographical reach, depth of expertise, quality of work, global client base and, quite frankly, deep pockets. Any managing partner who thinks that their top partners will not be interested in an approach is, to put it mildly, slightly delusional.

Ditto if they assume that clients will not be interested, either. There’s a lot of talk about ‘deep client relationships’ and the like, but as we have just seen with Clayton Utz, law is a relationships business. Clients identify with people, above all. They will move with a partner to another firm. Perhaps more fundamentally, these major English firms have a significant edge in terms of client service. I don’t mean web sites and free seminars. It’s the ability to deliver legal services innovatively, in multiple jurisdictions - at a price that represents real value to clients. Ultimately, it’s this strength that may attract top clients away from major Australian firms, unless we adapt quickly.

How did these firms become stronger? It’s important to note that these firms are not intrinsically any better than the major Australian firms. Rather, they have been forced to innovate and adapt in a way that Australian majors have not. Put simply, it’s a tougher environment over there, which produces highly effective organisations. In the relatively benign local scene, we have not had to experience the cut throat competition that has prevailed in England and Wales for over a decade. The large English firms have for years had to cope with a far more competitive market than the Australians. This has led to arguably negative consequences, for example the ruthless removal of non-performing partners. However, it has also led to real innovation in client service, a genuinely strong focus on the needs of their clients, as well as an appetite for risk that Australian firms arguably do not share.

Consider Allen & Overy. Their work on pricing with Markit RED is a good example of how this firm operates. Their innovation panel, which also uses two external consultants, has a £2 million budget. They have designed a 'Big Bang' Protocol for Credit Default Swaps, which was endorsed by the entire CDS market in 2009. And what about this quote – ‘It is my belief that PEP (profit per equity partner) is not merely an inappropriate star by which to navigate, it is in fact a dangerous and undesirable metric for the legal profession to follow.’ What a refreshing comment from a law firm leader. That was from Guy Beringer, the firm’s then senior partner, in 2007.

So, let’s assume that the leadership of a major local firm has decided to accept reality and adapt, rather than compete. What are the options? Well, the first one is to put up the ‘for sale’ sign and to become part of a larger international firm. No harm in that, well done Deacons.

The second is to put up the ‘strategic alliance/ best friend’ flag, as Phillips Fox have done with DLA Piper. Given Allen & Overy’s entry strategy, however, I’m not so sure that overseas firms will want to play this game anymore, unless it ends with them having some control. The third option is to stand alone.

This third option has risks, but also has opportunities for major Australian firms. There is insufficient space to go into detail here, but at a strategic level what is required is an urgent and careful review of the business, combined with the courage to make painful decisions.

Internally, the overall strategy here is to focus on strengths and to remove weaknesses. Do anything it takes to identify and lock in your top talent, now. Consider the overhead – is there a way we can deliver core services as effectively, for less? Can we get leaner? This might mean a decision to retain a national presence, but to get smaller by removing non-core business lines. Innovate, by developing commercial skills in your professional staff. Genuinely listen to your client’s needs, rather than your PEP targets. Externally, major firms that decide to stand alone may decide to compete with the resurgent mid-tiers, or to acquire mid-tier firms/ practice groups to build strength in key service lines.

There is only one option that cannot be considered by the leadership of a major firm – to do nothing. Business is not, as they say, ‘as usual’ anymore. It will be fascinating to see how the new reality plays out.

Ted Dwyer is an expert in law firm pricing, strategy, business development and profitability. He works with major firms in Australia, Asia-Pacific and England & Wales.