The China paradox

The actual number of foreign firms and their footprints in mainland China has gradually grown. According to China’s Ministry of Justice, the number of foreign firms’ representative offices by the end of 2012 stood at 228, double the 114 in 2003.

“China’s legal market has grown substantially, and so has the demand for international legal services,” says a Chinese partner in King & Wood Mallesons. “It is in a position to support the success of many international firms, but certainly not everyone. Most unsuccessful ventures are a result of a lack of strategic vision and differentiated products.”

He also points out that many small- to mid-sized firms rushed into China mainly driven by peer pressure and marketing needs, and their China offices are headed by opportunistic partner lateral hires because of the limited talent pool.

“More often than not, these local partners’ practice focuses and skill-sets don’t match the firms’ home offices,” he says. “They are run like a separate shop and have no synergy with the home market. These firms are having a tough time in China.”

Every global-minded firm knows the importance of having a China presence and, equally, no one is underestimating the challenges of succeeding there. However, when firms have invested in the market for some years but have yet to see satisfactory returns, their patience must eventually run out.

Many market observers expect a number of other firms to close one of their China offices following Vinson & Elkins’ move. But given the difficulty in obtaining regulatory approval to launch an office coupled with peer pressure, most will hold on with a leaner presence and wait for the tide to rise again.

Jones Day is one of the firms that has recently rejigged its Greater China teams to improve business efficiency. The reconfiguration in May saw almost half of its eight Beijing partners, along with several associates, relocate to Shanghai and Hong Kong. Jones Day’s Beijing office was opened in 2003 and was a 20-lawyer outpost prior to the moves. At its height, at the end of 2007, the firm had nearly 50 fee-earners in Beijing.

O’Melveny & Myers is another US firm that has been widely tipped to be the next one to scale back in China. Sources close to the firm suggest it plans to downsize in China, a decision said to have been taken by the firm’s new management led by chairman Bradley Butwin, elected in 2011.

“The firm’s previous management was keen on China and has invested heavily in the country, but the new management is understood to take a different view,” says a source close to O’Melveny & Myers. “There was also significant disgruntlement among US partners over all the investment in China. Its China practice is making money, but the figures are nowhere near the level of its home market, so the firm has decided to concentrate on the most profitable part of its practice.”

O’Melveny & Myers, however, forcefully rejects any local speculation that it might downsize and a spokesperson says: ”China remains a key focus area for our firm”.

In June the firm’s long-serving Asia practice chair Howard Chao, previously based in Hong Kong, stepped down from the post and the partnership to become an of counsel. He was not replaced; instead, the firm shifted governance responsibilities to its Asia committee. The leadership restructuring perhaps is a sign of things to come as well as a changing focus in Asia.

Rerun of events

US firms have a reputation of being sensitive to overheads and unproductive investment. Office closures and downsizing exercises are not new in China. In the early 2000s a number of US firms withdrew from Hong Kong or mainland China – legacy Dewey Ballantine, Paul Weiss and Gibson Dunn to name but a few. Several UK firms also departed China and later re-entered, such as legacy Denton Wilde Sapte and CMS Cameron McKenna.

Although magic circle firms generally take a longer term view on investment and are more established in China, they are under unprecedented pressure.

“Most China offices are dilutive to their firms’ global partnership’s profit distribution,” says a former magic circle China partner. “In the good years partners didn’t really care about reducing their profit shares to subsidise China, but no one can afford to leave one part of the business bleeding, particularly when the home market is tough.”

Although Freshfields’ commitment to China is unchanged and it remains a top international player there, it is believed that the only time its China offices were accretive to the global offering was in the boom time of 2006/07. The number of partners based in the mainland has decreased from eight in 2009 to five in 2013. The reduction in foreign firms’ China headcount is not obvious, as there is no public information available and ‘stealth layoffs’ are common practice.

A&O’s Greater China team has also shrunk noticeably over the past few years. In 2008 the firm had 34 partners in Beijing, Shanghai and Hong Kong. Now, the number has reduced to 26, with seven residing on the mainland.

“Five years ago, when Latham & Watkins took away a team of seven partners in Hong Kong, it really had a big impact on the China practice,” says a former magic circle partner based in China. “The firm still hasn’t quite got it back. The exit of the six senior partners in Hong Kong last year further affected certain practice areas. Overall, the China team is leaner now than five years ago.”

China’s legal landscape is vastly different from what it was 10 years ago and is still evolving. Both international firms and local firms are constantly responding and adjusting. The issues firms are facing are many and characteristic of an important developing market. Whatever steps firms take to address these issues it will be a fine balancing act.

For now, those that have reshaped their China strategy and chosen to have a leaner team but a sharper focus and a specialist offering are more likely to thrive than the ones that are yet to figure out what their raison d’être is in China.

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