Report on the "New Normal" and the changing nature and disruptive forces affecting the legal profession. Actionble advice for providers (attorneys and in-house counsel) and users (clients)of legal services.
- 1.Creative Destruction: Transforming theLegal Profession into the Legal-Services IndustryTimothy D. LaBadie, J.D., M.B.A. CandidateIndustry Analysis Atkinson Graduate School of ManagementDecember 7, 2011Rob Wiltbank & Sean Campbell
2. The recession forced corporate America to look hard for savings, and the people who were beingpaid hundreds of dollars an hour to nitpick were an obvious target. Some lawyering requires exceptionalskills and deserves high pay. But law firms were often charging stiff rates for routine work done bytrainees. Clients are right to demand better value for money. Law firms can increasingly oblige themwith the help of technology and globalization. The Economisti Clients say they want their lawyers to provide excellent service, at competitive and predictableprices, in a timely and professional manner, and all of this is true. But what clients most want from theirlawyers, what theyre really purchasing, is peace of mind. When a client buys a legal product or service,he or she is buying reliability, security and assurance in a word, trustworthiness. Jordan FurlongiiRoadmap: This report is intended for two main audiences. First, attorneys who want to understand howthe legal industry is changing (or, the New Normal), to understand client needs better, and to increasetheir competitive advantage. Second, for a general business audience and clients who want to know howthey can get more value for their legal spend.What the report is not about: its not about marginal changes (e.g., You can use an iPad to stay in touchand communicate with clients, use it in depositions, in court, and so forth.). Rather, its focus is onfundamental, structural changes facing the legal industry.Nor is the report directed at readers or lawyers who have incredible lack of interest in changing legalmarketplace.iii, or those who do not believe the legal industry is changing or are generally resistant to it.Many have good reasons for doing so. Attorneys coming into the latter part of their practice naturally arehabituated to the old model. But younger attorneys and those who find themselves in mid-practiceshould find the report more salient.This report will argue that legal industry is fundamentally changing because of changes in three broadcategories: (client) demand, technology, and globalization. The paper will proceed by analyzing thetrends in each of these three categories.I.Key Findings and Trends1. Demand (The Client)a. Corporate clients are continuing to insist on cheaper legal services from law firms and in- house legal departments, while simultaneously insisting on higher value. Corporate clients are still less-than-satisfied with many of their law-firm suppliers. Hence, it is still decidedly a buyers market.b. The most popular way to achieve these dual goals (higher quality at lower cost) when corporate clients choose to continue using law firms are through alternative-fee agreements (AFAs).c. There is a strong corollary trend of moving work previously done by law firms in house, or limiting work given to a few select, preferred firms because businesses can control costs more easily this way and many law firms have been proven slow to innovate. 3. d. Corporate clients are increasingly unwilling to pay first- and second-year associates historic billing rates.2. Globalization (Supply Side)a. Perhaps the most important, most profound trend is the rise of legal process outsourcers (LPOs), which are increasingly taking the bread-and-butter work away from many law firms, such as e-discovery, document review, contract drafting, patent filings, legal research, etc.b. Contract or adjunct attorneys are increasingly being used by in-house legal and law firms.3. Technologya. Individual clients and small businesses are underserved. These markets are being penetrated by many internet providers, such as LegalZoom and RocketLawyer.b. The internet is also offering new ways for lawyers to market themselves through crowdsourcing websites (i.e., sites that allow users and potential clients to receive answers to legal questions from numerous attorneys, such as LawPivot and Quora) and, to a lesser extent, social media (LinkedIn, Facebook, Twitter, YouTube, blogs, etc.).c. Cloud-based and virtual practice constitutes other emerging trends, which allow attorneys to simultaneously cut costs and communicate with clients more effectively (increase quality). It is transforming the face of law practice, and smart firms have been using these tools to deliver better results to clients.II.Industry Background:The Old Normal: The 1980s CalledIt Wants Its Business Model Back To understand the current trends in the legal industry and the structural changes taking place (the newnormal) it is necessary to sketch what the old normal looked like, especially for those who are less thanfamiliar with the industry.The legal industry earned great profits and grew rapidly during the latter half of the 20th century,going from a mere 0.4% of Americas GDP in 1978 to 1.8% in 2003, thus growing four times faster thanthe economy as a whole.iv By 2000 this translated into the typical U.S. law-firm lawyer making$191,000, compared with a mere $64,000 for all Canadian lawyers and $90,000 for Australians during thesame timeframe.v Barriers to entry (occupational licensing rules, ABA accreditation of law schools, andrules against non-lawyers investing in, or owning, businesses that do legal work) also helped to limit thesupply of lawyers and retard competition in the legal sector. vi These barriers, when coupled with analmost ever-present revenue growth, resulted in a gilded age, at least from the professions point of view. But things were even sweeter for law-firm partners1. The old law-firm model is often described aspyramid-like: relatively few partners at the top, with many associates (i.e., generally younger attorneys) atthe bottom. Partly because law schools have not emphasized practical training, associates had to learn onthe joband thus on the clients dime. vii Strikingly, it typically takes an associate 10,000 hours on thejob before he or she rises to mere competency or proficiency. So partners would have associates do themore menial legal work (reviewing documents, drafting routine contracts, due diligence, etc.), and would1I.e., attorneys that own equity in the firm. Under U.S. rules, nonlawyers are not allowed to own or manage a lawfirm, which includes companies that offer legal services and advice. 4. bill the client anywhere from $100-300 per hour for the associates work, while paying the associate asmall fraction of that rate. How could a firm not make profits? The essence of the model was summed upaptly by a law professor, John Heinz:A senior partner in a large Chicago firm told me that, until a few months ago, hiring moreassociates and more paralegals was, like printing money. A larger number of subordinates perpartner provides leverage for the partners assets. The firms bill the clients considerably morethan the firms pay for the time of these employees. viii Business clients were the first to get savvy, albeit probably belatedly. ix No wonder by 2010, andafter they themselves were being squeezed by the recession, almost half of law firms reported thatcorporate clients refused to pay them for work done by their first- or second-year associates!x Largebusiness and corporate clients were only half of the legal hemisphere, though.xi The other half consistsof individual and small-business clients, many of whom cannot afford to hire a private attorney,especially because of stagnating real wages. xii In fact, two legal-industry economists have recentlyconcluded, after controlling for a range of factors that would explain higher wages for U.S. lawyers, thatout of the $170b spent on American lawyers annually, about $64 billion is an unearned premiumproduced by market distortions, with another $10 billion in annual deadweight losslost or wastedeconomic activity.xiii Hence, it is no wonder that the legal industry has been rife for change, innovation,and competition from new entrants in both hemispheres of the legal profession: for both arguably over-served large business and corporate clients, as well as under-served individuals and small businesses.The Recession as a Tipping Point for the IndustryThe change seems well underway. Since the 2008 recession, many law firms have seen revenues andprofits falling significantly.xiv Thus the recession has been described as a tipping point, where hithertofake pressure became real pressure with respect to clients demand for change in how law firms operateand serve them.xv Further, most industry observers attribute the falling profits to creative destructionforces, and which are the focal points of this report, namely: (1) changing client tastes and preferences,or buyer power; (2) globalization (largely in the form of outsourcing), and (3) technologicalchange.xviNo, Its the Economy, Stupid As mentioned above, many lawyers are reluctant to the changing legal landscape, holding out hopethat the economic rebound will restore the profession to business as usual. Given the lucrative last fewdecades, it is not difficult to understand why some attorneys take this position.But this is probably wishful thinking. Though the vast majority of industry experts disagree with thisrosy prognosis, there are good empirical reasons for thinking the changes are fundamental, and not merelycyclical. First, in-house attorneysas opposed to law firm attorneysare seeing salary increases;companies are lifting salary freezes, and cash bonus levels are approaching pre-recession levels, yet manylaw firms (i.e., external legal suppliers) are not seeing a rebound in work.xvii Second, clients weredispleased with the majority of legal services offered by law firms even at the height of the economicboom. In 2006, about 70% of large business clients reported that they were unhappy with their primarylaw firm, and 50% reported they