People have predicted the downfall of the legal profession and the big firm model, specifically, for some time. The industry has experienced consolidation, but in 2018, the big law model is alive and well. In 2017, law firm revenue amongst the AmLaw 50 grew 6.8%. Firms outside of the AmLaw 50 saw growth in 2017 as well. Onward and upward, right?
It may be a slower death than predicted, but death of the current model seems inevitable. This does not mean that the firms themselves will cease to exist. It just means that they may look slightly (or grossly) different than they do now. There will come a time when hiring large classes of summer associates, who go on to become first year associates, and whose low cost and high billables line partner pockets, is no longer a viable model. The overhead of hiring that many people and costs of training them could prove too risky in a world where clients are not willing to pay high billable rates to practitioners who, just a few months ago, were sitting in a law school classroom. And they won’t.
An industry in transition.
The power dynamics of the law firm — client relationship have shifted. Firms have gone from price makers to price takers, and growing client demands on law firms could break the current structure. The catalyst for the change in power dynamics is the shift in buying control from company General Counsel to CFOs and legal operations professionals. CFOs are responsible for managing legal spend. Legal operations folks are hired to find ways to reduce legal spend through technology, working with legal process outsourcing companies (LPOs), relying on RFPs to create competition for work, and pushing for increased transparency from outside counsel. The process for engaging outside counsel has changed. Gone are the days of General Counsel having a group of trusted law firms, consisting of law school friends and colleagues from their former firms, to which all work is sent. For firms, this shift has greatly affected the ways in which they scope work and bill clients.
Suicide pricing has become the norm. Firms almost never charge clients standard or rack rates. Bruce MacEwen, former attorney turned law firm consultant, began sounding the alarm on this issue in 2012 (his interview with Bloomberg can be found here: “Suicide Prices” & the Coming Crisis at Big Law Firms — YouTube). With competition high, it’s become a race to the bottom just to get clients in the door. Some of these “loss leader” engagements can be an effective pathway to a sustainable book of business, long term. But when firms take on too many of these unprofitable matters, they rely on too small of a percentage of work to support the entire organization.
Firms are also under pressure from their clients to offer alternative fee arrangements (AFAs). If the trend continues, the term will become oxymoronic, with hourly rate billing the minority model. AFAs can take the form of flat fees, capped fees, shared cost in fees if they exceed a certain amount, or incentive based structures (more on AFAs). This has been a highly publicized topic in the legal industry. To be fair, the pervasiveness of AFAs is not entirely equivalent to the amount of coverage the model has received. According to a survey of in-house legal departments, 87% use some form of AFAs. But only 14.1% of these companies report that AFAs make up more than 50% of their legal spend. And 34.4% of this group reported that AFAs make up only 1–10% of total legal spend (source). But with companies like Microsoft publicly refusing to pay their law firms on an hourly basis, corporate legal departments could find themselves under pressure from management to move towards AFAs, eliminating hourly billing as the standard model for engaging outside counsel.
Firms are no longer competing only with their fellow AmLaw members. Legal departments are growing in personnel and capability, fast. “67% of law firms say they are currently losing business to corporate law departments that are in-sourcing legal work, and another 24% of firms see this as a potential threat going forward” (source). And they are right. Legal departments are growing — adding more lawyers, legal ops professionals, and striking deals with LPOs. General Electric just announced a deal with LPO, UnitedLex, that is said to reduce their legal spend by 30%. With over 800 in-house lawyers, GE’s legal department is massive. This move should change that structure, and signal a new model for other companies to follow. And the increase in personnel is only half of the problem for law firms. Through the use of technologies focused on automation of workflows, analytics and artificial intelligence, the volume of work that can be in-sourced will continue to grow (source).
Another form of competition law firms face is the growing number of legal tech startups. There are companies sprouting up in all areas of law, offering new ways for legal services to be consumed. Often, they are founded by former big firm lawyers leveraging their 3–7 years of experience to start a legal tech company as an alternative to going in-house or spinning off a small practice. Bob Ambrogi, legal technology writer, has a comprehensive list of 700+ legal tech startups. Legal Geek, out of London, has also created this visualization of legal tech startups by category:
With an increase in seed stage funding in the sector in 2017, the number of legal tech startups should continue to grow.
Perhaps the most fearsome startups are those using Artificial Intelligence to perform contract analysis, legal research, and compliance. AI capability is still fairly limited. But in narrow areas of focus, there are products available now that outperform human lawyers. Late last year (2017), an AI demolished human lawyers in an NDA review competition (Mashable article). Not only did the bot spot a higher percentage of issues, it did so in a fraction of the time (92 minutes for the human lawyers, 26 seconds for the AI).
Legal tech startups are resource constrained, but they do not have the same constraints on scale and speed as law firms. The more obvious limiting factor is time. There are only so many billable hours in a day for a human lawyer. Where product based companies are able to achieve exponential (hockey stick) growth, firms selling time can only scale linearly. The less obvious constraint on both scale and speed is the law firm partnership model. The General Partnership model was never intended to scale to the AmLaw behemoths we see today. It’s difficult to build and manage a global organization through consensus. And the model dis-incentivizes too much growth, too fast. Lawyers do not want to be responsible for the actions of their fellow partners practicing across the globe, whom they have never met. This is especially true where a firm has relied on lateral partner hires to grow. An effective means of growing firm capability and revenue quickly, lateral hires can add to the level of distrust within the partnership (source). If firms wish to grow, or even maintain their current market share, they will have to move beyond the constraints of the professional service/partnership model to find new means of, and business models for, delivering legal services.
Products > Services
The largest companies in the world (by revenue) sell products, not services. The delta in revenue between top professional services firms and product companies is substantial. Like 2 orders of magnitude. The largest ‘Internet’ company by revenue in 2017 was Amazon with $166B in revenue. The largest technology company in 2017 was Apple with $229B in revenue. The largest professional service firm in 2017 was Deloitte with $38B in Revenue. Kirkland Ellis, the highest grossing law firm in 2017, earned $3.1B.
This is an overly simplistic way of measuring the success of a company. But inherent in the human services model, is capped growth potential. Product companies are able to scale, and at a far greater pace. Deloitte was founded in 1845. That’s 173 years ago, as of this writing. Kirkland Ellis was founded almost 100 years ago (in 1909). At their current pace, perhaps Kirkland will 10x their revenue by 2082. Apple, after the release of the iPhone in 2007, increased their revenue by 10x in just 8 years (Apple revenue). It took Amazon just 15 years to reach Deloitte’s current revenue numbers (Amazon revenue), and have far surpassed that since. Product businesses scale MUCH faster. And that’s especially true of software products.
In 2011, Marc Andreesen (founder and GP of venture capital firm Andreesen Horowitz) penned a phrase that would feel obvious today — “software is eating the world” (this is a must read).
“Six decades into the computer revolution, four decades since the invention of the microprocessor, and two decades into the rise of the modern Internet, all of the technology required to transform industries through software finally works and can be widely delivered at global scale.”
The shift made by companies into the digital age has been referred to as digitalization (Gartner). It means more than just building software. It requires transformation of business models around selling digital products. In his post, Andreesen describes his experience as a board member at Hewlett Packard, where the company weighed dumping their PC business in favor of deeper investment in Software. If technology companies are making fundamental shifts to their business model because they see a brighter future in software, then traditional industries (like legal) should be investing twice as much in building out a digital product capability to keep pace.
Prioritizing software as the future medium for delivering legal services would require a change in personnel, marketing and business models. But most of all, it will take a shift in the mental model through which clients view their law firms, and lawyers view their own profession.
“Technology will be the main driver of this change. And, in the long run, we will neither need nor want professionals to work in the way that they did in the twentieth century and before.”
— Richard Susskind, The Future of the Professions
The role of lawyers, and other professionals, originated as that of a trusted advisor or expert. Lawyers were general practitioners, knowledgeable of the laws, bestowing that knowledge upon their clients based on their diagnosis. With the availability of information today, clients can often self diagnose. They may even know the legal remedy.
Technology capability continues to expand exponentially. Astro Teller, Captain of Moonshots at Google, describes the growth in AI as the ability for the computers to move from being fed data and producing an output, to now being able to determine the questions to ask in order to gather the data. This improved capability is meaningful. And it backs up Susskind’s position on the changes lawyers and firms will need to make in order to continue to add value beyond the technology.
But there is still a monstrous opportunity to build that technology in the legal industry. If lawyers (and their firms) find the areas where they can truly add value, and productize the rest, they will find that the business models afforded by software are quite favorable. And the benefits of scale not currently afforded to law firms could result in exponential growth for a few. The opportunity to rapidly disrupt the industry still exists. The question is whether it will be driven by a few scrappy startups, or through radical transformation by the incumbent firms.
Digital product design in the legal industry.
Amongst the top characteristics venture capital investors examine when determining whether to invest in a startup is competitive advantage. Part of the analysis of this characteristic is one of uniqueness. Why is that company (or the people building it) uniquely positioned to be successful? Perhaps they have more experience, an alternative way of viewing the market/problem, or a technological innovation not easily replicable. There are thousands of entrepreneurs building legal technology products. Few have the skill, experience and knowledge held by a seasoned partner practicing at a law firm. When you combine and access all of the skill, experience, and knowledge held within a firm, the competitive advantage over non-law firm competitors to bring impactful products to market becomes insurmountable.
Individual lawyers spend their careers learning what their clients need, and tweaking how the solution is delivered. The work is often complex, but the formula is not. Ask the right questions to acquire critical data (facts), then apply the relevant law. How the analysis is delivered may vary. And lawyers are constantly refining that part. A deliverable that requires hours to craft the first time, could be replicated across multiple clients. Firms have recognized the value of re-usable work product, as evidenced by the growing investment in Knowledge Management professionals and tools.
“The definition of KM that I like best is the art and science of capturing and re-using legal know-how and identifying colleagues with relevant experience.” (source)
— Ron Friedmann, Fireman & Company
A firm with 1,000+ lawyers has quite a bit of legal know-how. Collecting that know-how and transforming it into a user-friendly workflow is the basis of many great digital products. QuickBooks and TurboTax are digital representations of the workflow accountants used to serve their clients for years; Kayak and Concur have replaced the travel agents by delivering their travel packages in digital format; and Wealthfront and Robinhood invest portfolios using algorithms that leverage years of real investor experience. This idea has been referred to as moving from wet code to dry code, by Nick Szabo.
The above products were not created by an incumbent accounting firm/travel agency/financial institution. They were crafted by entrepreneurs who saw the problem differently, and leveraged a growing technology capability. There are plenty of digital products in the legal industry. But there are no real winners who have reached escape velocity. At least not in the same way that TurboTax has disrupted the personal income tax practice of CPAs. But the opportunities exist, and law firms are in the best position to win.
One of the core reasons why the tech startup space has exploded is the affordability of building software. In 1995, server costs could reach the hundreds of thousands of dollars per month. Today, a company can standup an application in a cloud environment in minutes for less than $50/mo. With these reduced costs, entrepreneurs are free to experiment with many ideas. A law firm with hundreds of millions, or even billions of dollars in revenue should allocate budget to experiment, constantly, with new product concepts.
Experimenting is also more valuable when you have a captive audience to provide feedback. For a practice group to exist in a law firm, they need clients. So not only do firms have the capital to allocate towards innovation, they have the clients with whom to test product concepts. This might be the most undervalued competitive advantage that firms possess. In his book, The Four Steps to the Epiphany, Steve Blank uses the term “Customer Discovery” to describe the need for companies to get out of the building to go learn from their prospective customers, and turn them into early evangelists. Blank’s former student, Eric Reis, applied this concept to building digital products in his book, The Lean StartUp. These concepts, combined, are the battle cry of Silicon Valley. Law firms and their lawyers have a tremendous opportunity to apply those same concepts, leverage existing clients to further understand the problems they face, and prototype solutions — relying on clients to refine through user testing and product feedback.
Once validated, these products can even be spun out into separate entities, offering experienced attorneys another incentive to invest in and support firm innovation. Where the ABA restricts non-attorney ownership in a law firm (ABA Model Rule 5.4), there are no rules against non-attorney ownership of legal tech companies. Spinning out viable products enable the firm to put the proper leadership in place to achieve real growth, and to offer equity in the spinout to some or all of the partnership that lasts beyond their interests in the firm itself.
The combination of legal know-how, capital and human resources to experiment with ideas, and access to prospective customers all give law firms a distinct advantage over the hundreds of startups working to disrupt the legal industry. Massive innovation by incumbents was not the case in the aforementioned industries (and others). Law firms have an opportunity to change that.
Rapid transformation requires commitment, long term. Law firms will not be successful if they start killing practice groups in favor of hiring product teams. Instead, focus on specific client problems. From there, infrastructure for solving these problems will begin to emerge. There are people within the firm (knowledge management professionals, client development associates, business analysts, etc.) who possess skills that are transferrable to product design. Train and leverage those people. And hire or outsource the rest.
Through a series of articles, we will discuss the process for building out a digital product design capability, including: personnel, resources, process, and tools. Based on our experience building digital products in the legal industry, it is our hope that we can help law firms who will listen, transform into scalable organizations who can continue to deliver value is this ever changing landscape. Stay tuned.