Mark Cohen: Legal Insights and Industry Commentary

Our #LegalMosaic series collects insights from the brilliant mind of Mark Cohen. These pieces can also be found at legalmosaic.com.


Good lawyers are problem solvers. The best ones forestall problems and, when they inherit them, prevent metastasis. So with demand for legal services robust and law firm demand flat three years and counting, law firms have a problem. Its crux is a misalignment of the traditional law firm model with the marketplace—except, perhaps, in certain high-value matters. Is it being fixed? Soaring partner profits (PPP) suggest it is. But the increasing percentage of legal services rendered outside law firms indicates the contrary. Which is it? Short answer: partners have fixed their challenge—how to increase PPP with a declining demand for law firms. Firms, on the other hand, have a worsening, systemic problem that threatens their sustainability.

The list of client gripes about law firms is long and familiar– high, unpredictable cost; limited understanding of their business; poor process/project management; and ineffective communication. Technology is an especially significant factor. Thoughtfully deployed, IT promotes efficiency; captures intellectual capital; streamlines process; fosters collaboration; substitutes products for services and—for all those reasons and more—is anathema to law firms’ performance and reward systems. The traditional law firm model is premised upon business generation and revenue. This is achieved by lots of billable hours under the rubric of ‘thoroughness.’ Any wonder why law firms have generally been laggards in effectively deploying technology?

The fiscal crisis of 2008 and its aftermath was an accelerant for the rise of tech and process savvy legal service companies. Unlike law firms that are prohibited by regulation from accepting institutional investment capital, leading service companies invest heavily in technology and process. They have a corporate DNA and mindset designed to create ‘better, faster, cheaper’ solutions to legal delivery that align well with corporate culture. Legal service providers have quickly become a multi-billion dollar market segment. Their agile, on demand models are attractive alternatives to the high on staff cost of firm attorneys. And so too is their reduced price structure.

But perhaps the biggest impact of the fiscal crisis is the explosive growth of in-house legal departments. It’s easy to dismiss the ‘insourcing’ of legal work as labor arbitrage. But the more fundamental reason for in-house growth is law firms’ inability to deliver excellence and value. The value deficiency is linked to the traditional firm model and culture. Law firm performance criteria and incentives are very different from corporate departments where business generation is not a success criterion–though advancing business and enterprise objectives certainly is. In-house lawyers have many ‘home field advantages’ over outside counsel. Some examples are: superior knowledge of enterprise goals and risk profile; collaboration with core business interests; and integration with the enterprise IT platform. For these and other reasons, corporate legal departments now comprise approximately 45% of total legal spend.

In-house size, influence, portfolios, compensation, and market share are rising steadily. Significantly, many departments now have almost as many non-lawyer members as attorneys. This is because legal delivery is now a three-legged stool supported by legal, technological, and process expertise. Law firms are strong on the legal side but generally lag in technology and process skills. And law firm DNA is not receptive to providing an equal seat at the management table for technologists and service delivery experts. Simply put, in-house departments are doing a better job than law firms integrating technology and process into the delivery of legal services.

The Law Firm Response: Preserve Profit-Per-Partner

Faced with competition from corporate departments and an expanding array of service providers, what is the law firm response? Most firms are making course changes, but they are internal ones designed to preserve PPP. So why are firms not taking more aggressive action to give the customer what it wants? Simple answer: partners—especially more senior ones—are prospering even as their model falters. And as Richard Susskind says, it’s hard to convince a room full of millionaires that they’ve got their business model wrong.

When one references a ‘law firm,’it’s important to distinguish between equity partners and everyone else. Because in today’s world, to paraphrase Caesar’s Gallic Wars, ‘All firms are divided into two parts.’ Partners are prolonging life for their model even as clients are increasingly rejecting it. Profit per partner (PPP), the law firm gold standard since The American Lawyer published its inaugural firm profitability rankings in the mid-‘80’s, is at once firms’ lifeblood as well as its disappearing hourglass. With the exception of a few brand firms, PPP is achieved by increasing rates and billable hours, restricting partnership, retaining rainmakers and pulling in big book laterals, and by thinning the partnership herd.  This stimulates PPP, not client value. It also explains the head-scratching rate increases and billing quotas that many firms are imposing at a time when clients routinely exact significant ‘rack rate’ discounts and increasingly favor fixed fee billing.

So as firm market share decreases with no signs of reversal, most partners—especially at about 20 brand- differentiated firms—have never been rewarded more handsomely. For The Am Law 100 as a whole, average profits per partner rose by 4 percent in 2015 after a 5.3% increase in 2014. Wachtell boasted a whopping $6.6 million PPP. The AmLaw 100 average PPP was well over $1.5 million—not bad for a model on the rocks. The law firm model might be under attack, but partners are feeling no pain—not yet, anyways. And that’s why firms are not reconfiguring their model to better align with clients.

That begs the question: what does this mean for the future of law firms as we know them? Where is the succession plan? And who will train the next generation of firm talent?  Where will capital come from to invest in technology, and when will firms embrace its crucial role in the delivery of legal services? Law firms are pursuing a short-term strategy that is readily apparent to clients. So as PPP is temporarily supported by lateral acquisition– individually or en masse– one wonders how long the current law firm model will survive.

Why Do Clients Still Engage Large Firms So Often?

The law firm model may be showing stress cracks, but it still accounts for the majority of legal spend. Why? Perhaps the principal reason is that there is not yet a ‘safe,’ scalable outsource alternative for high value legal work. And while some large companies—notably Shell Oil—are taking much of their high-end work in-house, that’s still the exception in part because not many corporations have (or have need for) such substantial legal departments. Another reason is that top law firms deliver more than legal services alone. They drive business to their clients, have ties to the C-Suite and Board, and provide ‘cover’ for bad outcomes (‘You don’t get fired for hiring IBM’ a/k/a ‘CYA’). Another reason is the symbiotic relationship between certain firms and in-house legal departments—an alumni club of sorts. And yet another factor is inertia tinged with the considerable cost of replacing firms.

It’s only a matter of time, though, until The Big Four or some other multi-disciplinary professional service provider with a platinum brand and global reach disrupts the legal vertical. Disruption might also come from global legal networks that deploy technology, process, local expertise, and a new delivery model that reduces legal cost, mitigates risk, and seamlessly integrates additional service providers on demand. The technology already exists; it is only a matter of time until the emergence of the first ‘safe’ provider with sufficient scale and a new, client-centric model.

Conclusion

It’s hard to say how long the bonanza for partners will continue or when the incumbent firm model will yield to a new one. The short-term approach that law firms are taking to sustain sky-high PPP cannot last for another generation. Chances are its end will come much sooner. Business today is about technology aligning customer with provider and cutting out the ‘middle man.’ The traditional firm model is a middle -man. Something’s gotta give.