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Law Firms 2011 Scenario

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Wednesday, February 11, 2009

Law Firms 2011 Scenario

Not surprisingly, it appears that I am not the only one thinking about the transformation that is going on within the legal market in regards to the paradigm shift of eDiscovery being brought in-house by corporations. As a follow-up to an article titled, "Does it make sense for Corporations to Bring Litigation Services and Technology in-house?" that I posted on Tuesday February 10, 2009, there was another article titled, "Law Firms' 2011 Scenario and the End of Leverage" with a very similar theme that was posted on the site by Paul Lippe from the The LegalOnRamp on Wednesday February 11, 2009. Mr. Lippe predicts that based upon the current worldwide economic conditions, law firm revenues are going to drop by 20% and therefore (based upon their 100% gross margins) are going to have to reduce their overhead by 40% to maintain profit margins resulting in the following four (4) outcomes:
  1. Clients will just flat-out spend less, drive harder bargains and get more for their money.
  2. Some work will go to outsourcers, whether onshore or off.
  3. More work will go to contract lawyers or proto-associates not on any kind of partnership track.
  4. Some associate time will get replaced by technology.
This is a great article and provides an interesting perspective of the harsh realities that are facing law firms over the next 24 months. And, although it doesn't specifically address the issue about corporations moving services and technology in-house, the take away from all of this is:
  1. The legal market is definitely in the middle of a paradigm shift or transformation.
  2. Law firms will be generating less revenue and reducing costs.
  3. Litigation service providers and litigation technology providers may need to develop new channels and support organizations to work directly with the corporations instead of the law firms.
  4. Outsourcing both on-shore and off-shore will flourish.
  5. Legal Staffing organizations will flourish.
  6. There is now technology to replace some of the previously expensive hourly legal work.

The full text of Mr. Lippe's article is as follows:

I just got back from London, where I met with my friend "Dave" from the legal department of "GlobalBank," which operates in Europe, North America and Asia. In 2007, GlobalBank spent around $700 million on legal costs, making it likely one of the 10 biggest clients in the world. In 2009, no one really knows, but spending will be more like $250 million to $300 million, notwithstanding a bump in restructuring, layoffs and investigations. According to Dave, "we have been through four rounds of layoffs so far. In addition to half of my team and several of my peers, my boss, my boss's boss and boss's boss's boss all have been let go. We expect the recession to last through all of 2009 and most of 2010, but then hopefully things will start to get better."

A mere 11 months ago -- a lifetime in meltdown years -- a group of industry experts published the Legal Transformation Study. The study outlined four scenarios for the evolution of the legal industry by 2020. The folks behind this are offering a free webinar to introduce scenario thinking.

Let me offer my own 2011 scenario in the simplest possible terms.
As Dave and others are now saying, the recession will last through 2010. Law firms will use this period to substantially restructure, and beginning in 2011, things will start growing again. While there's a lot of detail and nuance around the form this restructuring will take, it can be described in simple terms. A typical law firm bill in January 2011 will generate the same dollars for partner work as it does today, but it will generate half the revenue for associate work. Consider a bill in July 2008 for $1,000,000, representing $450,000 of partner contribution, $500,000 of associate contribution and $50,000 of "other"; in January 2011, the bill for an essentially identical project will be $800,000, reflecting $450,000 of partner contribution, $250,000 of associate contribution and $100,000 of "other."

Whether this is accounted for as hourly billing or "value billing" is not particularly strategic, except that to measure differently will, of course, incentivise firms to be more thoughtful about how to structure work.

Where will those dollars go? Four places.

1. Clients will just flat-out spend less, drive harder bargains and get more for their money.
2. Some work will go to outsourcers, whether onshore or off.
3. More work will go to contract lawyers or proto-associates not on any kind of partnership track.
4. Some associate time will get replaced by technology.

Why am I so confident that this will happen?

First, associate time is a pricing mechanism, not an indicator of value. Like so much in the modern law firm model, the explosion in associate hours, rates and leverage began with the Cravath IBM antitrust defense in the 1970s and 1980s, when the firm discovered that in the quintessential "bet the company" case, IBM would willingly pay full freight for associate time on massive and pretty routine document review, and that in turn would drive up Cravath's profits dramatically. Since this wasn't particularly compelling work for the associates, the firm had to raise salaries to hold onto folks, triggering the great associate salary escalation.

Second, clients have always recognized that associate time is overpriced. Every client I know views associate time as the price for getting access to partner time and to the firm "brand." In truth, there are two billable hours: the partner's, which should reflect deep expertise and judgment about the client, the law and best practices, and the associate's, which is generally spent on some form of information processing, which clients recognize as relatively poorly managed compared to other arenas of information processing. As Susan Hackett, general counsel of the Association of Corporate Counsel, recently put it, "I don't have a problem with the $1,000-an-hour lawyer, but the $350-an-hour junior associate isn't worth it." Third, as individual partners follow the example of Fred Bartlit and others and spin out of big firms with an "anti-leverage" model, they will be able to charge substantially less than traditional firms. While some sliver of work will still require the very large firm, enough won't, so that firms will have to largely match the boutiques for efficiency gains, or they'll have to shrink radically if they want to do just "high end" work.

For you math majors out there, you will have noticed that the 2011 scenario locks in a 20 percent drop in firm revenues. That's right. So firms will have to find ways to cut at least 40 percent of overhead to maintain profits (more on that in a subsequent column).
In another London meeting, a very able head of knowledge management for a Magic Circle firm quoted the Nobel Prize-winning physicist Sir Ernest Rutherford. "Gentlemen, we have run out of money. It is time to start thinking."

Pretty good advice.

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