Law Firms Push For High-End Work is Short Sighted

Photo by JayMantri (Pixabay)

Editor’s Note: The author of this article is a professor at University of Tennessee College of Law and wrote the book, Glass Half Full: The Decline and Rebirth of the Legal Profession. This is a first of a two-part series that pulls from Harvard Business School professor Clayton Christensen’s book, The Innovator’s Dilemma, and applies its findings to Big Law. 

By Ben Barton, Professor of Law, University of Tennessee College of Law

The most recent Altman Weil Report, titled Law Firms in Transition, is striking because it presents a clear set of challenges for Big Law, including computerization, in-sourcing, and outsourcing. While some firms have seen a return to pre-2008 profitability, others continue to struggle, and some firms report permanently lower expectations. In the face of these market forces, one might expect radical changes or a wide variety of strategies.  Instead, Altman Weil describes the changes as “limited, tactical and reactive.”

The lack of urgency or creativity is puzzling. America’s corporate law firms are staffed by some of the highest paid strategic thinkers in the world. The United States is the world’s largest exporter of legal services, and in an economy running a massive trade deficit, we ran a $5.3 billion trade surplus for legal work in 2011. So why aren’t these same lawyers better able to address their own challenges?

Clayton Christensen’s book, The Innovators Dilemma, offers an explanation.  Christensen argues that for market-leading companies it frequently makes sense, in the short term, to ignore disruptive technologies. This is because the new competitors start by focusing on a segment of the market that is lower margin (like discovery or due diligence), and frequently offer a worse product at much cheaper prices.

The producers at the top of the market are at first unconcerned. Why would they worry about losing the low end of the market when they are dominating the higher margin work? Initially, this strategy actually improves profitability, as market leaders abandon low margin work to focus on the most profitable areas.

But the producers in the lower end of the market eventually master the low margin work and gradually work their way up the chain to the higher margin work.  Thus, what appears to be the best strategy short-term turns out to be disastrous long-term.

Christensen’s work is directly applicable to Big Law. In the early days, insourcing, outsourcing, and computerization only took the most routine corporate legal work. This is the work for which clients have been demanding alternative fee arrangements, or nickel-and-diming in their bills.

Law firms were initially fine with losing that routine work, both because they could just find better, higher margin work, and because they still have not mastered the art of making money on fixed fee arrangements.

And yet over time, insourcing, outsourcing, and computerization have started to take more complicated and profitable work.  For example, e-discovery outlets started by creating algorithms to sort through emails. Now they handle all sorts of documents and pleadings. E-discovery vendors hope to become one-stop discovery experts. Since hardly any cases actually proceed to trial, these services are a significant threat to law firm bottom lines.

This does not mean all corporate legal work will disappear. The recent uptick in revenues and profitability at some firms clearly belies that claim. What it does mean, however, is that corporate legal work is being divided into two pretty distinct categories.  Daniel Currell of CEB argues that, for one type of work—“bet-the-company” work, like high profile mergers or large scale litigation—corporations are unlikely to balk at high bills and just want the very best legal services they can buy.

The second category is the more predictable “legal spend,” and that is the work that’s being eroded by alternative providers. Law firms are currently focusing on competing over the first category and are unwittingly abandoning the second category.

This is entirely consistent with Christensen’s theory: bet-the-company work is the highest margin, so it makes sense to focus there. The problem is that, as insourcing, outsourcing, and computerization get better, the “routine legal spend” category grows at the expense of the first, leaving more law firms fighting over high profile litigation or big mergers and acquisitions. There is already evidence of this occurring, as the most profitable firms in the Am Law 100 grow even more profitable, and others struggle.

Computerization, outsourcing, and insourcing are all so much cheaper than traditional, hourly Big Law services that law firms really do not want to compete in that market, for a couple of reasons.

First of all, they would probably be bad at it.  Big Law is excellent at what they do, but not so flexible at trying new models.  Law firms have struggled to make alternative billing work, how will they be able to master computerization?  Second, if firms got really good at these cheaper alternatives they would probably end up cannibalizing some of their most profitable business, a tough sell to a partnership in a down market.

Broadly, law firms have two options. They can shrink the number of equity partners, try to draw laterals, increase leverage, lower overhead by firing staff and shrinking offices, and otherwise stay the course.  Or they could fundamentally change the way they do business, and risk undercutting the very profitable business they already have, by offering services in an utterly unfamiliar manner.

The first option seems like the easier, and maybe even safer, choice. But is it also sustainable?  Only time will tell.