The 2016 Georgetown Report on State of Legal Market uses the apt analogy of Kodak to underscore the risk of law firms obsolescing themselves out of the legal services market. Those of us who write about innovation, legal industry change and the growing impact of legal tech are very familiar with the Kodak story which ends with the company’s bankruptcy. If you’re not, it’s worth reading if only to understand its import.
Although lawyers should read the report in its entirety (I’ve written about most of these issues over the last year), I’ve put together this synopsis to hit the highlights. The biggest call to action for law firms is that their market share continues to be eroded by a number of influences and actors in the legal services market.
What happened over the last year in the legal services market?
The report indicates that the law firm market continued for the most part on the same trajectory as it has since the recession. Growth was flat, with Am Law 100 firms and mid-size firms showing the strongest growth, and the Am Law Second 100 as a group faring the worst. Long term trends indicate that law firms are going to continue having difficulty competing, and the authors feel if proactive change doesn’t occur, many law firms will go the way of Kodak.
In the short term, it was a brighter picture over the last year. I would say this was the result of a recovering economy which has put more legal work into the system. From a legal jobs perspective, it’s been clear that transactional work has increased and made a recovery since the recession. Corporate and real estate experienced demand growth, whereas litigation (on a negative trajectory for the last seven years) and patent litigation had negative growth. Profitability levels have been maintained over the last few years because somehow firms have still managed to raise rates each year. They’ve also kept expenses from growing. Overall revenue across firms rose, revenue per lawyer grew, and profits per partner also increased.
How have most law firms responded to long term challenges in the legal services market?
After outlining the threat to law firms from clients who are continuing to demand value, more frequently disaggregate matters, utilize non-traditional service providers and keep more work in-house, the report takes law firms to task for being reactive at best and passive at worst. The authors assert that law firms are aware of the risks and choose not to act or take on a more proactive stance despite the consequences certain to be suffered. I’m actually more sympathetic to law firms (it’s rare that I would be) because it’s much easier said than done to transform an entity with a partnership structure and mentality into a corporate one. Most lawyers are lawyers and not business people for a reason. In addition to making operational changes, recognition that change management efforts need to take place takes a law firm a long way on the road to adapting to the market.
The good news is that firms who undertake proactive action to respond to their clients’ needs, as well as those firms that have changed lawyer staffing, service delivery and pricing appear to be outperforming their peers as a result. However, many law firms’ response has been to seek growth, which has resulted in the largest number of law firms mergers in many years. While it would seem this strategy is the only game in town in today’s legal services market, there are better solutions. In fact, most analysts agree there is no correlation between law firm size and profitability.
What are the fundamental problems in law firm structures?
Firms should be pursuing a number of alternatives to growth. Operational changes to control and track internal costs have gained in popularity. While different staffing models, LPM and process improvement initiatives, and alternative pricing structures have become more commonplace, there’s still huge resistance by partners who cling to old methods despite evidence that they are outmoded. While operational improvements can be effective, the authors highlight the constant barrier to improving law firms’ delivery of legal services – compensation models. The reason many alternative fee structures fail is that the underlying cost basis is still the billable hour. And the billable hour shapes virtually all compensation structures in most firms. It can’t be an effective way of measuring performance anymore.
Firms must have the capacity and wherewithal to measure true profitability in matters. Most don’t have (or don’t use) the internal structures to do so. It is right to question law firms’ ability to change and to successfully adapt to market forces if the billable hour remains the standard measurement for firms. Rather than pursue a losing growth strategy, most firms would be better off to invest in creating operational efficiencies, focus on their clients’ needs and respond to them, and to differentiate themselves. These business strategies are no different than any other successful business in today’s hyper-competitive legal services market.
This leads to the other major conclusion made by the authors of this report. Operational change gets stymied because law firm leaders have only so much power to institute change. Law firm partners still refuse to empower their leaders to undertake the type of change needed to ensure the long-term success and profitability of their firms. Law firm partnerships are inherently self-serving entities where there has historically been little incentive to work together for the benefit of the firm. Many law firm partners don’t act like owners when it comes to compensation and desperately-needed change. Partners can freely take their books of business elsewhere if they don’t like what’s happening. Partners nearing retirement focus on their short-term gains and law firm leaders are at their mercy, unable even to persuade them to transition clients and thereby ensure the continued retention of the client after a partner retires. This is the antithesis of a corporate culture where everyone is working toward the same goal.
Those firms whose partners have ceded real authority to their leaders to make change apparently perform better. This conclusion by the authors was drawn from Altman Weil survey data. Although I reviewed the same data, I am more skeptical about drawing a strong conclusion so soon from so little data. However, I also have anecdotal evidence from discussions with large law firm consultants that some firms are undertaking the kind of sweeping changes the report suggests needs to happen.
There are not a lot of new insights in this report for some of us. But it does serve to confirm what’s happening in the market and the almost-certain trajectory of some law firms. Those who begin to grapple with these issues substantively and drive change instead of continuing to ignore the market have the opportunity to move toward successful adaptation and will be assured a future. Law firms who continue to ignore what’s happening around them may not have a future at all.