Ladies and Gentlemen, looks like we have consensus about our situation. Or almost.
The Report on the State of the Legal Market (Peer Monitor/Georgetown) came out in early January followed by the Citi Private Bank 2014 Client Advisory (Hildebrandt) a week later. The Report on the State of the Legal Market noted an overall drop in demand for 2013 of slightly more than 1%, with a substantial shift to in-house work as part of a general reduction in engaging outside legal services and a further trend to move work that does go outside away from more expensive top tier firms to less expensive, more efficient ones. The conclusion was that there has been a permanent change in the marketplace that firms will have to recognize and adapt to. “The current trends… reflect fundamental changes in the nature of competition in the legal market, changes that have been increasingly evident since 2008… The first and perhaps most obvious change is that the legal market has become much more intensely competitive than it was five years ago.”
Included in the report were statistics from the 2013 Altman Weil Chief Legal Officer Survey that indicated that 44% of over 200 CLOs surveyed had shifted work to in-house lawyers during the prior 12 months, and 30.5% had reduced the total amount of work sent to outside counsel. “Moreover, some 29 percent of respondents indicated that they intended to decrease their overall use of outside counsel in the next 12 months, and only 15 percent said they expected to increase such use. Consistent with these responses, 47 percent of CLOs indicated that they had decreased their budgets for outside counsel during 2013 (a figure that compares to 39 percent in 2012 and 25.4 percent in 2011).”
The report concludes that: “[G]rowth-for-growth’s-sake strategy makes little sense… Even if there can be assumed to be some economies of scale… there’s little proven correlation between size and profitability – and at some point there are even diseconomies of scale.” As one commentator noted: “There are plenty of issues facing the law firm industry; this report makes the argument that the one strategy that firms seem to be consistently applying to address those issues – growth through mergers and lateral hires – is simply not going to meet the challenges.”
Debunking the growth-will-solve-everything approach is certainly not new. Bigger is not better is more recently the recurring mantra, and that started well before the Great Recession. Latest are the reports that Big Law is declining and mid-size firms are increasingly winning market share. An HBR author titled his blog entry “Law Firm Pedigree May Be a Thing of the Past,” quoting one GC who said: “I would absolutely fire anyone on my team who hired Cravath.”
Why are we stuck in the growth-as-a-solution ditch? According to the Report of the State of the Legal Market: “To address the concerns of clients for more efficient, predictable, and cost effective legal services, law firms must focus their attention on re-thinking the basic organizational, pricing, and service delivery models that have dominated the market for the past several decades.” However, “the message that we need to ‘build a bigger boat’ is more politically palatable than a message that we need to fundamentally change the way we do our work.”
The Citi Client Advisory comes to essentially the same conclusions about the current marketplace as does the Peer Monitor report. Citi reports that,“we do not project a return to pre-2008 levels of performance. We believe that we have witnessed a fundamental shift in the market for legal services, resulting in a changed and more muted demand environment for law firms. While some elements of demand are cyclical, the fundamental changes described in our Client Advisory will require law firms to embrace and respond to a new reality.” Or as one commentator put it: ”the growth curve has been permanently bent downward from the pre-2008 years.” (emphasis added)
But the Advisory is much more positive about law firms’ abilities to maneuver through the shoals. It characterizes growth as more deliberate and strategic, with better planning and execution, than in the past. Citi sees more firms moving from cutting expenses and prices toward actively pricing legal matters, using more sophisticated professionals and technology in the process. And finally, “Unlike the commentary of many observers of the legal profession suggesting that today’s senior management do not ‘get it,’” it argues that law firm leaders have recognized the need for changes and have beefed up their management skills and staff expertise to effectuate them.
However, the Peer Monitor Report makes the case for how uncommitted to the hard process of change law firms in fact are, noting “that few firms seem willing to go there, showing little appetite for new price models, staffing models, and packaging and delivery models.” Citing Altman Weil’s 2013 Law Firms in Transition Survey of 238 managing partners of U.S. law firms with 50 or more lawyers, “the law firm leaders surveyed clearly understand that the legal market has changed in fundamental ways, with substantial majorities agreeing that permanent changes in the market [are taking place]… And 66.7 percent of respondents indicated that they believe the pace of change in the legal market will increase going forward. And yet, only a minority of firms has undertaken any significant changes to their basic business models.” (emphasis added)
What’s the hold up? Fingers point rapidly away. When asked to rate their “partners’ level of adaptability to change” on a 0 to 10 scale, the median rating was 5 (in the “low” range), with only 2.2% indicating a “high” level of adaptability. “[A]sked how serious they believe law firms are about changing their legal service delivery model to provide greater value to clients (as opposed to just reducing rates)… respondents produced a median rating of 5 (in the “low” range). That compared to a median rating of 3 given by corporate chief legal officers when asked the same question in October 2012.” Woops. Client perception is dangerously out of line with our own.
In fact, when asked to list “the greatest challenges their firms face in the next 24 months, the top four answers from respondents (which constituted just over 50 percent of all responses) were all internally focused issues aimed at protecting the status quo of the law firm and not at becoming more responsive to clients.”
As the Peer Monitor Report concludes: ” [T]he legal market may be currently poised for what could be a dramatic reordering based on the same type of disruptive forces that have reordered many other businesses and industries.”
Almost a decade ago ClayChristensen authored a white paper on “Transforming Legal Services,” in which he noted that law firms have been able to successfully make outsize profits –40% on average for the AmLaw 100, or roughly twice the average margin of the country’s 100 largest publicly-traded corporations–without updating their product or their business model. He warned, though, that that success was unlikely to continue: “In the parlance of disruptive innovation theory, corporations are ’over-served’ when they pay top-firm rates for routine matters… Corporations have reacted by fragmenting their legal spend… For the leading law firms, fragmentation means loss of market share.”
Christensen’s article in the October 2013 issue of the Harvard Business Review argues “that a disruptive transformation in the legal market may well already be underway… . The pattern of industry disruption is familiar: New competitors with new business models arrive; incumbents choose to ignore the new players or to flee to higher-margin activities… [A]lthough we cannot forecast the exact progress of disruption . . ., we can say with utter confidence that whatever its pace, some incumbents will be caught by surprise. The temptation for market leaders to view the advent of new competitors with a mixture of disdain, denial, and rationalization is nearly irresistible… As we and others have observed, there may be nothing as vulnerable as entrenched success.”
What was it that bankruptcy specialist Martin Bienenstock said, who toward the end was made a member of Dewey & LeBoeuf’s office of the chairman? ”I think the world changed… and no one saw the new world coming.”