The More Things Change

Change, Same Green Road Sign Over Dramatic Clouds and Sky.Two reports issued in the opening days of 2014 show a sharp juxtaposition between dynamic and disruptive trends in the legal market and the static strategy of firm leaders.

The first was from Georgetown Law Center for the Study of the Legal Profession and Peer Monitor. Their 2014 Report on the State of the Legal Market detailed data about the current state of the market, including the dropping demand for legal services, productivity and profits per partner.  The authors cautioned firms against following a growth-for-growth’s sake strategy, arguing that new client-based business models providing more efficient, predictable and cost-effective legal services are the only way to viability.

Ironically, nearly simultaneously, Altman Weil released a report showing that 88 law firm mergers or acquisitions were announced in 2013, an increase of 47% over 2012 and the highest number of combinations since Altman Weil started tracking them seven years ago.

A continuing tension between firms and clients over billing rates is reflected by detailed billing data in the Georgetown/Peer Monitor Report. Over three years, firms increased their standard rates by 11 percent whereas the collected rates actually achieved by firms went up only 8.8 percent.  Realization rates, the percentages of work performed at a firm’s standard rates that are actually billed to and collected from clients, have continued to drop.  “On average, law firms are collecting only 83.5 cents for every $1.00 of standard time they record.  To understand the full impact, one need only consider that at the end of 2007, the collected realization rate was at the 92 percent level.”

An unsustainable law firm model based on the ability to raise rates 6 to 8 percent a year is one of the several factors (others being the growing availability of public information, the drive toward commoditization of legal services, the emergence of non-traditional service providers and the changing role of in-house counsel) the authors point to as having contributed to fundamental changes in the nature of competition in the legal market.

Over the last several years, clients have been exercising increasing control about the key decisions relating to representation, beating a constant drumbeat for “value” a/k/a efficiency, predictability and cost efficiency in the delivery of legal services.  Quality is no longer a selling point—it is assumed.

Against the historical data, the authors debunk the common justifications for growth and urge that “[s]trategy should drive growth, not the other way around…. Much of the recent growth violates this premise and masks a bigger problem—the continuing failure of most firms to focus on strategic issues that are more important for their long-term success than the number of lawyers or offices they have.”

Getting into the mindset of managing partners is an exercise in inconsistency. Managing partners nearly uniformly stated in responses to a 2013 survey that they understood that permanent changes in the legal market included more price competition, a focus on improved practice efficiency, more commoditized legal work and more competition from non-traditional service providers.  At the same time, their responses indicated they had little confidence in their own firms’ ability to keep pace with the challenges in the new legal marketplace and candidly admitted their law firms were not serious about changing their legal service delivery model to provide greater value to clients.  Asked to identify the greatest challenges their firms faced in the next 24 months, the majority of the respondents prioritized issues not focused on becoming more responsive to clients but instead aimed at protecting the status quo of the law firm, i.e., increasing revenue, developing new business, growth and profitability.  And growth as a strategy?  Despite all the responses leading to an opposite conclusion, fifty-six percent of the survey respondents said that increasing lawyer headcount is required for their firms’ continued success.

This leads us back to the Altman Weil report and the record number of law firm combinations in 2013.  The report also showed early indications that 2014 may bring more of the same. (The word “combination” actually is a misnomer because a merger between equal-sized firms is rare, fraught with conflicts and “any number of potential pitfalls on the way to the altar,” according to Altman Weil principal Ward Bower.) “The surge in 2013 numbers was driven by a boom in acquisitions of small law firms…smart, low-risk moves to enter new markets and acquire new clients, and we expect the trend to continue in 2014.”

These moves may be ill-advised if one believes that the legal market is being disrupted and will be re-ordered along the lines of the changes that have re-shaped many other industries.  However, the M & A activity may be a manifestation of the resistance and denial that is a common response to evidence of disruptive change.

In a fascinating article in the Harvard Business Review last fall, Clay Christensen, Dina Wang and Derek van Bever discussed their research and conclusions about the forces that bring about changes affecting the professional services industries of consultancy and law.  Every industry will face disruption, according to the authors. They point to the changes that have affected the legal industry over the past several decades as a harbinger of disruptive change coming to the world of consultancy.  “The leaders of the legal services industry would once have held that the franchise of the top law firms was virtually unassailable, enshrined in practice and tradition—and, in some countries, in law.  And yet disruption of these firms is undeniably underway….”

In concluding, the authors warn that although the exact progression of disruption cannot be predicted,

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.  U.S. Steel posted record profit margins in the years prior to its unseating by minimills; in many ways it was blind to its disruption.  As we and others have observed, there may be nothing as vulnerable as entrenched success.”

Indeed.  I wonder what growth will characterize the legal industry in 2014?

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