Transforming the Three-Dimensional Law Firm Business Model

In the legal profession, upheaval is the new normal. Every person who works in a law firm of any size – partner or associate, staff or administrator – is affected by this upheaval. It has also hit travel agents, stock brokers, print journalists and many middleman professions that are endangered by overstaffing, loss of specialized knowledge as the Internet becomes pervasive, and commodity pricing. The issue in every such profession is the customer's evaluation of cost versus benefit. And for law firms, this goes to the heart of the traditional business model.

Three basic dimensions of that traditional business model have not changed: marketing (securing new clients and maintaining existing ones), production (completing the legal work as efficiently and effectively as possible), and finance (collecting enough money to keep the firm in operation). Multiple factors affect these fundamental elements and are changing rapidly. The over-abundance of lawyers in the profession for the more affluent client creates more competition and price pressure in the marketing arena. Computer technology is making the production function so rapid and efficient that clients consider legal services as fungible commodities. And the ongoing price pressure means that firms need new billing approaches as fees are constrained.

In the new normal, lawyers must partner with their clients and work to reduce client legal costs through efficiencies that bring in more work and revenue to maintain overall profitability. This must be done within the formula that defines all business success: Profit equals revenue collected less expenses, or P = R - E. Using technology to provide efficiency is essential to transforming the marketing, production and finance dimensions of the legal business model. New competition, new technology and new billing pressures are creating a new cost-benefit dynamic that defines the profession's three-dimensional future.

MARKETING AND OVERSUPPLY

An oversupply of lawyers has impacted the marketing function even as it has strained the human resource dynamic. With aging lawyers working longer, and law schools continuing to crank out at least 40,000 new juris doctors every year, something has to give. De-equitization of underperforming older partners and layoffs of other firm members at every level are grudgingly accepted – law firms no longer have any such thing as tenure. But there are wider implications than this for the future of law firm marketing.

The problem is not lack of work for lawyers. As society becomes more litigious and more highly regulated, causes of legal action impact the everyday lives of hundreds of thousands, if not millions, of people around the country. There is plenty of work available for those small firms that are flexible in their cost structures and nimble enough in their legal analysis. And that directly relates to the use of technology in the production function.

Today, American law schools are like factories that continue to produce excess product – young lawyers – that the market can no longer absorb. The results are such marketing trends as:

• The convergence in which large corporate clients reduce their legal expenses by paring down the hundreds of outside counsel firms that they previously used to a few dozen or less

• The onshoring by legal staffing companies that hire lawyers in lower-cost areas in the United States and pay them less compensation for repetitive work, which is provided through a virtual online relationship

• The proliferation of do-it-yourself websites purporting to offer advice, research and forms in such areas as family law, probate, real estate closings and even patent filing

The problem is not lack of work for lawyers. As society becomes more litigious and more highly regulated, causes of legal action impact the everyday lives of hundreds of thousands, if not millions, of people around the country. There is plenty of work available for those small firms that are flexible in their cost structures and nimble enough in their legal analysis. And that directly relates to the use of technology in the production function.

PRODUCTION AND COMMODITIZATION

Commoditization has become a major issue in the production model. Today's firms are frequently expected to provide certain kinds of work with relatively steady volume (such as patent filings or employment litigation) at fixed rates over a certain period of time, turning these matters into the legal equivalent of a commodity. With commoditized services lawyers focus on specific targets, such as settling cases for the lowest legal cost and settlement amount where warranted. Large corporate law firms and small solo practices are equally impacted.

• Here is how the impact of commoditization transforms the legal production function:

• Very few matters are seen by corporate clients as bet-the-company issues. As a result, there are fewer absolutes for what is best in terms of firm quality and reputation.

• Leverage is no longer as powerful an economic tool for firms. The principle of using associates and paralegals, who are paid less to do work that is billed for more, has been replaced by clients outsourcing this work or taking it in-house to do it themselves.

• To counter this trend, law firms increasingly use technology to control work flow, almost on an assembly-line principle. For example, the more equipment a factory uses to make a product, the less labor it requires and the lower it can make its prices. With lower prices, the factory can increase volume and profits. Law firms will increasingly validate this principle.

• Cost efficiencies can no longer be had by cutting overhead – whether that means people or infrastructure. After years of recession, there is not that much left to cut. The real need is not cost-cutting, it is efficiency. And that means efficiency in use of human resources: merit-based compensation, a smaller partner track and the end of "up-or-out."

It also means using technology as a competitive tool. This trend in litigation is well-advanced, as e-discovery software can analyze documents required for litigation discovery in a fraction of the time for a fraction of the cost when compared to using lawyers for the task. Some programs not only find documents with relevant terms at high speed, they extract relevant concepts and deduce patterns that would have eluded lawyers examining paper copies. Inescapably, many lawyers who used to conduct document review will no longer be billable. Profitability for the firm comes from swiftly analyzing the millions of equivalent paper pages that electronic documents represent. This is the template for the future production function.

COLLECTIONS AND REALIZATION

Law firms cannot continue to try to do marketing and production using the same tried-and-true techniques of past generations with the hope that somehow they will produce more revenue for the firm. The result is inevitable: Collections, and thus, cash flow will be impacted by the heightened competition for reduced price services, so small firms must fixate on their realization rate. Low realization remains the biggest financial problem for most lawyers. Failure to have a 95 percent realization rate means that, even as the firm pays expenses at 100 cents on the dollar, it is earning less. This lost cash flow leads to disaster if it continues.

Striving to get paid quickly for the work that has already been done requires ongoing emphasis on the firm's receivables, which means charging other than a strict hourly rate for greater efficiency. Being able to maintain billings while becoming more efficient necessitates changing the billing system to embrace alternative fee arrangements. Using contingent, fixed, capped, value fee approaches – where time is not the relevant issue – to determine the fee is essential to leverage technology effectively. Any such billing system must demonstrate value to the client, as the client defines it, to ensure that they pay promptly.

Only technology can reduce the cost of operations and thereby allow firms to pass on to the client some or all of those savings.

Most clients recognize the importance of and are willing to pay a fair fee for value. What they do not want is to pay too much – to pay for inefficiencies, duplications or unnecessary services. Firms can use case management software, client relationship databases, knowledge management databases, e-discovery software and more to improve legal service efficiency and quality, while simultaneously lowering legal costs to their clients. The clients care about the overall legal cost, not the hourly rate. Only technology can reduce the cost of operations and thereby allow firms to pass on to the client some or all of those savings.

NEW WORLD, OLD FORMULA

This review of changes in the marketing, production and collection functions summarizes a process that is far from complete. It does seem inescapable that lawyers will have to alter their business practices and cost structures in the new world created by oversupply, commoditization and billing pressure. As a consequence, lawyers will need to pay closer attention than ever to the needs and wants of their clients. But this is nothing new. Law as a profession must be client-centered for lawyers to retain their clients' loyalty. That requires lawyers and law firms to partner with their clients, and work to reduce client legal costs through ongoing transformation of marketing, production and billing efficiencies.