Something's Gotta Give: Partner Profit Rises While Law Firm Market Share Declines
Updated: Aug 15, 2020
Good lawyers are problem solvers. The best ones forestall problems and, when they inherit them, prevent metastasis. So with demand for legal services robust and law firm demand flat three years and counting, law firms have a problem. Its crux is a misalignment of the traditional law firm model with the marketplace—except, perhaps, in certain high-value matters. Is it being fixed? Soaring partner profits (PPP) suggest it is. But the increasing percentage of legal services rendered outside law firms indicates the contrary. Which is it? Short answer: partners have addressed their challenge—how to increase PPP with a declining demand. Firms, on the other hand, have an unsustainable model that remains largely in tact even as clients are seeking options.
The list of client gripes about law firms is long and familiar-- high, unpredictable cost; limited understanding of their business; poor process/project management; and ineffective communication. Technology is an especially significant factor in declining market share for law firms. Thoughtfully deployed, IT promotes efficiency; captures intellectual capital; streamlines process; fosters collaboration; substitutes products for services and—for all those reasons and more—is anathema to law firms’ performance and reward systems. The traditional law firm model is built on business generation and revenue. This is achieved by lots of billable hours under the rubric of ‘thoroughness.’ Any wonder why law firms have generally been laggards in effectively deploying technology?
Intense Competition For Firms - Especially From In-House Departments
The fiscal crisis of 2008 and its aftermath was an accelerant for the rise of tech and process savvy legal service companies. Unlike law firms that are prohibited by regulation from accepting institutional investment capital, leading service companies invest heavily in technology and process. They have a corporate DNA and mindset designed to create ‘better, faster, cheaper’ solutions to legal delivery that align well with corporate culture. Legal service providers have quickly become a multi-billion dollar market segment. Their agile, on demand models are attractive alternatives to the high on staff cost of firm attorneys. And so too is their reduced price structure.
But perhaps the biggest impact of the fiscal crisis is the explosive growth of in-house legal departments. It’s easy to dismiss ‘insourcing’ legal work as labor arbitrage. But the more fundamental reason for in-house growth is law firms’ inability to deliver legal expertise and value--as well as to integrate technology and process in delivery. The value deficiency is linked to the traditional firm model and culture. Law firm performance criteria and compensation is very different from corporate departments where business generation is not a success criterion--though advancing business and enterprise objectives certainly is. Plus, successful corporate counsel can earn equity (residual equity) whereas law firm partners whack up annual profits. Corporate lawyers have a long-term financial stake in their organization's success. In-house lawyers also have several ‘home field advantages’ over outside counsel. Some examples are: superior knowledge of enterprise goals and risk profile; collaboration with core business interests; and integration with the enterprise IT platform. For these and other reasons, corporate legal departments now comprise approximately 45% of total legal spend.
In-house size, influence, portfolios, compensation, and market share are rising steadily. Significantly, several large corporate legal departments have almost as many non-lawyer members as attorneys. This is because legal delivery is now a three-legged stool supported by legal, technological, and process expertise. Law firms are strong on the legal side but generally lag in technology and process skills. And law firm DNA is not receptive to providing an equal seat at the management table for technologists and service delivery experts. Simply put, in-house departments are doing a better job than law firms integrating technology and process into the delivery of legal services.