Sooner Than You Think! When Do Law Firms Need to Take Alternative Legal Providers Seriously?

Topics: Billing & Pricing, Corporate Legal, Law Firms, Legal Innovation

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It’s now been eight long years since the beginning of what amounted to the financial crisis and the ensuing countless predictions of the demise of big law firms. But nothing like it happened. Looking back, you can only conclude that law — as practiced by the big firms — is a stable business.

The perpetual rise in firms’ revenue and income reversed briefly as demand dropped by 10% to 15% over an 18-month period between the middle of 2008 and the end of 2009. Rates — the equivalent of prices — showed softness as a result of lawyers rushing to offer discounts to their good clients and prospective ones. Lawyers also entered into alternative fee arrangements without much of an idea of how to manage them commercially. And since law firms uniformly reacted by shedding excess supply, i.e. firing underproductive lawyers, their realized rates trended downward only by a few percentage points.

Many legal pundits suggested that firms faced existential threats from dropping demand as General Counsels and Corporate Legal departments demanded “more for less”, while technology-assisted disrupters and alternative service providers ate away at the law firms’ share of legal spend.

And yet, firms’ rates have recovered, rising year-over-year since 2010: demand is stable, and firms have figured out other ways to grow revenue and profit, albeit at a slower pace than before. Some firms, especially in the UK, have decided to compete with technology and alternative providers by offering their own solutions. But most firms have done, frankly, nothing beyond adding some fig-leaf “fixes”.

The Threat at the Doorstep

So why should law firms take alternative providers seriously now?

Well, unless law firms integrate alternative delivery (including technology) robustly, they may be facing an existential threat after all. And that threat could be arriving on their doorstep sooner than you think.

Currently, alternative delivery in the US is estimated at less than 1% of the total market. Europe is probably a bit lower; the rest of the world is lower still.

The alternative players, from first movers who became industry leaders like Axiom Law and Pangea3 (now Thomson Reuters Legal Managed Services) to the many, many tech-focused legal market ventures that have seen the light of day in the past few years, are said to be growing at 20% annually.

Still, you may ask: what’s the big deal? Growing a less-than 1% share at 20% every year still doesn’t get you to even 1/20th of market share in a decade, right? And that doesn’t even factor in that over the next 10 years, law firms will have figured out how to compete with the alternative providers through their own, captive means.

All true, and yet this view ignores three factors which all lead to a very different outcome by the year 2020:

  1. We project a linear development when, in fact, it is more likely to be exponential. Today’s less than 1% market share represents the bottom of the S-curve. Money, hungry for returns, has discovered the legal market and made its first killings. That sight attracts more money. And all that capital will get better and better at finding profitable revenue within legal services. You should expect growth more in the 50% per annum or even higher range. The math quickly becomes scary.
  2. We don’t account for the displacement effect of revenue earned by the alternative players. Law firms in the aggregate have been growing revenue at around 2% to 3% annually since 2010 (excluding revenue changes from acquisitions and divestitures). If one dollar earned by an alternative provider means a dollar lost to law firms, the rise of the alternatives would only stop total revenue by all law firms from growing in about 10 years. But a dollar earned by the alternatives displaces approximately three dollars lost in law firm revenue. If the displacement effect is at a factor of three, then total law firm revenue stops growing six years from now.
  3. Finally, we are also forgetting that law firms implode because they don’t make enough money to keep partners happy. The partnership business model of every law firm today requires growth: stagnation and/or shrinkage tanks profitability, risking key partner defections. Of course, firms can manage a bit of revenue shrinkage from one year to the next if they react early and take action by cutting costs. But an unexpected shortfall of revenue by 3% translates to a 7% to 10% shortfall in distributable profit and almost certainly will also translate into the end of that firm. It doesn’t require a huge revenue decline for fickle partnerships to bite the dust.

And still, you might say: Meh, I am still not convinced that law firms must collaborate with alternative delivery providers now. And you are right in that a few will never be threatened because of what they do. But the group is quite small while the number of firms who think they are part of the group is a lot larger.

Of course, every firm does a good amount of work that is only tangentially affected. The mistake, however, is to look only at that work and conclude that the firm is doing fine. Today, 25% to 50% of the revenue of most large law firms is already squarely under attack. And that portion will only grow over time.

It is smart to face this reality and embrace alternative providers and technology, and to proactively show clients how to integrate both of those factors to achieve better, faster and cheaper delivery of legal services overall. That offers the best chance for most large law firms to survive and thrive in this market.