Law Firm Report Holds Several Urgent Wake-Up Calls for Industry

Originally published for Thomson Reuters Legal Executive Institute on January 14, 2015

Another important early report on law firm financial performance is out: The 2015 Report on the State of the Legal Market, produced by Georgetown Law and Peer Monitor. I encourage anyone who manages or depends on the delivery of legal service to read it.

David Curle made some excellent comments on the Report in his blog post last week. Today, I want to add a few more thoughts, focusing on three observations the Report makes, which I think identify powerful systemic factors affecting the evolution of the legal service marketplace.

The Legal Service Market Is No Longer a “Near Monopoly”

Not so long ago, the market for legal service and the law firm market were one and the same. Law firms enjoyed a “near monopoly” in the delivery of legal services. As the Report sets out in clear and objective detail, those days are over.

The Report notes how the buying habits of clients have changed, especially the habits of business clients. These changes are seen in more work being assigned to expanding in-house departments and increasing work being assigned to providers which are not law firms, which the report calls the “new competitors.”

The Report puts particular emphasis on the new competitors. It provides a useful overview of the breadth and nature of the new enterprises that are entering the market. Interestingly, it also discusses the inroads of the major accounting firms as another significant dimension to the market.

All in all, it is a new market, one the Report says is “awash with new, non-traditional competitors” and one that is “much more vibrant and competitive.”

As one would expect, in such an expanded and vibrant market, the market share of the traditional providers is declining, as is the price the market is willing to pay them. This is an important reason that law firms find it ever more difficult to keep their highly paid lawyers fully utilized and why realization rates continue to plummet.

For all those who manage and lead law firms, the Report’s observations about the changing marketplace should serve as yet another wake up call. The challenges each firm experiences every day are caused, in part, by the profound change in the makeup of the market. The long-term welfare of all law firms requires thoughtful long-term strategic action that takes into account changed client behavior and the benefits the new competitors offer clients. Short-term tactics won’t work for the long-term.

The Law Firm Market May Have Segmented Permanently

The law firm market seems to be evolving to into two segments: an elite few and all the rest. The Report confirms this idea and says it may be here to stay.

According to the Report, “there is now strong evidence that the U.S. legal market has segmented in discernible categories of the highly successful and less successful firms, and that the performance gaps between those categories has been steadily widening.” It finds this phenomenon not only in the AmLaw 100, where 20 “elite” firms have pulled away from the pack, but in the AmLaw Second-100, as well.

The Report further observes that the combination of the market-leading nature of the practices of the “elite” firms and the magnitude of their profit advantage are creating barriers to entry for other firms. “…the segmentation that is now emerging feels somewhat different and more permanent than before,” the Report states.

Obviously, there are enormous competitive advantages for the “elite” firms, which almost certainly will compound over time.

For everyone else, however, this development will intensify the competitive pressure, especially in light of the growing body of new competitors vying for the same work. In fact, these two changes in the market will have a compound effect, literally.

Another wake up call.

Law Firm Metrics Impede Progress

One of the curiosities about the current legal service market is how little sense of urgency law firms, especially BigLaw, exhibit. The Report calls it “astonishing.” Everyone acknowledges that profound change is underway, yet few firms are doing anything truly meaningful to adapt the way they deliver and price service.

The Report considers several possible explanations for law firms’ resistance to change: human nature, inherent lawyer conservatism, and the financial success law firms continue to enjoy. All of these surely are at work.

Most interesting was the final reason the Report identified: the metrics that law firms use to measure performance and make compensation decisions. Nearly all of those metrics are based on “inputs”—hours spent—rather than “outputs”—value received by the client. Misguided as this may be (the Report calls it “absurd”), it erects a powerful “roadblock” to changing delivery systems. Lawyers are rewarded for working more hours and generating higher client bills. It is not in their interest to find ways to do things in less time for a lower fee. In this environment, it is not surprising that there is not much urgency to find more efficient delivery systems.

Lawyer behavior won’t change until firms change the metrics they use.

Yet another wake up call.