The stratified legal market and its implications

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An extraordinary conversation has emerged among multiple authors in the blawgosphere over the past few days. It revolves around a pressing question: in light of the huge changes in the marketplace, what will become of law firms? More specifically, given the increasing segmentation and stratification of the universe of legal work, how can law firms — traditional, inflexible, one-size-fits-all businesses that they are — respond to these changes and continue to thrive? Can law firms serve multiple segments of a newly diverse market simultaneously, and if so, how?

No fewer than seven articles by six writers have explored this subject so far, and I recommend you take 10-15 minutes and go read these pieces (if you haven’t already) before continuing:

Collectively, these posts represent a deep dive into a subject that should command the attention of law firm leaders in firms of every size, because they identify a fundamental challenge. The nature of legal work is changing, and when demand changes, markets require suppliers to change as well. Law firms must adapt to at least some degree; but how, and in what ways? Inspired by all these posts, here’s my assessment of where we find ourselves right now and whether and to what degree law firms can move forward from here.

When viewed from the perspective of clients (which, when you think about it, is the perspective that counts), there are three types of outsourced legal work (that is, work not performed in-house). This is roughly how clients would describe them:

1. Mission-critical.

This requires a lawyer.
It really matters who we use.
It doesn’t matter how much it costs.

“This is mission-critical stuff; if this doesn’t work out, the company takes a major hit and my job could be on the line. Conversely, though, if it works out, the company avoids a hit and/or makes a huge gain, and my star rises considerably. There’s no way we can pull this off ourselves — it’s too big. So we need to hire the best — that is, either the very best lawyers to get it done right, or the firm with the best reputation so that if it goes wrong, I can point to the firm’s rep and say, look, I chose the cream of the crop, so don’t blame me. I’ll pay whatever lawyers or firms like that cost.”

2. Ordinary course of business

This requires a lawyer.
It doesn’t matter who we use.
It matters how much it costs.

“This needs to get done, and it’s definitely lawyer work, and we don’t have the manpower in-house to do it. But it’s also the kind of thing that comes up pretty frequently in our business. And of course we want it done well, but a loss or a failure wouldn’t be fatal. ‘Good enough” is good enough here. Many lawyers and a lot of firms do this kind of work, so we’ll be well served no matter who we choose. But with the budget pressures I’m under, I’m going to make sure that whoever we hire has a good system in place for doing this work and bills below the median rate. I can afford to set some conditions.”

3. Commodity

This doesn’t require a lawyer.
It doesn’t matter who we use.
It really, really matters how much it costs.

“This needs to get done, but this is basic stuff and it’s the sort of thing that comes up over and over again. I’ll find a cost-effective outside solution that can process these matters rapidly, repeatedly and reliably: a professional staffing firm like Axiom, a freelance contract lawyer, or maybe an LPO. Unless we’re really lucky and can find a law firm to do it as well and as cheaply as these other suppliers (which I seriously doubt), I can’t justify asking a typical firm to do this — even their discounted rates are more than this is worth.”

(This division is inspired in no small part by John’s rate pyramid. It also helps to think of these three types of work as occupying, in declining order, the five stages of legal matters proposed by Richard Susskind: bespoke, standardized, systemized, packaged, and commoditized.)

Law firms have long supplied all three types of work to clients, invariably by way of the cost-plus billable-hour system. Clients, lacking both other options and the incentive to go look for any, went along. One market, one model. But now there are three markets: mission-critical, ordinary-course-of-business, and commodity. The universe of legal work has segmented and stratified. (One can argue that it was always segmented and stratified, but that the market mechanisms to recognize and process this segmentation didn’t exist till now, which I think is fair.)

The question before us is whether one law firm can still supply all three types of work, or even two of the three. More specifically: is it possible for a firm to do so, and then, is it feasible?

1. Is it possible? Yes, as my friends make clear in their blog posts. Ron and Toby point out that the hotel and banking industries feature companies that successfully serve different market needs through different brands. In a similar vein, Steve points to Toyota, a company that profitably produces both the Lexus and the Yaris. To those three examples, I’d add a fourth: shoe stores. Many people don’t realize that the five or six different shoe stores in your average shopping mall, each geared towards a different market segment, are often owned by the same company. Theoretically, there’s nothing preventing law firms from taking the same approach, adapting their offerings to the demands of each market segment.

2. Is it feasible? Here’s where it gets tricky. In practical terms, how would a law firm go about offering both mission-critical and ordinary-course-of-business services simultaneously, within the same enterprise? This raises problems that, on the whole, I see as insurmountable.

  • The structures for each tier (let alone for the commodity work) are very different and would require, at a minimum, separate facilities in different locations: Hilton doesn’t house Astorias and Hampton Inns in the same complex.
  • They would have to operate under different brand names: Cravath can’t start up an employment-law subsidiary under its high-end corporate name, for the same reason that Florsheim doesn’t sell basketball sneakers: the brand dilution is too strong.
  • And as Mary points out, support systems and infrastructure will differ too. Will one part of a law firm will suffer systematization and efficiency measures when other parts of the firm continue to happily bill by the hour? And could that even be managed financially?

But I think there’s a more fundamental challenge, which Mary also raises: “How do you handle the potential for income disparity and differing levels of respect for the lawyers in each practice?” To an extent, this is a problem in current full-service law firms, where some partners earn ten times or more what others make. But in an explicitly two- or three-tiered law firm, it would become intolerable, because there would be clear divisions in quality of work, level of pay, and inevitably, quality of lawyer, and that simply will not be borne.

Every lawyer considers himself or herself to be an exceptional talent, and if there are some within the firm who make more money, well, that can be an accident of economics, and if there are some who are clearly incredibly gifted, well, we all like to have a few superstars on board; but let’s be perfectly clear, we’re all excellent around here — we’re only talking about degrees of excellence. This is the fiction that all lawyers in a firm tell themselves, even when the hard truth is that, as Mark puts it, most lawyers are mediocre (I’d use the more charitable term “ordinary”). The politeness of collegiality (which some partners lack the manners to maintain) asserts this fiction of excellence because it makes everyone feel better about themselves and improves morale and unity of purpose. But a firm that publicly announces, “We have one set of lawyers for extraordinary work and another set for the basic day-to-day stuff,” abandons this fiction and  suffers the consequences. Firms hide this division today under the “full-service” label, but it exists and everyone knows it; keeping it hidden and unspoken is one of the things holding many law firms together.

At a certain point, the multiple divisions within a tiered firm would diverge so widely that they would  effectively become separate firms, bringing into question the point of the whole exercise. Could a law firm create a holding company to manage a fleet of separate legal enterprises? Within the right legislative environment, sure — but why would it want to? How could it be worth the hassle? It’s hard enough to manage a single law firm, and as Ron suggests, lawyers don’t possess a ton of management acumen or entrepreneurial spirit. Berwin Leighton Paisner’s Lawyers On Demand service, which Ron references, may be the only really successful example I’ve seen of a law firm operating two legal business models simultaneously — and even that service, which explicitly offers different types of lawyers serving different types of client needs, looks like it might be spun off into a separate entity.

For these reasons, I think it’s next to impossible, in practical terms, for a law firm to explicitly serve both the mission-critical market and the ordinary-course-of-business market: the requirements are too different and the cultural pressures too intense. A firm can position itself to offer ordinary-course-of-business services — Mark cites the example of a “big-firm quality at small-firm prices” brand that presents a sensible-yet-still-professional image to the market and allows everyone to save face. But that image can’t co-exist, within the same enterprise, with a “We’re the very best in the world and you’ll never get fired for hiring us” brand. Very few lawyers beyond their third year of call will voluntarily wear the “second-class status” discount tag with a smile.

So how will this dilemma be resolved? Legal work is segmenting and stratifying, and law firms can no longer profitably perform this work in a one-size-fits-all business model: mid-level work requires a degree of management and systematization, while the truly commoditized work requires full-scale business process re-engineering. But it seems to me that trying to operate two or three different business models under the same roof, name or brand will generate centrifugal forces too powerful to contain. How does this story end?

I think, inevitably, it ends with the breakdown of many of today’s large, full-service firms into smaller enterprises that serve these component markets:

Mission-critical work will go to a small cadre of firms with outstanding lawyers and outstanding reputations: they might be global, but they won’t be as massive as they are today, because they will require fewer lawyers on-site to carry out their work and will instead make use of the “commodity”-type enterprises described in #3 above to carry out the more routine work that associates and junior partners used to do. These mission-critical firms will retain the powerful names and brands that their best lawyers helped forge over the years. They will charge stunningly high rates and will likely operate much the same as today’s law firms do.

Ordinary-course-of-business work will be the province of large firms that have evolved the types of systems, procedures and philosophies that reflect the “Law Factories” Ron writes about. They will routinely make use of legal project management, automated document assembly, dynamic knowledge management, online service delivery and other innovations that reduce the cost and increase the efficiency of legal service delivery. Will they do good work? Of course! Competence is not an issue within any of these tiers. But the work will be less valuable to clients and will be priced more competitively, necessitating a frugal-innovation approach. These firms might very well employ lockstep partner compensation, since the corner-office gorillas will have decamped to the mission-critical providers. Some of these firms will be direct descendants of today’s big firms, with the same names and addresses; but many more will be entirely new creations, formed from the splintered remains of today’s big firms that found themselves caught in the no-man’s land between the high-end critical and low-end commodity markets.

Commodity work will, for the most part, have left the legal profession behind. It will belong to enterprises that resemble informatics providers more than law offices. Indeed, leading the pack will be companies like Thomson and its Pangea3 division, along with other financial, data and information companies like Bloomberg and LexisNexis (and maybe Google?). Legal process outsourcing companies will be players, some of them riding a wave of venture investment made possible by the Legal Services Act and its North American progeny. At the consumer end, look for outfits like Wal-Mart or CitiBank to offer as many basic legal services as regulations will allow. This is the work that has, in Steve’s words, risen up “through the floorboards” and is now, as Toby suggests with banks and check-cashing services, no longer lucrative enough to warrant lawyers’ efforts.

That, to my mind, is the near-term future of the legal marketplace: a wide-scale disaggregation of full-service law firms into smaller enterprises adapted to meet stratified market segments. If you think that sounds like a chaotic, messy and deeply upsetting experience for the legal profession, then I think you’re right. Law firms are complex business models of the kind Clay Shirky warns about, and when these models pass the point of maximum complexity, they don’t gradually disassemble themselves in an orderly manner: they simplify, quickly and radically. I don’t hope for that outcome. But it’s difficult to see another likely way for this to end.

Jordan Furlong speaks to law firms and legal organizations throughout North America on how to survive and profit from the extraordinary changes underway in the legal services marketplace. He is a partner with Edge International and a senior consultant with Stem Legal Web Enterprises.

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7 Responses to “The stratified legal market and its implications”

  1. Carolyn Elefant

    I was wondering about this recently on solosez- designers like Norma Kamali or Mossimo also have a discount line for Target and Walmart – yet it does not seem to impact their brand.

  2. John Wallbillich

    This is great, Jordan. It’s almost like we are witnessing the anti-convergence. What was once a virtue (“full service firm”) now sounds like a vice (“commodity work at mission-critical prices”).

    I did update my diagram today (and included a PDF of it as well):

    http://www.wiredgc.com/2011/03/25/legal-billing-rates-the-next-wave-2/

    The timing of this is the great unknown. Most GCs dip a toe in something new before jumping in. Small projects pushed one layer down the pyramid could lead to bigger ones jumping a layer or two.

    The best part of your summary of Ron, Toby, Mary and Steve’s work is that it is so much more interesting than yet another “Value Billing and AFAs” debate.

    Howrey failed faster than most AFAs take to negotiate.

  3. James Hannigan

    Thanks Jordan for this analysis, I’m a fan of your blog and tweets. I was curious to know why you think legal info companies like Thomson and Bloomberg would specialize in providing outsourced legal services. There’s nothing that strikes me on a superficial level of that being an obvious play.

  4. Jordan Furlong

    James, thanks for your comment! I was as surprised as anyone when Thomson bought Pangea3 last fall, but in the bigger picture, it makes sense: Thomson has been adding more client-facing services recently (Serengeti is the best example) and it seems to me they’re intent on being at least a parallel supplier to clients and maybe a directly competing supplier vis-a-vis law firms. My theory is that the most coveted position for a supplier is to sit at the client’s right hand, receive its instructions, and coordinate the responses of numerous diverse suppliers to deliver its legal solutions. I’ve no idea if this is what Thomson is angling for; but their recent activities would be consistent with this strategy.

    Bloomberg might not be pointed in exactly the same direction, but it’s another information services company and it’s already served notice of interest in the legal market with the launch of its legal research service. Basically, any entity that’s in the business of processing information is a potential competitor to law firms, because processing information is part of what many firms sell right now. It might be that LPOs aren’t the best play for companies like these, but I can easily see them invest in other offerings that could cut law firms out of the “knowledge” market altogether on both expertise and price.

  5. James Hannigan

    Thanks, I see. Certainly ediscovery is one area where that’s true, maybe due diligence also – bingo, just what the LPOs specialize in. Ediscovery is becoming more and more about search technology and process efficiency which is up their alley also.

  6. Kevin Thompson

    Jordan, first time I’ve read an article on your blog. Great post. I particularly like the statement you made: ” they’re intent on being at least a parallel supplier to clients ” in response to James’ question. I think this speaks directly to the fact that potential clients look at traditional, inflexible law firms as just that, traditional and inflexible. Why go through the process of wading through countless close-minded firms when Thomson (or whoever) will be there with a much more diverse solution for the consumer. Speaks to the lack of foresight of the firms that Thomson can even position itself there and be a parallel supplier.

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