The platform is changing

Seth Godin calls it the WordPerfect Axiom, and he’s exactly right: When the platform changes, the leaders change.

WordPerfect had a virtual monopoly on word processing in big firms that used DOS. Then Windows arrived and the folks at WordPerfect didn’t feel the need to hurry in porting themselves to the new platform. They had achieved lock-in after all, and why support Microsoft. In less than a year, they were toast.

When the game machine platform of choice switches from Sony to xBox to Nintendo, etc., the list of bestelling games change and new companies become dominant. When the platform for music shifted from record stores to iTunes, the power shifted too, and many labels were crushed.

Again and again the same rules apply. In fact, they always do. When the platform changes, the deck gets shuffled. …  Insiders become outsiders and new opportunities abound.

This is happening, right now, in the legal services marketplace. The platform for legal service delivery is changing, and if you’re standing on it — and most lawyers are — you’re going to find it very difficult to keep your balance.  The platform used to be the traditional, top-down, hourly-billing, pyramidic law firm, where lawyers set the parameters for where, how, and at what price their services would be made available. Other potential platforms were either underfunded, impractical, or unauthorized. The legal profession as we know it today grew up secure and well-fed on this platform and has flourished as a result. Now, a platform shift is occurring.

We’ve already felt some tremors; now the full-scale quakes are arriving. Howrey LLP is preparing to cut 10% of its partnership after experiencing a 35% drop in equity partner profits. Clifford Chance has changed its governance structure allowing it to do the same thing. A major report from Hildebrandt and Citibank warned that more de-equitizations are coming this year because there’s nothing else left for firms to cut. Respected New York IP boutique Darby & Darby disappeared without warning (and, if you believe the accounts at Above The Law, it went out poorly). Corporate law departments are pulling work back in-house, spending less on outside counsel and turning to alternative fee arrangements. Law firms across the United States are cutting back radically on law student and new lawyer hiring (sample stat: median summer offers per firm dropped from 30 in 2008 to 8 in 2010). And looming over everything is the prospect, now little more than a year away in England & Wales, of full-scale non-lawyer equity ownership of law firms.

We can’t blame this on the recession anymore — what we’re seeing is more fundamental than that. The traditional platform for legal service delivery is giving way, overburdened by its own inefficiencies, inflexibility, and market-unfriendliness. In its place is emerging a new platform — the internet. And on that platform is springing up a multitude of new models by which clients can purchase the legal services they want, whether through virtual or distributed law firms with minimal overhead, advanced software for the completion of simple documents or the facilitation of basic transactions, process-savvy lawyers in other countries or quasi-lawyers in our own jurisdictions, and other platforms yet to emerge that we can’t currently envision. The common thread is client customization: the type, quality, and timeliness of service you want at the price you’re prepared to pay. Law firms will emerge and compete on these bases as well, but they’ll be far from the only game in town.

It’s a revolution, and like all revolutions, the benefits will lag behind the costs. It’s going to be messy and even ugly for awhile — platform shifts are neither neat nor bloodless. Think back to the hassles we all went through with Word-to-WordPerfect conversions while the two programs battled it out. Remember the upheaval in the auto industry as electricity began to shove oil off its fuel platform and the damage that caused to gigantic automakers saddled with suddenly unsellable gas-guzzlers. Think of the carnage in the record and newspaper industries as the internet took away their platforms and rewrote the rules of their games. It may take longer, it may not be as brutal, and it may not generate as much attention in the wider world, but the legal services marketplace is starting to go through something very similar. And there will be casualties.

It’s ironic that Seth chose WordPerfect for his lead example — the legal profession was one of the very last professional groups to abandon WP for the now-ubiquitous Word. Many lawyers to this day insist that WordPerfect was the better program, but when the platform changed for good, even lawyers eventually had to switch. The parallels are close enough to be striking and extremely uncomfortable.

When the platform changes, outsiders replace insiders and opportunities abound. Get ready.

Targeting the variable fee

For as long as most lawyers can remember, the billable hour has defined, powered, and shaped their law firms. It determines how lawyers work, how they sell their work, how much they earn, and how they assess and reward their employees. It breeds inefficient, overworked lawyers and frustrated, resentful clients; but it has also proved almost impossible to kill. I’ve come to believe that we haven’t been able to kill it because we’ve been hunting for the wrong beast. We’ve been calling our target the billable hour, whereas we ought to have been describing it, more accurately, as the variable fee.

The fundamental client objection to lawyers’ fees is uncertainty: the client rarely knows the final price before the work is done. Neither, in most cases, does the lawyer — either because the price is truly unpredictable or, far more likely, because the lawyer has neither the means nor the incentives nor the inclination to figure it out beforehand. The fundamental variability of legal fees powers a business model that has proven enormously profitable for lawyers: because the fee varies according to the amount of time and effort devoted to the task, the lawyer has every incentive to maximize that time and effort. Uncertainty creates risk — 100% to the client — and reward — 100% to the lawyer.

The radical change facing law firms today is the end of variable fees as law firms’ financial engine and their replacement with non-variable fees — or, in the parlance of the day, fixed fees. Evidence continues to emerge not only that fixed fees are the immediate future of how lawyers’ services are sold, but also that they’re long-term future of how lawyers’ entire businesses operate.

Fees that vary according to the lawyer production process, rising in tandem with time and effort expended, naturally give rise to inefficient workflow, reinvented wheels, maximized activity and over-accomplished tasks. Conversely, fees that are fixed in advance by the purchaser naturally give rise to proportional efforts, recycled know-how, streamlined processes and hyper-efficient workflow. The first type of law firm business model is starting a steep decline; the second is in sharp ascendancy. In the result, we’re going to witness a sea change in the culture and operations of many law firms. It’s not destiny or professional genetics that makes law firms houses of horror for both the lawyers who sweat to docket the hours and the clients who grimly pay for them — it’s the fever grip of the variable fee. The rise of the fixed-fee-driven law firm is going to demonstrate just how different and better a law firm can be.

Two examples: first, an excellent article at LegalBizDev by Steve Barrett, former CMO of Drinker Biddle, with a title that says it all: “Alternative fees demand improved project management.” It argues that any firm thinking about adopting a fixed-fee approach to sales must be prepared to overhaul its internal systems and business culture. Fixed-fee firms can’t survive massive writeoffs by lawyers who made clients promises about price that they couldn’t keep, or succeed without tracking the progress of past fixed-fee approaches and instituting technological tools to analyze them. And no firm can even contemplate fixed fees without a very clear understanding of the most important aspect of their business: what it has cost them in the past to deliver their services:

Many firms mentioned that a good understanding of cost patterns has never been developed in their firms.  One said (paraphrasing) “We should know how much an ‘XYZ financing transaction’ typically costs, since we do hundreds of them every year.”  Another (again, paraphrasing) said “I can’t believe we don’t know the cost of a typical deposition, since we must do thousands a year.”

As clients ratchet up the pressure on their lawyers to deliver results on a fixed-fee basis, firms will be obliged — forced is probably a better word — to implement these systems and gather and use this data. Just as the variable-fee model discouraged the adoption of these processes and approaches, fixed-fee models will require it.

Second example: firms’ use of associates. Pamela Woldow and James Cotterman of Altman Weil warned law firms in a recent seminar on associate compensation that they need to cut associate salaries much more deeply and accept the fact that clients will never again pay for new associates billed out by the hour. Clients would much rather rely on their own contract lawyers or on offshore professionals than on inexperienced associates; but the opportunity to train associates with this work —  and, much more, the ability to generate revenue off these associates’ billed hours — is key to law firms’ success. The solution to this impasse: fixed fees.

Woldow pointed out that corporate clients are more amenable to using first- and second-years on their matters in fixed-fee arrangements. “So if you really want to use and train your first- and second-years, then up the alternative fee arrangements,” she said.

Endless battalions of associates only make sense in a variable-fee system. When the amount of money you make is tied directly to the number of people working on a file and the amount of time they take to do it, you have every incentive to increase both. In a fixed-fee system, profitability flows in precisely the opposite direction: fewer people hired, fewer hours spent. Law firms that abandon variable-fee structures will shortly find themselves completely rethinking how many associates they hire, how much they pay them, and what tasks those associates are assigned. Under a fixed-fee system, a firm that genuinely wants to train its associates can afford to do so, not least because there’ll be fewer of them — the demand for associates will plummet, along with their cost.

As variable fees give way to fixed fees, we’re seeing a corresponding shift of burdens from the client to the lawyer: the risk of financial shortfall, the maintenance and analysis of relevant data, the obligation to control costs, the necessity of working smarter, the requirement to properly define productivity, and the responsibility to prioritize value. These changes are poised to transform lawyers’ incentives, processes, systems, and attitudes — for the better. Forget the billable hour: the future of law practice is tied to whether lawyers’ fees remain variable — or, put differently, to whether the client or the lawyer decides how much the client will pay. If I were you, I’d bet on the side that’s holding the money.

Hands across the water

I don’t normally focus on very large law firms and mergers thereof, but I’ll make an exception for this one. As you might have heard, US-based Hogan & Hartson and UK-based Lovells have apparently reached an agreement to merge their respective firms by May 2010. The combined entity (Hogan Lovells, provisionally) would crack the top ten worldwide in terms of both number of lawyers (circa 2,500) and annual billings (north of $1.9 billion), would have a massive global reach (as many as 40 offices, including substantial presence in China, Hong Kong and Germany), and would represent a rare joining of roughly equal-sized firms that appear compatible in both practice and culture.

I won’t try to improve upon the analyses already provided by Bruce MacEwen, Alex Novarese and Aric Press, among others. But I will provide one quote from each to indicate that this is not your garden-variety merger announcement:

– Bruce: “This is potentially a transaction that will change a conspicuous portion of the BigLaw landscape globally.”

– Alex: This is “the first concrete evidence to back up the claims made for months by managing partners on both sides of the pond that the general mood is warming to transatlantic mergers.”

– Aric: This is “a sign that while the Magic Circle and most financially elite New York firms continue to insist on their independent futures, firms just one step behind can see a future where a combination is greater than the sum of their parts.”

And in its daily e-newsletter, The Lawyer put it this way: “[T]he consensus so far in the market is that this deal could genuinely see the creation of something not seen before. ‘At a stroke you’ll have a firm the size of [Allen & Overy], better quality than DLA Piper, broader in scope than Herbert Smith and far more international than anything in the current UK mid-market,’ is how one London consultant sums up the deal.” The arrival of anything truly new in the legal services marketplace is always noteworthy, but a Hogan/Lovells merger could have significance beyond whether the firm manages to become more than the sum of its parts (which at this point seems fairly likely).

For one thing, this firm could be really transatlantic, in ways previous cross-ocean expansions (cf. Clifford Chance and Rogers & Wells) were not: a mega-firm, created by a merger of equals, with a center of gravity somewhere between the two capitals rather than vying between them (Hogan & Hartson, with a strong government practice, is headquartered in Washington, D.C., such that traditional London-New York rivalries might not kick in.) Back in February, I forecast a true US-UK powerhouse emerging from the recession, although I thought the American entry would hail from the Big Apple, and I didn’t think it would happen quite so soon. If the experts are right, other cross-ocean mergers might follow and a real wave of consolidation could be at hand.

Secondly, it’s instructive to note the innovations that each side is bringing to the table. The Lawyer reported earlier this month that Lovells is preparing to abandon its lockstep partner compensation system in favour of Hogan’s pure merit-based approach. Merit-based compensation has tremendous momentum in large firms right now, and although no one’s denying the challenges of partner compensation facing a potential Hogan Lovells, this suggests that more complex systems for assessing lawyers’ productivity are at hand. At the same time, Lovells was one of the first law firms to publicly acknowledge it was outsourcing legal document review to India, back in December 2007. UK firms are substantially ahead of their US counterparts in offshoring, so the Hogan side of the deal is going to acquire direct experience with this phenomenon. So in at least two ways, this is going to be very much a 21st-century law firm.

But here’s the main reason why I think this deal could be a game-changer: about a year after the expected May 2010 date for the Hogan Lovells merger to be completed, key provisions of the Legal Services Act come into force, and UK law firms will be allowed to accept non-lawyer investment and ownership under Alternative Business Structures (ABS). What if a future Hogan Lovells decided to take advantage of those provisions? It doesn’t figure to be the kind of Magic Circle or white-shoe firm that most agree would disdain the entrepreneurial offerings of the LSA — in fact, it looks exactly like the sort of firm (fresh, ambitious, global, innovative and unencumbered) for which the non-lawyer equity investment provisions were designed. If this new firm — or any other powerhouse resulting from a US-UK merger in the near future — went down that road, extremely interesting things would start to happen.

Hogan Lovells would be both English and American — and not one of the 50 states allows non-lawyer ownership of even a fraction of a law firm. So if this new firm did in fact accept venture capital or investment-fund equity, or float shares on a stock exchange, it likely would be in immediate contravention of the ethics rules in all the states where it carries on business. Hogan & Hartson, by way of example, currently has offices in Maryland, Colorado, Texas, California, Florida, New York, Virginia and Pennsylvania, as well as the District of Columbia. The ensuing tangle, it seems to me, would rapidly bring to a head the burgeoning conflict between how UK firms and US firms are structured and governed. In a globalized legal profession, this conflict is inevitable — but this new firm, if it comes into existence and if it acquires an ABS under the Legal Services Act, could actualize that conflict much sooner than we  expect.

So keep a closer eye on this merger than you normally might. It could be just another instance of two large firms becoming an even larger firm, still struggling to make its way in a challenging marketplace. Or it might turn out to be the catalyst for unprecedented change in the profession worldwide.

The solution or the problem?

Last week brought news of three innovations that, each in their own way, aim to increase access to justice. It’s noteworthy that none of them came from lawyers.

First is a report that for the first time in Canada, a third-party litigation funding company, BridgePoint Financial Services Inc.,  persuaded an Alberta trial judge to allow it to provide funding to the representative plaintiff in a class actionHobsbawn v. ATCO Gas and Pipelines Ltd. The judge’s reasons aren’t known because the ex parte order was sealed, and Alberta’s class actions costs regime is a little different than other Canadian provinces’, but this is still a potentially pivotal ruling. It could remove the chilling effect of brutal costs penalties for would-be plaintiffs, which nominally should increase access to justice. It also gives rise to substantial ethical concerns, and I’m on record as having serious misgivings about treating a civil action as an investment. But there’s no denying it’s innovative, and that it should make it easier for people to get to court.

Also making inroads in Canada is legal expense insurance, as the local arm of worldwide provider DAS inches closer to approval of its offering by the national superintendent of financial institutions. Already popular in Quebec, legal expense insurance could become widespread throughout the rest of the country if DAS is given the go-ahead. For an annual premium of $500, policyholders receive indemnification of up to $100,000 in legal costs for matters like wrongful dismissal disputes, tax problems and personal injury claims — but not, significantly, family law matters, the most common source of access problems. Legal expense insurance also raises the question of who makes the decisions about how a legal matter is conducted: the policyholder or the insurer? But again, it’s hard to argue that this offering leaves potential litigants worse off than they are under the current system.

And finally, shifting gears and hemispheres, comes word from Australia of what is so far a successful family law initiative called Family Relationship Centres. This excerpt from the story summarizes the project better than I could:

Everyone who walks through the door, or calls the toll-free line, is entitled to three free hours of help every two years, whether it be on-site counselling and mediation or off-site specialized services. After that, costs are based on ability to pay. Walk in the door of a Family Relationship Centre and you are greeted by a “parenting counsellor” rather than a wall of pamphlets. Their job is to get a sense of your personal situation and how it’s playing out for your family, and to assess what help you need to start moving ahead.

The centres are meant to act as triage units for ex-partners who may be hobbled by mental health issues and addictions, or children acting out because of prolonged family conflict. “They will not close that file until they are certain that person has got the help they need,” says Parkinson. Mediation is a mandatory first step, a move aimed at making the costly and adversarial court system a “mechanism of last resort.” The last of the centres opened last year, and already Australia has seen an 18 per cent drop in court filings.

These Centres are part of a massive and very expensive state overhaul of the family law system in Australia, and so far they seem to be working very well. But like the other two advances noted previously, this project apparently developed with little if any leadership from the legal profession.

We seem to be ceding the innovation ground in law to private companies, which by definition are primarily interested in turning a profit, and to government, which has a different set of priorities than either lawyers or their clients. Last month, the very first InnovAction Honourable Mention handed out by the College of Law Practice Management went to the Practical Law Company; last year, an InnovAction Award went to Novus Law LLC — both private companies. I doubt they’ll be the last winners from outside the practicing bar.

So why aren’t lawyers, law firms, or lawyer regulating bodies leading the way in developing innovative legal service delivery solutions? Part of the reason lies in the profession’s singular resistance to initiatives that involve risk or an entrepreneurial spirit. But part of the reason, it seems to me, is also the fact that the solutions these entities are providing are to problems the legal profession helped create.

In most cases where plaintiffs shy away from using the legal system, it’s because the cost of the trial is both disproportionate to the potential award and completely out of reach of the great majority of individuals. And the cost of a trial is largely within the control of lawyers, because lawyers’ fees are by far the single biggest component of litigation costs. Who else bears responsibility for how much we charge? Yes, there are other factors inflating trial costs — better funded courts could reduce backlogs and delays, and discovery can be difficult to predict and control. But if there’s a case to be made that someone or something other than the price of lawyers’ services bears the majority of responsibility for litigation costs, I’d like to hear it.

Most innovations in the law these days are devoted to making the legal services delivery process more streamlined, more efficient, and more affordable to more people. A good number of these solutions come from individual lawyers and law firms, which is extremely encouraging. But as a profession, we should be concerned about the extent to which other solutions are emerging from outside our walls — and the extent to which they’re aimed at solving legal cost problems for which I think lawyers bear primary responsibility.

The electric law firm

“Electric” as an adjective has kind of a dated feel, harking back to the 1970s when it modified Horseman, Company, Mayhem and Light Orchestra. But electric cars still retain a 21st-century buzz, keeping the momentum they developed during the recent oil shock as a serious alternative to gasoline-powered vehicles. The Economist recently devoted a special section to what it calls the electrification of motoring, and it makes instructive reading for lawyers. The legal profession could take some lessons from how some key innovations are completely redefining  the basic assumptions of the automotive industry.

Battery-powered cars operate on a different set of rules than gas-powered cars, not just in a mechanical or engineering sense, but also in paradigmatic terms. What you use your car to do, how far you can drive it, how fast you can accelerate, where and how you acquire your fuel — all these considerations and more are very different with battery-driven vehicles. For example, one electric car manufacturer is looking to create “electricity stations” where drivers can trade spent batteries for new ones, something made possible by selling — or renting — the battery separately from the car itself.

Separating ownership of the battery from ownership of the car changes the economics of electric vehicles. If you rent the battery rather than buying it, that becomes a running cost (like petrol) and the sticker price of the car drops accordingly. … Better Place, indeed, plans to go further. It will charge for its services (battery and electricity) by the kilometre travelled. The cost per kilometre will be lower than for petrol vehicles, and if you sign up for enough kilometres a month, it will throw in the car for nothing.

This isn’t completely new, of course — cellphone providers have been practically giving away the devices themselves, making money instead off the service plans. It’s the basis of the Free economy that Chris Anderson writes about, launched by King Gillette’s realization that he could give away razors but sell the blades. More and more manufacturers now make products available at no cost while charging customers for the service that makes the product useable and/or valuable. But for all that, it’s still shocking to think about getting a car for free in exchange for renting the fuel.

Law firms obviously don’t sell shavers, cellphones or cars. But what they do have in common with many modern manufacturers is that their tangible work product is becoming more commoditized, less differentiated, and more susceptible to low-priced, non-lawyer competition. Forms, contracts, simple wills, divorce papers and other basic documents are now available from kiosks and websites operated by courts, non-profits, and the non-lawyer private sector. The difference in quality between a document drafted by a  lawyer and one drafted by one of these alternative services is rapidly narrowing, and with it will narrow the premium that lawyers can charge above what these rivals charge (which in some cases is $0).

So how might a law firm give away products while selling services? Jeff Carr has observed that lawyer work falls into four categories: content, process, judgment and advocacy. The first two are well on their way to commoditization; the latter two remain the high-value and near-irreplaceable purview of lawyers. The day might soon arrive when firms publish and automate their legal knowledge, document assembly and document review process free of charge, over the internet, to anyone who wants them — but will charge a monthly retainer fee for the personal judgment, advice and representation that animates those documents and processes and provides real value. Wilson Sonsini’s term sheet generator is a step in this direction, but so are child support calculators and PCT calculators. The tangible product is the giveaway; the value, and the profit, are in the service.

To take another example: putting a battery in a car means taking out the internal combustion engine and its associated plumbing and wiring. That, in turn, means you suddenly have not only a whole lot more space under the hood to work with, but also the opportunity to completely reconfigure the space itself.

[O]nce the engine block and the gearbox are gone, the game of car design changes.  …  A number of carmakers and component companies are, for example, looking at getting rid of drive trains, and fitting electric motors directly into cars’ wheels. With wheel-mounted motors that mix motive power, braking and active suspension, more of the things conventionally fitted to a car become unnecessary. Because a gearbox, clutch, transmission and differential unit are no longer needed, and springs and other suspension items will probably go, too, vehicles could assume all sorts of shapes and sizes.

In the law firm context, we’ve long assumed that some elements, like extensive law libraries, were permanent physical fixtures. But while I hardly recommend tossing away all your texts, the fact is that many firms have streamlined their expensive premises by downsizing and computerizing their knowledge resources. But the electric car example offers many other possibilities. What if most of your administrative and secretarial support were outsourced to lower-cost jurisdictions or different time zones? What if telecommuting and telepresence became so affordable (as they almost certainly will) that your lawyers didn’t need to congregate in one place five days a week? Then you suddenly have the opportunity to rethink  your physical plant altogether. If you don’t have law books or legal secretaries or law firms, what does your law firm look like? Does your physical premises become less important than your website? Good questions, and they’ll need answers.

The Economist has long boosted electric cars, but even the magazine acknowledges that internal-combustion engines will rule the roads for some time to come. In the same vein, traditional law firms will continue to be the norm for a while yet. But we have the opportunity now to realistically picture what comes next.

Think of all the longstanding features of a law firm we take for granted — up-or-out partnership tracks, hourly billings to clients, billable-hour-based compensation for lawyers, powerful rainmaking partners, annual partnership draws, exclusive lawyer ownership, and on and on. Then loosen or remove even one or two of them, and consider the multiplicity of variations that result — the possibilities just keep unfolding. Next time you’re trying to picture the future of law practice, give some thought to the electric car.

The apprenticeship marketplace

Critical mass, like the famous definition of obscenity, is one of those things you can’t necessarily define but that you know when you see. We’re approaching a critical mass of discourse on the necessity of change within the American law school system, and when we reach that point, the focus will switch overnight from necessity to inevitability. The latest step in that direction comes courtesy of a National Law Journal article with the suggestive title “Reality’s knocking.” It details efforts underway at numerous law schools — including Washington and Lee, Dayton, Northwestern, Indiana/Bloomington, UCLA, UC Irvine, and the latest entrant, Duke — to integrate market-readying client-focused training into their programs.

[A] growing number of law schools are emphasizing teamwork, leadership, professional judgment and the ability to view issues from the clients’ perspective. “I think we are at a moment of historical change across the landscape of legal education,” said Washington and Lee Dean Rodney A. Smolla. “When we look back at this period in five to 10 years, we will mark it as the time when the whole mission of law schools made a fundamental turn.”

The thrust of these changes — whether shortening the law degree by one year, supplementing traditional coursework with legal skills instruction, simulating law firm environments (complete with client relations and billing), or introducing professional values training in the first year — is to accelerate law graduates’ development into full-fledged lawyers. By doing so, these schools hope to improve relations with the private bar (an increasingly important source of funding), better compete with other school for the most promising pre-law candidates, and (one would like to think) better serve the long-term interests of their students. By and large, these are very welcome developments, and there’s no doubt in my mind we’ll see a lot more of them in the next few years.

What especially caught my interest in the NLJ story, however, was a nearly-throwaway paragraph illustrating the kinds of pressures schools are feeling from the private bar:

The legal labor market is saying that it’s no longer willing to pay top dollar to recent graduates who lack work experience. Law firms including Washington’s Howrey and Philadelphia’s Drinker Biddle & Reath recently announced apprenticeship programs wherein starting associates earn less and spend a significant amount of time training and shadowing partners.

I’ve written about these programs before — Frost Brown Todd, Strasberger and Price, and Ford Harrison have followed suit — and I hope to put together a much more detailed treatise on this subject down the road. Under these initiatives, the law firms pay their new associates much less than the market rate and require far fewer billable hours from them; associates spend most of their time in apprenticeship, training and shadow programs with experienced lawyers, with (unbilled) client contact and observation opportunities where possible. These firms have heard their clients complain about paying to train new lawyers unprepared by three years of law school, and either to mollify these clients, to stake a marketing advantage, or (one would like to think) to actually better serve both their clients’ and their lawyers’ interests, they’ve responded with this new approach.

But what’s most interesting is that these innovative new programs at the law firms don’t really differ in any substantial way from the innovative new programs at the law schools. Both are focused on providing new lawyers with the practical training, skills development, and professional awareness that a traditional law degree and most bar admissions processes fail to deliver. Both aim to reduce the steep learning curve that new lawyers have always had to climb, making them readier to serve clients and generate billable work than they otherwise would be.

What this means is that for the first time, law schools and law firms are providing the same service — apprenticeship training. And when two or more providers offer the same basic service, you’ve got yourself a marketplace. Very good things can happen in marketplaces — intense competition to improve offerings, constant pressure to innovate, a diversity of ideas and approaches, continual erosion of barriers to entry. All of these developments work to the ultimate benefit of that marketplace’s consumers — in this case, new lawyers and (ultimately) the clients whom they’ll serve. The more schools and the more firms that enter this marketplace, the better and faster the results will flow.

I can’t wait to see what a lawyer apprenticeship marketplace might produce over the next several years. But there’s a potentially major problem with this playing field: one of these providers charges its consumers an annual tuition to receive this service, while the other pays its consumers an annual salary. That’s no contest, and in the long run, it will mean that this is a service you can’t charge students to receive — or, more radically, one that new lawyers won’t earn a salary to obtain.

Why change is so hard

Last week’s New Yorker column by James Surowiecki talked about health care reform in the United States, but it has something important to say about change in the legal profession too. Surowiecki noted the sudden remarkable rise in the number of Americans who say they’re satisfied with their current health coverage. Among other factors, he puts this down to people’s deep-set psychological aversion to give up what they’ve got in favour of something new:

Most of us, for instance, are prey to the so-called “endowment effect”: the mere fact that you own something leads you to overvalue it. A simple demonstration of this was an experiment in which some students in a class were given coffee mugs emblazoned with their school’s logo and asked how much they would demand to sell them, while others in the class were asked how much they would pay to buy them. Instead of valuing the mugs similarly, the new owners of the mugs demanded more than twice as much as the buyers were willing to pay….

What this suggests about health care is that, if people have insurance, most will value it highly, no matter how flawed the current system. And, in fact, more than seventy per cent of Americans say they’re satisfied with their current coverage. More strikingly, talk of changing the system may actually accentuate the endowment effect. Last year, a Rasmussen poll found that only twenty-nine percent of likely voters rated the U.S. health-care system good or excellent. Yet when Americans were asked the very same question last month, forty-eight per cent rated it that highly. The American health-care system didn’t suddenly improve over the past eleven months. People just feel it’s working better because they’re being asked to contemplate changing it.

Compounding the endowment effect is what economists dub the “status quo bias.” Myriad studies have shown that, even if you set ownership aside, most people are inclined to keep things as they are. … Some of this may be the result of simple inertia, but our hesitancy to change is also driven by our aversion to loss. Behavioral economists have established that we feel the pain of losses more than we enjoy the pleasure of gains. So when we think about change, we focus more on what we might lose, rather than on what we might get. Even people who aren’t all that happy with the current system, then, are still likely to feel anxious about whatever will replace it.

That sounds to me like a neat encapsulation of what’s happening to a legal profession facing unprecedented pressure to change. The outside forces attacking the industry’s status quo (technology, competition, client sophistication and generational shifts) grow stronger every year. In addition, there’s more dialogue than ever before within the profession about changing billing practices, law firm structure, talent management, technology usage, billable targets, client relationships, etc. And by most measures, a remarkable number of lawyers aren’t really that satisfied with their work or their careers. In theory, change should be rolling like a river through the profession right now.

But those of us in the change camp remain perplexed by the steady and growing levels of resistance we still encounter — not just among lawyers and law firms, but also among clients, law schools, and others. It seems like the harder we push, the more tightly lawyers grip the familiar features of their current system. And Suroweicki’s article presents a plausible explanation — the very act of advocating change increases lawyers’  resistance and their belief that the status quo is just fine, thanks.

So I’m coming to think we’ve been taking the wrong approach. Many of us, and I’m as guilty as anyone, tend to dismiss lawyers’ opposition to change — change that would make for a profoundly better legal system — as being grounded in selfishness, short-sightedness, and bloody-minded traditionalism. And I still think these factors do play some part.  But if we look at the situation through less jaundiced eyes, and take into account these natural and largely inescapable human tendencies towards preservation of the familiar, we can come to understand the resistance more clearly, and judge the resisters less harshly. The way things are, even if they’re not that great, still seem self-evidently good and preferable to the cost that change might exact.

So how can change be effected in an environment psychologically programmed to over-value the status quo? Here are three possible approaches:

1. Question the permanence of what people already have. Surowiecki suggests that Americans’ health coverage is far more tenuous than they think it is, and that therefore “the endowment that insured people want to hold on to is much shakier than it appears. … The message, in other words, should be: if we want to protect the status quo, we need to reform it.” Lawyers have been warned about the unsustainability of the current system and how much they stand to lose if wholesale reform from outside the profession sweeps away their privileges. But lawyers don’t frighten easily, and many have an unrealistic picture of their irreplacability in the greater scheme of things. This approach could yield more success as the upheaval inevitably gets rougher down the road, but probably not before.

2. Demonstrate the great advantages of change over the status quo. People may not want to sell that free mug for less than twice its value. But offer them a titanium thermos with built-in GPS and they’ll trade up in a hurry. Resistance to change springs largely from overestimating both the benefits of what you now have and the costs of what you would get, so headway may depend on showing that change is overwhelmingly positive: you will make more money, get more clients, have more free time, be happier, by taking a different approach. So we need to highlight (and reward) as many huge success stories of innovative lawyers as possible. We need more projects like Legal Rebels, showing off all the benefits to be derived from abandoning the status quo and embracing better ways of being a lawyer. It won’t convince everybody, but it will push us closer to a watershed.

3. Make the change as incremental as possible. People are usually more amenable to change if they don’t think of it as something wholesale and irreversible. So instead of advocating fixed fees across the board, maybe you isolate one or two small clients or practice  areas that could serve as laboratories. Rather than abandoning lockstep compensation altogether, maybe you start by adding some merit-based criteria to the existing salary structure. Once these small innovations take hold, you can press forward with more. Over the years, I’ve found that terms like “pilot project,” “test case,” “private launch” and so forth are remarkably effective in getting lawyers to lower their guard and try something different. Minimizing the risk and playing down the possibility of permanent change might undermine the overall case for innovation, but in practical terms it could deliver better results.

There’s at least one big difference between the US health-care debate and the upheaval in the legal profession. To a great extent, the health-care consumers themselves control the process of change through the electoral system, so if they decide they want things to stay the same, they will — at least until the system breaks down someday. Lawyers, by contrast, don’t control any of the factors that are causing or, like the recession, accelerating the change in the legal services marketplace. We can ignore the tsunami all we like, but the waves are still coming in regardless.

That makes it all the more important that resistance to change within the profession — natural and understandable as it is — be overcome. Most lawyers are either comfortable with their existence or don’t ask too much from their careers, so they automatically defend the current system without asking themselves: Is it really all that great for me? Couldn’t I do a lot better? What, exactly, am I fighting so hard to preserve? Getting lawyers to ask — and then answer — these questions will be more than half the battle.

The real impact of private equity

It’s coming to the attention of many North American lawyers that our overseas colleagues are or soon will be selling equity interests in their law firms. Earlier this summer, American Lawyer profiled the progress of pioneering publicly traded law firm Slater & Gordon in Australia. More recently, Bloomberg News announced that at least three UK law firms are willing to accept private equity investment starting in 2011, when radical measures introduced by 2007’s Legal Services Act take effect. Neither of these developments will be news to regular readers here, but many other lawyers newly faced with these prospects are hitting the books to figure out how to respond.

Often, the first book they pull out is their code of professional conduct. Objections to outside investment in law firms tend to cluster around the twin assertions that shareholders would demand maximized return over professional and ethical considerations, and that outside investment would create too many opportunities for disqualifying conflicts of interest. On the second point, when you think about it, conflicts arising from external investors aren’t really qualitatively different from conflicts by current investors — i.e., the other partners in the firm. And in any event, not every conflict of interest is a disqualifying conflict that undermines the lawyer-client relationship. More complicated to manage? Quite possibly. Irreconcilably difficult? I’m much less sure of that.

On the first point, it seems to me that we’re confusing two different types of obligations. There’s a difference between a binding ethical obligation owed to a client — to do your best work to further the client’s interests, in complete confidence and loyalty — and the general corporate obligation to return a profit to a shareholder. The first should and will trump the second, always. And really, when you get down to it, these obligations dovetail more than they conflict. A good lawyer who acts ethically in his clients’ best interests is by definition maximizing the value of the firm and the return to the shareholder. It won’t serve an investor’s interests to encourage behaviour that would wreck the law firm’s reputation for trustworthiness and ethical conduct  — it would be a surefire way to ruin the value of the investment.

Now, the ethical waters around non-lawyer equity interests in law firms do run deep, and I’m not the captain to ply them. At the moment, I’m more interested in the defensiveness that talk of outside investment generates in many lawyers. Although I accept that many lawyers’ objections on ethical grounds are sincere, I suspect that many other lawyers object because of the threat non-lawyer influence presents to two foundational elements of lawyers’ lives: change and control.

When you look closely at the discussions around non-lawyer investment in law firms, it becomes clear that such investors actually have very little interest in the work lawyers do for their clients — they’re really not that into what we do. Their interests are entirely profit-based, and they view law firms through the single lens of revenue generation. From the Bloomberg article:

“Law firms are pretty attractive investments as they have stable cash flows, long track records of business operations and increasingly are much better run,” said John Llewellyn-Lloyd, executive director of Noble Group Ltd., a London-based investment bank. “You would expect them, like any professional services business, to provide a pretty good return.” Alan Hodgart, a law firm consultant at H-4 Partners in London, said investors are expecting “fairly high returns, in excess of 15 percent.”

So law firms are attractive because they’re a steady, reliable investment. Nothing new there — partners have been comfortably aware of that happy fact for years now. But there’s more to it than that. Your average law firm isn’t just a reliable investment — in many cases, it’s a vastly underperforming one. Investors look at the short-term, narrow-focus, seat-of-the-pants way most firms are operated, and they salivate at the thought of what even a basic injection of systemic discipline and workflow reform would do to already-fat profit margins. Again from Bloomberg:

Lyceum Capital, the London-based buyout firm, is interested in investing in the legal industry, with a “focus on new business delivery models, not traditional law firms,” Hand said in an e-mail. … Lyceum Capital wants to invest in ways to reduce legal costs and make some types of legal work cheaper and more efficient.

Further along these lines, consider what consultant Joel Henning predicts about the impact of outside investment on law firm management:

The result might be very different service delivery, billing and compensation systems, minimizing individual performance and maximizing team, practice and firm performance. Investors would bring to bear a more contemporary suite of tools and techniques for managing the delivery of legal services. They would be astounded by the enormous duplication of efforts at law firms.

If we allowed businesspeople to invest in and join the leadership of our law firms, I suspect that more and better smart systems and processes would be developed and refined on an accelerated basis, systems that would accomplish many legal tasks beyond drafting and researching, reaching even to some problem solving. If this were to happen, the billable hour and the lawyer compensation systems grounded upon it would largely become anachronisms. Savvy outside investors would find that too many smart lawyers and too few smart systems currently inhabit our law firms.

And here’s Altman Weil’s Tim Corcoran on what would happen in a law firm where business decisions aren’t left to lawyers alone:

Fundamentally altering the firm’s recruiting strategy?  Establishing true associate training and apprenticeship?  Re-designing compensation systems to drive collaborative behavior?  Which Biglaw partner wants to raise his hand and dive deeply into these issues?  …

If a PE firm purchases a significant stake in a large law firm, rest assured that the investor representative they install on the management committee, whether this is a COO, CFO or some derivation, will be able to do the math justifying why process improvement will lead to substantially better returns — for the investors, for the partners and, oh yes, for the clients.  This isn’t rocket science, and cost containment programs based on ROI, investments based on NPV and even formal business process improvement programs like Lean Six Sigma are really not much more than common sense ideas backed up by math and a governance structure which places the good of the firm above the desires of individuals.

Of course it will be hard.  But the PE investors who truly want to unlock the value embedded in Biglaw will understand the potential return on delving into the tough issues.

That, I think, is the key selling point for potential investors in modern law firms. They see the enormous value that’s hidden away under layers of wasteful processes, poor client communication, and amateurish management. They’d love to get their hands on and polish up these rough diamonds. Lawyers say they object on grounds of professionalism; I say there’s nothing unprofessional about running a business efficiently and effectively. In fact, experienced business management that does away with internal inefficiency will reduce costs, thereby making it possible to lower prices, which absolutely serves clients’ interests. Outside equity investment as a tool to improve access to justice? I think it’s more than just arguable.

Lawyers could continue to object that equity investors wouldn’t pass these cost savings on to clients — they’d simply pocket the difference as extra profit. I find that enormously funny, because how is that different from what many law firms already do now? If there’s any difference, it’s that outside investors — motivated to take a longer-term view than partners, whose vision usually extends only as far as this year’s draw — have an incentive to build the business for future success, which would encourage any measures that would make the business more appealing to clients and boost market share.

At the heart of it, I think this is what motivates a lot of opposition to outside equity investment in law firms — the knowledge that the new people would do things a whole lot differently. They’d change the way lawyers do their work, which for many practitioners is the most sacred cow of all. Non-lawyer shareholders wouldn’t tolerate some of the stuff law firms get away with now, and the lawyers know it. So it’s about change, and it’s about loss of control — two things lawyers really don’t like.

Equity investment in or outside ownership of law firms will be neither a panacea nor an unalloyed good — mistakes will be made, lines will be crossed, abuses might well take place. No innovation arrives perfectly safe and sound. But what such investment does offer is something the legal services marketplace has needed for too long: law firm management singularly driven to improve efficiency, effectiveness, and above all, client satisfaction, because it makes business sense to do so.