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9Feb 2017

The 2017 Georgetown Report And The Sunset Of The Traditional Law Firm Model

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The Center for the Study of the Legal Profession at Georgetown University Law Center and Thomson Reuters Legal Executive Institute recently released their 2017 Report on the State of the Legal Industry. ‘The Georgetown Report,’ as it’s commonly referred to, confirms that corporate legal buyers are directing more work away from large law firms, electing to take it in-house or to legal service providers (read: alternatives sources to the traditional law firm partnership model). The Report provides a broad range of data confirming weaknesses in the traditional model: flat demand for law firm services in a market with growing demand; shrinking leverage (one of the cornerstones of the BigLaw model); reduced realization; intense competition; and the failure of most law firms to innovate in a market demanding it. The Report also cites growing market segmentation among law firms with about 20 pulling away from the pack once collectively called ‘the AmLaw 200’ and later ‘AmLaw 100.’  It also notes that clients are increasingly  sending work “down market” to smaller firms with specific expertise and lower rates.

The Report’s headline grabber is ‘the death of traditional billable hour pricing’ over the past decade and ‘the widespread client insistence on budgets (with caps) for both transactional and litigation matters.’ This conclusion overlooks an even bigger item– many of those matters are no longer assigned to law firms in the first instance. Example: Shell Oil has formed a global in-house litigation team for the bulk of the company’s largest litigation cases and recently handled a  multi-billion dollar corporate portfolio divesture in-house.

The eye-popping profit-per-partner (PPP) numbers that persist for many firms—something not specifically mentioned in the Georgetown Report– create a false-positive image of their fiscal health. High PPP has been achieved principally by internal cost slashing including staff cuts, reducing real estate overhead, and other measures. It also involves thinning the equity ranks and jettisoning ‘service’ partners who are highly valuable to clients but a potential drag on PPP. The Report notes that firm internal cost cutting has gone as far as it can go, suggesting that PPP at most firms will begin to dip. That will only fuel the lateral frenzy and add to the long-term instability of most firms. PPP was long the glue that bound firms together. Now, it is a vulnerability for all but the fiscally strongest in a Darwinian ‘survival of the fittest’ marketplace.

The Georgetown Report also cites, ‘erosion of the traditional law firm franchise,’ a euphemism for ‘clients no longer need large law firms to handle many legal tasks.’ Erosion of leverage–equity partners atop a pyramid of other lawyers billing lots of hours at high and non-discounted rates, and ‘market segmentation’—a few elite firms distancing themselves from the pack– are additional trends cited by the Report and supported by its data. The inescapable conclusion is that most large firms are confronting an existential crisis that demands an aggressive response lest they experience a collective ‘Kodak moment.’ So far, most firms have been at best reactive and at worst static to the rapidly changing market. That’s one reason why in-house legal departments and service providers now account for nearly half of total legal spend.

 There’s More to It Than That

There are other, more fundamental and systemic reasons why legal buyers are turning away from traditional law firms. For a long time, firms monopolized the supply side of legal expertise when that was the only element of legal delivery. Consumers effectively had no viable, scalable, and ‘safe’ alternative supply sources. Also, legal fees were a trifling line item on the corporate budget. That’s changed, of course– especially during the past decade. Legal delivery is now a three-legged stool supported by legal, IT, and process expertise. Law firms remain strong on legal expertise but that’s just part of the equation. Plus, the dramatic rise in their cost has far outpaced other goods and services at a time when legal expense—like virtually every other line item—is closely scrutinized in a business climate that demands ‘better, faster, cheaper.’ And consider that the urban myth that ‘work performed by law firms is bespoke’ has been debunked. Disaggregation—the creation of a legal supply chain—is now standard fare as buyers commonly engage more than one source for individual matters or portfolios that were once handled start-to-finish by law firms.

Corporate legal departments and service providers have stepped in to fill the law firm vacuum. They tend to be more innovative than law firms, utilizing technology and process far more effectively than firms that remain loathe to provide a meaningful seat at the management to anyone but (rainmaker) lawyers. Corporate legal departments and service providers, in contrast, commonly function as corporations, not fiefdoms. Their DNA more closely resembles clients than law firms do, and they accord technologists, process experts, and others essential to the legal delivery commensurate status and rewards.

There are several other systemic challenges confronting traditional law firms–minimal capital invested in research and development; an economic model that rewards inefficiency more than efficiency; limited understanding of the increasingly complex business of multinational clients—especially contrasted with in-house counsel; and a failure to appreciate that “legal” problems are—from the client perspective—“business challenges”

Why Don’t Law Firms Retrofit Their Model? 

 The Georgetown data confirms that the traditional law firm model no longer dominates the legal marketplace, nor does it align well with its direction. This begs the question: ‘why don’t firms retrofit their model?’ Simple answer: there exists an economic conflict between aging equity partners ‘running the table’ and the next generation that is beginning to appreciate its vulnerability. Translation: don’t expect the old guard at law firms to morph into innovators, especially where to do so would require them to be the largest investors in a model with no residual equity. The absence of real residual equity value at law firms is yet another nail in its coffin. Contrast this, for example, with senior in-house counsel that have a very significant financial interest in the long-term success of the enterprise—even after they retire.

In-House Legal Departments and Service Providers Have Limitations, Too

In-house legal departments are more palliative than cure for the vacuum left by law firms. While they continue to expand in size, influence, and portfolios, their cost is rapidly escalating, too. There is also an inherent conflict in the dual role in-house counsel is asked to serve—defenders as well as business partners of the company. This is not to say that equipoise cannot be achieved, but there is risk, too. Outside counsel can serve a valuable role in mitigating this potential risk factor–but there is no longer need for the entire traditional firm model to achieve this. Firm lawyers can be cherry picked to serve this purpose.

Likewise, service providers bring a great deal to the table, but they too have limitations—especially in the U.S. where the current regulatory scheme prohibits joint ownership between lawyers and anyone other than lawyers. Service providers, on their own, cannot ‘engage in the practice of law’ even though they perform many of the same functions as law firms. Apart from U.S. regulatory hurdles—for which there are workarounds—is the ‘stigma’ many top lawyers feel for taking their talents anywhere other than law firms, corporate legal departments,  government, or public interest groups . This will change over time, but it’s a tough sell for legal service providers to attract elite legal talent to complement their IT, process, and stable of other experts that are the ingredients in the legal delivery stew.

Wanted: A Safe, Scalable, Cost-Effective and Integrated Delivery Model 

What’s missing in the current legal landscape is a safe, scalable, cost-effective, legal delivery model that integrates the legal supply chain. There are many different structures and models that would accomplish this objective– the most likely being a Clearspire ‘two company model’ where a law firm enters into a bundled services agreement with a legal service provider. Another iteration might involve a corporate legal department breaking off and rebranding itself as a law firm that is pared with legal operations capability, either in-house or via an established outside service provider. Additional elite legal talent would be readily available because there will soon be a diaspora of lawyers looking for a new model and a new home that aligns better with their interests as well as their clients’.

Conclusion

The Georgetown Report confirms where the market is. The more interesting question is where it’s headed. Doubtless, new delivery models will soon appear that better align the interests of the three principal stakeholders in legal delivery: (1) lawyers, paraprofessionals, and other experts that perform the work; (2) the delivery entity that bundles it; and (3) clients. My bet is that a new legal delivery paradigm will emerge that will transform the fraying legal guild into a 21st century model that will benefit clients, lawyers, and society. Stay tuned….

This post was originally featured on Forbes.com.

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