Last post, we highlighted some inherent tensions in the law firm business model. Demand is flat but law firm partners keep finding ways to increase profits without improving value for clients. Law firm management recognizes the need to scale innovation but can’t overcome resistance from key rainmakers. And client loyalty to those key rainmakers makes credible the rainmakers’ belief that they don’t need to invest in innovation to bring in business, as well as the attendant threat that they can make more money if they lateral to a firm that is even more beholden to keeping them happy.
That partners resist change and clients aren’t asking for it are the top responses from managing partners when they are surveyed as to why their firms are not doing more to change the way they deliver legal services. The idea that clients aren’t asking for change is at the same time laughable and true.
The notion that clients are not expressing a desire for change does not comport with observable reality. High-stakes, bet-the-company, price-insensitive work keeps going to the top domain experts and their firms. The still-important but price-sensitive run-the-company work is increasingly being handled by expanding law departments and, to a lesser but still material extent, our alternative service providers. The internal spend on corporate legal ($160B) has almost reached parity with our combined external spend on large ($95B) and mid-size ($73B) law firms. Clients are communicating our dissatisfaction with our wallets, not just in the many, many surveys where we explicitly state that we are dissatisfied.
And yet there is a difference between asking for a manager and simply leaving the store to shop elsewhere. Most firms do not know they’ve been fired, the phone simply stops ringing. Even if they know, they rarely know why. Clients have relied on exit, rather than voice, in expressing our dissatisfaction. Those surveys are anonymous and do nothing more than repeat long-standing but nebulous complaints about innovation and value. Our failure to articulate our issues to our firms has made it much harder for firm management to sell change internally. While there is innovation, it doesn’t scale. While there is investment in technology and R&D, it lags well behind most other industries.
Client preference for exit over voice has much to do with resource constraints. We need results now, innovation now, efficiencies now. We haven't the time to wait for our firms to catch up. There are also an increasing multitude of accessible alternative solutions and technologies that were not previously available, making the exit not only easy but the responsible decision for our businesses. Organizations such as the Corporate Legal Operations Consortium (CLOC) provide a forum to share best practices including how to better in-source legal work or move day-to-day work to lower cost alternatives.
The fact that clients can in-source a non-core function to save money speaks to brokenness of the legal market. That outsourcing should result in cost savings is so fundamental to economic theory that they have awarded Nobel Prizes for explaining why corporations even exist instead of treating every employee as a third-party contractor. The answer is multi-faceted—they don’t hand out Nobel Prizes for the simple stuff—but much of the theory revolves around transaction costs and the related inability to write perfect contracts. At scale, management is required to make people capable of joint performance, and certain aspects of management are more tractable if the people being managed are employees.
The relationship between size, organization, and management does not just speak to the dynamic between clients and firms. It also speaks to the internal workings of law departments. Bringing in lawyers to do work that was previously outsourced saves money immediately. But is also means importing many of the cultural characteristics, organizational challenges, and barriers to change that have plagued law firms. Much of the recent evolution in law departments has been as much about increases in sophistication as it has been about increases in size. In many respects, we are now operating more like the dynamic businesses we serve than the captive law firms we used to resemble. The precipitous rise of legal operations is the most visible trend in this professionalization of management within law departments.
Given the decades-long increase in demand for legal services, some rebalancing between law departments and law firms was to be expected. But, consistent with the standard economic theory, there are limits to the amount that can be insourced and how quickly. This is part of the explanation for why insourcing has been experienced mostly as stagnation, rather than a decline, in the demand for law firm services. The need for law departments to get their feet under them is also an explanation for why reliance on alternative service providers has lagged behind the growth in law departments.
As law departments have increased in size and sophistication, we have come to a point where we are better positioned to use voice in addition to exit. We are ready to talk to external service providers about not just individual expertise but expertly designed systems for delivering legal services. And we have found alternative service providers to be willing participants in that conversation. Firms not so much, yet.
Firms still want to sell us individual expertise and bespoke services. That was fine when they were telling us they were smarter than other firms—we had to choose one of them. But it is less persuasive when we have the option to bring the individual expertise in-house and then leverage that expertise through the low-cost, high-impact process and technology of alternative service providers. Again, this does not presage the end of law firms for high-stakes matters. But, as all the trend lines indicate, it makes them less attractive for volume work.
Alternative service providers offer compelling value propositions. The most obvious is labor arbitrage. There is nothing wrong with getting the same quality at a lower price. Indeed, in a world that demands tradeoffs, there is often a case to be made that slightly worse quality at radically lower prices is worth exploring for certain kinds of work. Gold plating is a poor use of resources. Except alternative service providers do not deliver lower quality. They hire talented people, and their capital structure is more amenable to investing in infrastructure. Combining people, process, and technology, they institutionalize expertise rather than keep it siloed in the heads of individual flight risks. They cost us less, and, in many areas, give us more.
The silver lining for law firms is that they still have unparalleled intellectual capital and, in theory, substantial financial capital to go along with great brands, track records, relationships, and a talented corps of allied professionals. The trend lines suggest a continued erosion, not an imminent collapse. And, while they have problems scaling it, there is even a fair amount of innovation at law firms. So firms have time, opportunity, and capacity to pivot—to augment that valuable expertise with process and technology in ways that appeal to clients for our volume work. But not that much time. Their current business model is premised on growth and, unless something dramatic happens, growth is dead. As clients, we do not mourn its passing.
Connie Brenton is the Chief of Staff and Director of Legal Operations at NetApp and a founder of the Corporate Legal Operations Consortium (CLOC). Casey Flaherty is a former in-house counsel and CLOC member who started his own legal consultancy, Procertas.
 Hirschman, Albert O. Exit, Voice and Loyalty: Responses to the Decline in Firms, Organizations and State. Cambridge: Harvard UP, 1978.
 Yes, Alfred Nobel didn’t actually create a prize for economics. But 75 years later, Sweden’s Central Bank did create an economics prize “in memory of Alfred Nobel.”
Ronald Coase won for “his discovery and clarification of the significance of transaction costs and property rights for the institutional structure and functioning of the economy" as it related to the “theory of market institutions.” http://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/1991/coase-facts.html
Oliver Williamson subsequently won because he “provided a theory of why some economic transactions take place within firms and other similar transactions take place between firms, that is, in the marketplace.” http://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/2009/williamson-facts.html
 MacEwen, Bruce. Growth Is Dead: Now What?: Law Firms on the Brink.