In chatting with my boss / colleague / mentor about the economic state of the legal industry, we stumbled on an interesting analogy. We were discussing the recent CT TyMetrix Real Rate report and the fact that the number one driver of differences in billing rates is a lawyer’s location. We concluded that law firms still live like its 2005 and base their billing rates on a lawyer's comp instead of their value. So lawyers in NY and LA will have higher rates than those in Denver or Dallas. And this all hinges on the very standard market level of pay for new associates in each jurisdiction.
This lead us to the thought that law firms have been acting in an informal cartel. Previously I have written about the “Monopoly” of the legal profession, but in many respects “Cartel” is a better moniker.
The purpose of a cartel is controlling pricing such that commoditized products and services can be priced at non-commodity levels, enabling the realization of higher levels of profit. You see this behavior on the in-bound side of firms in how associates salaries have been set in the market. And you see it on the out-bound side in how billing rates were increased in a similar lock-step fashion over the past 20 years.
The legal industry has been able to support this informal cartel subject to demand increasing at a faster rate than supply. About 5 years ago this balance began to shift. The shift is a result of a greater supply of lawyers entering the market and the impact of new technologies. The Great Recession accelerated these forces, putting us in our current situation.
The crazy thing is that so many firms continue to treat the market as if the cartel is still in place. Once the economy started to turn-around, firms went right back to their former associate hiring and pay model. And they continue with their old-school compensation models. They only thing that hasn’t gone back to “normal” is the way they raise billing rates and bill hours in a relatively unchecked fashion.
Bottom-line this means firms are using the cartel model in how they managed the price of inputs, but they no longer control the price of the outputs. The results of this type of behavior are obvious yet remain elusive to many law firm leaders.
Ultimately all cartels breakdown under the strain of market pressures. Only under normal circumstances, the market players are aware when this has happened.