3/22/11

“Bet the Farm” Versus “Law Factory”: Which One Works?


Ron Friedmann of Strategic Legal Technology blog and I consider in this joint post the impact of "Law Factories" on the future of large law firms.

Introduction - by Ron Friedmann and Toby Brown 

Law firms face an uncertain future, with competitive markets, intense price pressures and a drive to change. So they are beginning to ask fundamental questions about the nature of their business. These include what shape should a firm be and how will a firm approach this new market? Will firms be "Law Factories" that provide services to numerous segments of the market? Or will they be niche players that protect their brands in high-end markets and maybe even spin off sub-brands for servicing mid-level and low-end markets?

Ron and I started discussing this question in follow-up to an ILTA session last August where Ron was a co-panelist. The panel suggested that in the future, law firms would need to choose one of two strategies: bet the farm or law factory. This oversimplifies but helps air important issues. The panel struggled to answer whether the two models can co-exist in one firm. If you think the question is academic, consider the recent news about Howrey’s demise. Managing partner Bob Ruyak attributed the fall of the firm, in part, to more efficient e-discovery vendors and document review. Even if apocryphal, this illustrates the impact law factories can have on law firms.

So we decided to take up this question and compare the two approaches in a back-to-back blog post. Both views are shared on both of our blogs. We hope this "debate" spurs dialog in the market over many aspects of how firms are structured and sell themselves to their clients. We welcome comments, input and even offer up guest posting opportunities for those who want to take on this subject with us.

For Reference: Ron's post; Toby's Post


SUITING UP FOR THE LAW FACTORY by Toby Brown


The Banking Analogy “Commodity” is a dirty word at most law firms. It implies a ‘less-than’ level of expertise and is not the sort of brand any thoughtful lawyer would want for their firm.

But should they?

The opposite of ‘commodity’ in this context is “Bet the Farm” work - high-end, high-value niche services; the kind clients gladly pay full hourly rates for. In even the recent past, a lot of firms have been able to get away with pricing all of their services at bet the farm rates, since they held the market power and could designate a greater portion of their services as high-end, high rate work. But that’s not the case anymore, as evidence in the market by expanding buyers’ market power, and the rise of discounts and AFAs. I have argued elsewhere that lawyers, via their monopoly position, were able to artificially hold off the commoditization of their services. The bottom-line: most firms services are no longer in the high-end niche portion of the market. Pretending to be there, doesn’t make it so.

So where does that leave law firms? I see they have two options. First – stay very focused on the high-end, high margin niche segment of the market and then develop lower brands as noted in Ron’s post. Or firms admit they can’t play exclusively in that space and embrace the commodity concept a.k.a. as a Law Factory play. I believe the latter approach makes sense for most law firms, merely based on the fact that there is room for only a very few firms in that high-end segment. But … will embracing commodity services tarnish a firm’s brand, excluding it from high-end opportunities?

Banks present a feasible model for law firms to consider. They serve a very broad piece of the market, yet maintain a high-value brand. They sell basic banking services to the mass market and sell specialized services to high net-worth individuals and companies.

A Law Firm Scenario: The Three Tiers of the Patent Litigation Market. From a Case Study I am preparing, I will paint a picture of a new patent litigation market. I suggest this is a relatively accurate picture, but know some variations and modifications of the exact numbers should be in order. In any event, this concept demonstrates the Law Factory approach from an economic / market perspective.
Tier 1 – High stakes matters. This is the classic “Bet the Farm’ work. I would put it at 15-20% of the market, and declining.
Tier 2 – Mid-level stakes. These matters will have valid legal claims involving enough money they require a reasonable legal response, but not at the level of Tier 1. This segment of the market has seen increasing price sensitivity. Two to three years ago the work may have commanded fees near Tier 1 level. Put this segment at 50-60% of the market and growing.
Tier 3 – Nuisance matters. This tier covers questionably valid legal claims and thus low financial exposure. This segment has high price sensitivity and clients benefit from quick, low cost resolutions. Put this segment at 20-25% of the market, relatively stable but with occasional spikes.

Given this market dynamic and utilizing the banking industry concept above, how might a law firm approach this market?

What this segmentation tells us is that the mass of market spending is occurring in Tier 2. And since prices are dropping that this work is begging for some innovations to moderate the costs. So although Tier 1 may have had good margins, it’s a shrinking market with a large pool of competitors. Unless your firm is willing to invest significant dollars in securing this market segment, which will cut into those margins, you will be wasting your time. This doesn’t mean you will ignore this segment, but only that you approach it smartly. Tier 2, in contrast, presents much greater opportunity for market growth and reasonable, sustainable margins. To do well in this segment, a firm will need to “commoditize” some of its work.

In contrast, Tier 3, may well fall off the radar of larger firms. To be profitable here requires serious changes in the personnel and compensation structure of a firm.

The hard questions for law firms are - Can they actually make these changes and then maintain their brand across market segments?

I would suggest a relatively simple and easy to accomplish approach would be to target Tier 2 work and watch for Tier 1 opportunities within your client base. A given client can have work in all three tiers. So, by holding the client relationship strong via Tier 2 service, you create the opportunity for getting Tier 1 work from them without having to overspend on market protection. The internal challenges will come with making practice management adjustments in order to be profitable in Tier 2. I suspect a number of firms have slipped into this approach by accident. However without making changes, their margins in Tier 2 are disappearing and they will struggle to maintain quality service. Absent a proactive approach here, Tier 2 work will move away from a firm to more innovative firms, leading to a dissolution of a firm's Tier 1 opportunities.

As an aside, let’s assume for a moment a firm adjusts internally to serve all three segments of this market. Should they then go after smaller businesses or other “low end” clients? This is not a brand risk. JP Morgan Chase servicing low-end markets will not hurt its brand, but may in fact enhance it as it demonstrates depth and strength.

Although you do reach a point when banks will not service a segment. But it’s not a brand issue that stops them. Instead it’s the “cost of customer acquisition and maintenance” that stops them. When no other organizational structures are available and it becomes impossible to make money on a customer segment, the banks leave the segment. Currently this is shown in the growth of “payday loan” check cashing services, an alternative provider serving this segment.

This shows that concerns about brand reputation issues can be addressed when law firms chose to embrace commodity type services.

So the elephant left in the room is: Can law firms restructure in this way? I would argue that structures for servicing Tier 1 and 2 markets are definitely possible. However, I question how many law firms will have the institutional will to implement them. Suggesting that certain partners’ comp should be adjusted to reflect their real contribution to the bottom line will be a difficult conversation. This means the less radical the adjustment, the more likely it is feasible. I would argue that shifting to a Tier 2 provider fits this approach. Process innovation combined with Legal Project Management (LPM) should suffice for this.

In contrast, firms that chose the “Bet the Farm” approach will need to dramatically increase their investment in expertise, marketing and client relationships. This approach seems much more challenging for a firm, since their willingness and ability to make large investments in their firm is quite limited.


Toby's Conclusions 

The Law Factory is not only possible, it may be the only viable option for a large number of firms. Absent this type of approach, firms will see a shrinking market and declining margins. In a market that is driving the commoditization of services, failure to embrace that change will result in many failed firms.



LAW FACTORY LESSONS FROM HILTON HOTELS by Ron Friedmann



The Business Analogy: Hilton Hotels As a frequent traveler who typically stays at Hilton brand hotels, it strikes me that hotels offer a useful analogy for thinking about law factory versus bet-the-farm firms.
Hilton offers multiple sub-brands to appeal to different buying segments. Conrad and Waldorf Astoria cater to the luxury crowd. At the other end of the spectrum, Hampton Inn appeals to the budget-minded. Multiple brands in the middle offer different feature-price trade-offs: Hilton Hotels, Hilton Garden Inn, Embassy Suites, Homewood Suites, and Doubletree.

Each brand operates in a discrete location; indeed location is an attribute that separates brands. Individual Hilton brands also tend to have similar architecture and design. Because location, architecture, and amenities differ significantly, brands have different cost structures. A Hampton Inn in a distant suburb without room service, doorman, or concierge costs less to operate than a downtown Hilton Hotel offering these plus other amenities.

All Hilton brands presumably benefit from centralized, shared services such as branding, marketing, purchasing, and the all-important loyalty program, which Hilton has just started promoting heavily. Though not precisely a shared service, I assume Hilton shares hospitality know-how across sub-brands. (Do they have a formal KM system!?!)

From the consumer perspective, I suspect most frequent travelers understand the difference among Hilton brands and choose the sub-brand based on trip-specific travel needs and budget.


Lessons from Hilton The Practice Area Analogy 

What can law firms learn from Hilton? One analogy is to consider practice areas (e.g., M&A and T&E) as sub-brands. Consider two practices seldom seen at top law firms: immigration or labor / employment. If bet-the-farm firms such as Cravath, Davis Polk, or Slaughter & May were Hilton or Marriott, they might also have these and other "law factory" practices. Like Hilton, they could house the lower-end practices in separate offices with cheaper real estate.

Simply paying less rent, however, does not make a non-premium practice profitable. The entire support structure for lower margin practices must change: less lawyer support (e.g., fewer secretaries), more fixed or alternative fees, and higher leverage.

Hilton and its competitors clearly know how to operate properties at different price-value points. It is not at all obvious that law firms do. I can't think of many (any?) that run practices with dramatically different volumes, margins, and support requirements.

Why are there no obvious examples? Perhaps clients would not buy multiple services from "law firm chains". That seems a weak hypothesis to me. The better explanation is that law firms lack the management talent and capital. Regulatory constraints may also play a role.

Absent these constraints, we might see the emergence of law firm holding companies that can take advantage of shared services and be the equivalent of Hilton. Watch the UK, where outside ownership will be allowed soon, and Australia, where it is already allowed.


Matter Tasks as an Analogy Another analogy is to view unbundled (disaggregated) tasks within a single practice as akin to sub-brands. For example, in M&A, the core merger agreement is like the Conrad or Waldorf but many lesser agreements are more like Hampton Inns.

The market seems to be moving in just this direction today. The proliferation of service providers - for example, boutique law firms, high-volume staffing companies, high-end staffing companies (e.g., Axiom), and legal process outsourcers (LPO) - suggest the market is already disaggregating tasks.

A key question is one law firm can unbundle sub-tasks. We do have some examples. In the UK, Berwin Leighton Paisner has its Managed Legal Services and Lawyers on Demand and Herbert Smith its Northern Ireland document review center. In the US, WilmerHale and Orrick have low cost centers (Dayton, OH and Wheeling, WV respectively) where staff attorneys support law practice.

In my recent Integreon blog post US Legal Market Trends Favor Law Firms Working with LPO I suggested, based in part on a recent Citi / Hildebrandt report, that large law firms can benefit by partnering with LPOs to support high-volume legal work. Of course, working for an LPO I might be biased. That said, large law firms have little experience running high volume legal support operations with industrial discipline. Of course firms can "industrialize" – the examples cited are instructive – but as a practical matter, mindset, management, and capital constraints make it difficult.


Ron's Conclusions 

My current conclusion is that law firms will struggle to manage both bet-the-farm and law factory. Law firms today develop deep but rather narrow capability. Beyond management, capital, and regulations constraints, I would add lack of courage and imagination. A more neutral way of phrasing this is by reference to The Innovator’s Dilemma (Clayton M. Christensen), which explains why successful organizations rarely change their business model and why upstarts often eventually eat their lunch. We may yet see a bet-the-farm law firm operate an industrial-strength law factory but I suspect it will not be at an AmLaw 100 firm.

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3 comments:

VMaryAbraham said...

Toby and Ron -

Bravo! You've given us lots of good food for thought here. In fact, your posts are so good that I couldn't resist adding to the conversation. You'll find my contribution at http://aboveandbeyondkm.com/2011/03/law-firm-investment-portfolios.html.

Thanks again.

- Mary

Steven B. Levy, author of Legal Project Management said...

Good stuff here. I've tried to take the arguments just a bit further here: http://lexician.com/lexblog/2011/03/the-law-factory-debate-another-perspective/

Anonymous said...

good points and food for thought.

BTW, you shoudl change the dateon your copyright notice.

 

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