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Part 1 of this series set the stage for the perfect economic storm, covering the forces pushing change in the legal market. Part 2 covers the first pain felt in the legal market and how firms have reacted.
Along Comes 2008
Even before the Lehman collapse, clients had already started sending signals to law firms about rate concerns. But after the collapse those signals became directives. Some clients went as far as sending letters dictating rates for 2009. A good friend summed the scenario up well when he noted, “The Guild was broken in the General Counsel’s (GCs) office.” What he meant by this statement was that legal departments and legal budgets were no longer getting a pass when it came to cost reductions. The CEO had come to the GC for his annual “you need to cut costs” visit, but this time wouldn’t take “I can’t” for an answer. In some situations, the CEO brought in Procurement and instructed the GC to use this group as a resource to get control over legal costs. Prior to this, GCs were cautious about pressuring outside firms on rates, fearing they might not represent them in the next large case if they were offended by discount requests. The CEO gave them something bigger to fear.
Alternative Fee Arrangements (AFAs) began to rise in popularity at this time. At least they were in conversations. But many times the GC would ask for AFAs, not really knowing what they wanted out of them. The fallback was another 5% discount off of rates; which the clients pretty much got whenever they asked for it.
As their clients were attempting to do, law firms gave major focus to their own cost cutting in 2009 and in to 2010. One report documented more than 12,000 lay-offs from large firms in 2009 alone. Law firms sought and found many ways to cut costs. It was an exercise not conducted in quite some time, so cost reductions were easy to identify. Of course these cost reductions had an impact on the legal market vendors, further extending the financial pain into the market.
One cost factor left relatively untouched in these efforts was partner headcount. Partners, as owners, are not as easy to terminate. As well, there is a loyalty to partners, making this type of cut a last-ditch approach. And in the short-run, it was easy to avoid. The cost savings turned out to be more than enough. Many firms posted record profits (on lower revenues) in 2009 and 2010.
But these cost cutting measures can only go so far. Firms faced continuing challenges in 2011 with: 1) no more easy cost cuts available, 2) clients continuing to push on rates and prices driving down realization, and 3) less-than ideal leverage (a.k.a. too many partners). Simple economics indicates that under this scenario, firms began facing a real squeeze on the bottom line. Additionally, the market for legal services is not growing. There are some practices showing modest growth (e.g. Patent Litigation), however the overall size of the legal market is not changing and firms wanting to grow their revenue to sustain profits must do so at the expense of other firms.
You may have noticed I did not refer to the economic shift as going to a buyers’ market. My sense is that the legal market is now in a traditional, competitive market; one where firms have to employ a broad range of business strategies and tactics. In the old sellers’ market, the only differentiator was that of perceived legal skill. Lawyers only needed to market their skills, resulting in clients sending them work. In a competitive market lawyers need to show clients an arsenal of differentiators. I shy away from labeling this all as a buyers’ market, since I feel that label obscures the need to utilize all types of tools. Until very recently, there were many lawyers who held to a belief they could just wait this whole storm out and once it passed, bask in the warm glow of another sellers’ market. Given the deeper shift in market economics, this belief is unwarranted. Approaching the market as being competitive in a new and enduring way will lead to better decisions.
Part 3 brings new players in to the equation and offers a suggestion for how lawyers might refocus to meet this challenge.