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In Part 2 of this series we covered the beginnings of major change in the legal market along with the initial responses from firms and lawyers.
An emerging and compelling reason for lawyers to make different business decisions is coming from new breeds of competitors. One example is the Legal Process Outsourcer (LPO) market. These companies started as off-shore (typically India) based providers for first document review in litigation. They hire English speaking, American law trained candidates in other, lower wage countries. These much lower-costing, well-enough trained lawyers were appropriately suited for this level of work. So well-matched to the tasks, that in very short order, these document reviewers became viable competitors. Most lawyers glossed over this market encroachment, seeing it as commodity level work no longer worthy of their skills. In reality, this meant millions in fees were no longer going to US lawyers.
The LPOs originally targeted law firms as their customers. But law firms were slow to respond to these offerings, in part due to the ethical constraints of profiting from third-party services. But firms were also concerned about diluting the law firm brand with low-level services. The result was that LPOs shifted their sales and marketing efforts directly to clients. With the acquisition of the Pangea3 LPO by Thomson Reuters, the market saw strong validation of this model. LPOs are now offering a broader range of services including: Contract Drafting, Contract Review, Patent Application Drafting, IP and M&A Due Diligence and other services.
It should be noted that these legal-type services are being provided by non-law firms directly to clients. To date, it appears that no regulatory authorities are investigating these practices leaving these new competitors ample opportunity to go after the legal market, which they appear to be doing. As law firm revenues have gone stagnant or declined over the past few years, LPOs have been experiencing 50% growth per year.
In the solo / small firm segment of the market, other competitors are appearing. For example, LegalZoom is a provider of online legal forms which also provides customer service to assist clients in completing the forms. Some states have taken issue with LegalZoom for, what they believe to be, engaging in the Unauthorized Practice of Law (UPL). These states’ efforts do not seem to be having much impact on LegalZoom’s growth. The company reports raising $100 million in funding to-date and $100 million in revenue for 2011. This market for online legal content was further validated via Google’s $18.5m investment in Rocket Lawyer in mid-2011. These providers are taking full advantage of 1) the ability to raise capital, and 2) next generation technology. Lawyers are barred from the first activity and generally unwilling to engage in the second one.
Profit vs. Revenue
Lawyers and firms have been living in a cost-plus business model world for the past 50 years. ‘Cost-plus’ is having the cost of a service plus a profit built into the pricing. Hourly billing rates are a manifestation of this model. As long as there were enough billable hours to go around, profits were virtually guaranteed. This model created a mind-set bent on billable hours and revenue, for which the industry is well-known. The challenge for firms now is that these rules no longer hold true. The shift that began in 2006, accelerated by the recession in 2008, changed that dynamic.
AFAs presented a viable alternative to work through the shift. Instead of looking at just hours and rates, fees and cost of delivery became part of the equation. Now firms began looking at matter financials in a profit margin way.
Most businesses operate on the margin model. Although not a complicated formula (price minus cost equals profit), it is still an elusive one for lawyers. I contend that by the end of 2009, firms were unknowingly operating in a margin world. Unknowingly since their compensation models are founded on a cost-plus model that rewards revenue versus profitability. Therefore firms have a structural blind-eye to the profit squeeze problem. They are unable to even expose the problem, when they really should be focused on resolving it.
At one point in 2010, a law firm partner asked me if I could do one thing to restructure a firm for the future, what would it be? I gave a simple answer: Change the financial conversation from revenue to profit. Most of the challenges facing firms would come in to focus and receive the attention they need and deserve if that one criterion were in place. Every effort in a firm would shift from supporting a cost-plus model to the margin one that actually exists.
Part 4 provides a forecast on the technology aspect of the perfect storm. This rapidly advancing force brings serious challenges, and hopefully some opportunities to lawyers.