Last week I was able to attend the Bridgeway Customer Connective Conference in Nashville. Unlike many of the conferences I attend, this one is directed at clients, not law firms.

One of the sessions I attended really got my attention. Pratik Patel and Peter Eilhauer of  Elevate presented on a Practical Data-Driven Roadmap for Spend Management. This was primarily a case study on how one client approached cost control for their outside counsel. Pratik gave an excellent presentation on how the client took a methodical approach to understanding its legal spend by analyzing how and where it had been spending its budget. Then they took a step-by-step approach to tackling the problem.

One component of the analysis was understanding the rates the client was paying on a practice-by-practice basis. Normally I find this type of analysis marginally useful, since rates are only one component of cost control. However, the practice breakdown was interesting, since it separated out different specialities. This meant tax lawyers were not being lumped in with labor lawyers.

With this breakdown the client was able to determine market rates by timekeeper level for each type of service. For their needs, it didn’t matter whether these were market rates on the broader level or not. Then they identified firms with rates above these client-based market rates.

And here’s where it got interesting. Pratik asked the audience how many firms pushed back on the client when they asked the firms about the discrepancy. He prefaced this by saying the client expected that number to be 50%. People gave various guesses, including mine which was “low.”

The number was 5%.

Pratik singled me out – since I was the only law firm person in the room and asked me why firms didn’t push back. I replied it was firms’ superior negotiation tactics in action – which got a good laugh. Then on a more serious note, someone else commented that he viewed it as an admission by the firms that they had been over-charging the client.

Ouch.

The Lessons:

  1. Pratik made a point early on that the client did not want to push too hard on their firms. They want their law firm partners to be financially healthy. In fact the other presentations I saw at the conference echoed that sentiment. Although clients are wary of their firms, they don’t want to be mean about it.
  2. And when firms react as if they have been charging high rates, they can be sending a bad message. If they act like they have been treating the relationship poorly, then they shouldn’t be surprised when clients view it that way.
  3. Lastly – law firms need to grow a pair. They employ very talented people. Instead of always bending over, they should have some confidence in defending their prices. Failing to do so means they will undersell the value of their services.

The legal market needs to mature around these ideas. This chaotic, wild west situation is resulting in many unintended consequences. As usual, I continue to recommend that lawyers take a more proactive approach to dealing with all of this change. To shy away from this, only leads to confusion and unhealthy relationships.

Image [cc] Grand Canyon NPS

My posts have subsided a bit lately as I felt an echo chamber growing and started questioning a lot of stuff I was reading as either echoes or reiterations of prior statements. Some of these echoes are new angles on old subjects, but they merely restate the basic premise: BigLaw is broken and doomed. I feel lately, the echos are drowning out critical thinking.

And now I shall unfairly pick on my good friend Jordan Furlong.*

His recent post on “The decline of the associate and the rise of the employee lawyer” struck a nerve with me. It started with this phrase:

We’re now on the verge of entire associate classes whose only purpose and value is to generate leveraged work. They are not meant to be future partners: they are temporary employees meant to sustain the practices of current partners for as long as those partners need them.

The unstated presumption here is that the proper purpose of an associate class is being on a path to partnership. From my point of view the presumption that all workers should be on a path to ownership is nuts. Which is not to say that generating profit is the workers’ “only purpose”. Quite the contrary, I think their purpose should be providing value to clients. But that effort needs to be profitable or a firm will soon go out of business.

What is wrong with hiring talented lawyers to be valued, potentially long-term employees and not future owners? True – firms need to nurture future owners, but doing it under a false pretense that every associate could or should some day be an owner is part of the problem. The history of this approach has shown that not many make it to that level. And it appears that even fewer may make it in the future. But is that bad?

I don’t think so. With any business, some talent is suited for working and some is suited for business development. Do we pick at clients for hiring in-house lawyers as employees who are “generating leveraged work?” I think not. I recently heard about one BigLaw firm that created a non-partner track for associates, thinking they would have to go outside to fill this track. So far they have not. What this tells me is that many associates “just want to practice law” and not be under pressure to become an owner. This up-or-out pressure turns a lot of excellent lawyers out or away from law firms. Why can’t a talented lawyer become a world expert on a legal subject without aspiring to be an owner?

Another echo chamber comment I read recently had to do with how bad the billable hour is – since it encourages associates to bill time. Say what? Last time I checked, most employers encourage their workers to … work. And the more they work, the better the employer likes it. Some employers even pay bonuses for putting in extra effort. It’s not the billable hour, but instead the lack of management oversight reigning in effort that doesn’t deliver value to clients that is the problem.  Bashing BigLaw for rewarding extra effort seems misplaced to me. But it is very easy to do. I think it is more appropriate to bash BigLaw for rewarding poor effort. If associates are bringing value with every hour they work – I don’t see a problem in rewarding that effort.

And now back to the Echo …

* We have a history of trading barbs.

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In the 19th century one of the big business revolutions was the adoption of a new technology called “Railroads.” Of course when railroads were first proposed, two things happened. The first was a general uprising from the establishment about why this was a bad idea. This push-back came from those you would expect – the ones with a financial interest in keeping things the same way.

Although the first railroads were successful, attempts to finance new ones originally failed as opposition was mounted by turnpike operators, canal companies, stagecoach companies and those who drove wagons.

The second reaction was an “irrational exuberance” over the potential profit to be made and the speed at which change would occur. Mass quantities of speculative dollars were thrown at building rail lines from here to there to everywhere. Which of course resulted in much lost money when change didn’t come that fast.

Obviously railroads did not fail in general. I understand we still use them. But what did happen? It took about 50 years for railroads to fully embed in the US economy. From then on, this new way of doing business was considered business-as-usual. So instead of a quick revolution, change came about incrementally over a much longer period of time.

In the 20th century something similar happened with TV, only the commercial adoption was shortened to about 20 years. This highlights the accelerating rate at which new technologies are being adopted. For tablets, I think it was 3 years – although I just made that stat up.

The obvious conclusion, according to this history and everything I read about BigLaw, is that we have about 10 minutes left before BigLaw collapses and the Phoenix of the New Normal rises. By the time you come back from the bathroom, it will all be over.

For those of you who followed my suggestion and are now back, you will notice my predictions were proven false. Not much has changed.

As an alternative, I suggest the revolution in the delivery of legal services will take a bit longer to occur. Now I am not suggesting it will take 50 years. But I do suggest it will not come as fast as many might predict. We all know things need to change. And many see financial opportunities in that change, as they well should. However, I have been feeling a bit of irrational exuberance lately about how this will all play out.

So don’t look for BigLaw to collapse or for new-style providers to sweep through the market in short-order. Instead watch for steady, incremental changes in the way law firms function and deliver their services. Next generation providers will continue their growth, law firms will merge and things will generally keep changing. Much like the railroads, change will come, just not all at once.

Not too long ago, Jordan Furlong wrote a good post on what law firms sell. Normally I would go all “Dan Aykroyd” on him, but not this time. His post got me thinking about the broader question of what law firms sell in terms of product offerings. And here’s the catch: They don’t know what they sell.

And now a car analogy …

If Ford acted like a law firm, they would know they sell automobiles. They would probably know they sell some volume of sedans, SUVs, trucks, coupes, etc. But beyond that, they would not know how many of each product they sold. Under SUVs they would not know how many Explorers versus Escapes versus Expeditions were sold. Oh, and in the SUV category there would be some sedans, trucks and coupes included.

Of course if Ford acted in such a fashion, they MIGHT know they sell automobiles

Law firms know what they sell only at the high level because that is all they have needed to know until recently. Although most firms have some taxonomy of matter types, they are rarely used effectively. For most firms, the work gets a high level categorization based on the billing partner’s practice designation. This means transactional work can be tagged as litigation if the billing partner is a litigator. The choice of matter type when it is an option, is too often made by a secretary. These well-intentioned secretaries picked the most convenient type or the one least likely to get anyone’s attention. Therefore when someone wants to see “Single Plaintiff Employment” cases, the only way to find such a list is manually – which means it never happens.

This is obviously an opportunity for Knowledge Management (KM) to shine. But I predict the usual challenges for KMers who tackle this problem. First – a firm will appoint a committee to develop a ‘comprehensive’ list of matter types. The Committee will want to make sure every possible matter type makes it on the list, since Fred’s Admiralty practice is just as important as the rest of the firms’ commercial litigation practice. The result will be a long list of never-used matter types … and we’re back to where we started.

My advice: Firms need to know what they sell, down to a reasonable product level. Finding that reasonable product level is a task for marketing and leadership and then KM can be the engine to continually support this effort. Once firms know the true volume and margins on each of their product offerings, then they will know where to focus their market efforts and product resources.

Image [cc] Marc Samsom

My recent post on the Price Point Law Firm generated a few interesting discussions. One included Kingsley Martin. Kingsley asked whether law firm work volume would go up if a firm lowered their rates (a.k.a. prices).

Poor Kingsley. This engaged my Economist Engine at Warp 10.

The “real” question is obviously about the price elasticity of legal services. For those smart enough to avoid taking Econ classes, price elasticity has to do with the expected change in sales volumes based on incremental changes in price. In price sensitive markets, prices can be very elastic, meaning that small changes in price can drive large changes in demand volume. The result of a price decrease would theoretically be both increased revenue and increased profit, especially in markets that require heavy capital investments. Although legal is currently experiencing price sensitivity, it does not require significant capital investments in equipment. Its investments are in variable costs – a.k.a. human capital.

In any event let’s examine Kingsley’s challenge. What if a firm lowered its rates? What should it expect? Coincidentally one of my former firms suggested just such a pricing tactic. And why not? If the market is angry about price, lowering price would be the best response. Right?

Although clients are concerned and focused on price these days, it is not their primary purchasing decision point. They ten to vet firms with expertise, then go to price. So any firm looking to profit from a price decrease would have to already be on numerous client short-lists. And even then, clients don’t exclusively decide on price.

So what is more likely is that a BigLaw firm that lowered its prices might see an incremental increase in volume of work. The challenge would come from the clients this approach would attract: Price Point Shoppers. These market segments are usually the most difficult to profit from, since they require similar cost inputs, with reduced revenue. So volume is necessary to generate sufficient profit. And the client’s loyalty is to price, so they are easily lost to other price point providers. If your firm was totally committed to commodity work, then you might consider such a pricing strategy.

So where would my Price Point Law Firm fit in the market? Likely this firm would take work from mid-level and regional firms first, eventually taking work from larger firms as its reputation grew. This firm’s value proposition is a national firm with local rates. It would have to earn its way up within the client work value chain. But it likely could succeed. (Think Target Stores, as they took out local stores and are now taking down Sears and KMart.) So its success is not based on price elasticity, but instead on market segmentation.

Getting back to Kingsley’s elasticity question – I refer to my recent article on the State of Legal Pricing. The punch line there is that the market is in chaos, craving a rational pricing mechanism at the fee level. Absent such a pricing mechanism, it is near impossible to determine price elasticity. So my economics counsel to firms would be to hold off on using price decreases to attempt to grow your market. Either that – or open up your own price pont firm.

Geek #1 had the opportunity of asking Casey Flaherty a question during a presentation recently. One of his takeaways is that clients still do not trust their outside law firms. After posting my recent piece on SOLP 2013, a thought clicked in my head. Consumers of any product will grow angry if they believe the providers are extracting profits at higher-than-market levels for any length of time.

Consider oil companies. During the mid 2000’s, the price of oil per barrel was jumping dramatically. There was much talk about what was driving this. Some claimed it was due to speculators. But the result was higher and higher prices at the pump. In a relatively short period of time gas prices increased by 50% and then stayed there. It was not long after that the Majors started announcing record profits. It was not long after that people started clamouring for Congressional investigations into price gouging and the like.

History is replete with examples of customers who react negatively when they think providers are using market power to raise prices and extract higher than normal profits.The Sherman Antitrust Act is the embodiment of this reaction.

I should point out that lawyers do not have a monopoly on legal services in the classical economics sense, since there is competition in the market from a large number of providers. However, there are definite restrictions on who can enter the market. These restrictions were placed as a protection on consumers, keeping them from receiving significant legal harm via untrained and incompetent providers.

At that top of the market (a.k.a. BigLaw) there has been a more restricted set of provider options for customers. I recall a consultant telling me as recently as 2008, that clients were afraid to ask for bigger discounts since their BigLaw providers might choose to not take their cases. Of course that has changed.

The real crux of this issue is that many clients perceive legal providers as engaging in price gouging. One can easily argue the market has been setting prices (via hourly rates), just like the case with the price of gasoline in 2007. Law firms have been behaving ‘rationally’ in an economic sense, as their price increases were accepted by the market.

The main difference between oil companies and law firms is that alternative legal providers are more readily available and more are emerging.

The old saying goes “Perception is Reality.” Therefore firms need to find a credible way of responding to this market influence. I’ve noted recent record profits from big banks. Back in 2008 these clients asked for their firms to work with them through the downturn by holding the line on rates. I wager that even with the market turnaround, they will not be going back to their firms with offers to raise prices and will continue their downward pressure on legal costs.

This is the market we now live in.

What is your reaction to that title?

Most lawyers will probably turn their noses up at this. Since law is a reputation-based business, who in their right mind would want their reputation associated with being cheap?

Many clients will likely be quite interested in this concept. Not that all of their work will ever go to a price point firm, but currently their work that is more driven by price has few, if any, law firm provider options. So client ears will perk up when hearing this firm mentioned.

What would this Price Point Law Firm look like?

I propose a firm that strongly differentiates as a price point alternative. For hourly deals they might have some maximum rate, say $350. For other pricing options, they would provide very competitive bids.The focus of this firm would be on 2nd and 3rd Tier legal needs, also known as the high volume aspect of legal services.They could easily serve everything from very large companies, down to small businesses. This would mean they would have an extremely large market to attack.

Of course this Price Point Law Firm would structure itself such that it could profitably serve such a market. Given the over abundance of legal talent available in the market, finding suitable lawyers should be relatively simple. Their starting pay could be kept reasonable – say $40k to start. With their starting rates at $150-200 and only a billable base requirement of 1500 hours, they would be quite profitable for the firm.

Our Firm will spend more money on professional development for these lawyers than traditional firms. And by professional development, I mean actual skills training, with management oversight and hard goals. This also means our lawyers will have well-defined career paths, especially ones that do not lead to owner positions, since most people are not suited for or even desire that level of responsibility and stress.

The Firm will have extremely strong leverage, meaning you do not become a partner unless you want to act like an owner. How does an owner act? They drive business, over performing client work. We won’t expect our front-line workers to be sales people, and we won’t expect our owners to be front-line workers. A recent conversation with a “partner” in a non-law professional services organization told me his annual billable expectation is about 400 hours. His biggest expectation is bringing in business. Our Firm owners will be compensated based on similar factors, versus how many worker hours they bill.

In this scenario, the owners of this firm will easily enjoy profits at or perhaps above what BigLaw partners currently make.

So why isn’t anyone creating a Price Point Firm? From an economics perspective, it is absolutely crazy (or more appropriately – stupid) that no one is. The market is screaming for such a provider. The sad truth is that too many lawyers have become so internally focused that the screams of their clients are not being heard. True – many firms are providing bigger discounts to clients, which is responding at some level. But clients are literally begging for quality legal work at reasonable prices. Absent the LPOs and a few niche firms, no one is listening.

Do I hear opportunity knocking …?

.

Time is Money
Image [cc] Tax Credits

Back in January, Tom Wolfe wrote a Newsweek article called Eunuchs of the Universe where he articulated the new style of Wall Street versus the Wall Street that most of us knew. Instead of a raucous gathering of traders in a pit, scrawling information on sheets of paper and signaling wildly to buy or sell the next trade, today’s traders work on computer networks designed to take advantage of milliseconds and use it as a strategic advantage over competitors or to find flaws within the system to nearly guarantee a profit. High-speed networks were optimized and placed along specific geographical corridors in order to have bids, orders and sales conducted ahead of other traders. These days, speed, technology, and out-geeking the next trader is where it’s at. A few milliseconds meant the difference between a good deal and a great deal. It was no longer about being Gordon Gekko and the sexy, ruthless player in a pinstriped suit… now the hero of Wall Street would be to find Doctor Who and travel milliseconds back in time to make trades.

Imagine how powerful you could be if you could beat the competition by two-seconds? Wolfe would have had a field day in his article had he known that a mere $6,000 a month could buy you that information a full two-seconds earlier than your competition. I’m sure he would have written an entire chapter on that story and how the geeks could upload financial outlook reports into massive supercomputers and have trades ready to buy or sell a full one-second before the competition even had the report in hand. What a story that would be.

The only problem is… it isn’t really fiction at all. Turns out that Thomson Reuters has been doing this very thing with the University of Michigan’s Consumer Confidence Index. It pays Michigan an amount North of $1 million each year to release the information five-minutes before UM launches it on its website. The money management companies pay a premium to Thomson Reuters for the information. That practice is well known. It is the secondary practice that goes on that has caught the eye of New York Attorney General, Eric T. Schneiderman. Apparently, a five minute head start over the public is not good enough. A five-minute and two-second advantage has been given to an elite group of about a dozen clients from Thomson Reuters. Schneiderman seems to think that this little group may be receiving an unfair advantage and investigating whether this preferential treatment is a fair and appropriate business practice.

Thomson Reuters claims that the tiered pricing is not illegal and that as a private company it can disseminate the information any way it pleases, so long as it disclosed to those purchasing the information. Schneiderman seems to be channeling his inner Eliot Spitzer on this one and is bringing out the Martin Act to challenge practices that are deemed unfair, even if technically legal. Regardless, it would be naive to think that this type of tiered access is limited to this one report.

Luckily for us in the legal field, we aren’t tied to milliseconds like our counterparts in the financial industry. However, what if we could pay a premium to Thomson Reuters to let us know of law suits filed against certain companies a few minutes before they let our peer firms know? Would law firms pay to be on the top-tier of that knowledge? It makes me wonder if anyone on the financial side of Thomson Reuters is brainstorming of ways to bring this practice over to the legal side of the house as a way of enhancing revenues? What could law firms do with a few two-second head start over our competitors? Most of us believe that law firms are far to slow to react to this type of advantage, however, the idea is a fascinating one to contemplate.

Image [cc] paojus

One of Adam Smith’s great contributions to economics was his commentary on the ‘division of labor’ – explained in his pin factory example. For those of you who may have fell asleep during this part of the Econ 101 lecture, Adam Smith demonstrated how productive capacity increases with specialization.

He evaluated an artisan craftsman who makes pins with great care and quality, one at a time. The craftsman performs every function, from straightening the metal to attaching the pin head. Adam Smith then describes a factory where each function is performed by a specialist who only straightens the metal or only applies the pin heads.

He researched this to compare how many pins could be made each day per worker with each approach. His thesis was that the division of labor leads to much higher productivity. “The result of labor division in Smith’s example resulted in productivity increasing by 24,000 percent (sic), i.e. that the same number of workers made 240 times as many pins as they had been producing before the introduction of labor division.” His argument was compelling to the point that Henry Ford modeled his car factories based on these principles.

You may have already jumped ahead of me in how this applies to the practice of law, especially after I used the term “artisan craftsman.” Most lawyers are generalists / craftsmen (please excuse the sexist reference)  as it relates to their functions. They may specialize in patent litigation, but under that umbrella they perform all of the practice functions. One might argue certain functions are reserved for more experienced lawyers, however that is not specialization. That is expertise. Specialization would be document drafting, or oral arguments at hearings or prior art research or any other specific function.

Instead lawyers fancy themselves as artisans who work with clay (e.g. words) to create works of art (e.g. pleadings). In their minds specialization, and the standardization that follows, equals lower quality. In contrast, in Adam Smith’s world, specialization and standardization equal efficiency and quality.

For as smart as lawyers can be, they continue to miss some basic business lessons. In this instance, Adam Smith was proven right decades ago … repeatedly.

Add “division of labor” to the list of changes needed at law firms.

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Everyone seems to agree that BigLaw is f’d up. The business model is completely screwed up and not in alignment with reality. This allows great sport for those of us who enjoy picking at the various aspects of exactly how BigLaw is headed for disaster.

But what does this disaster look like?

Many prognosticators are on death watch. Which firm will be the next Dewey / Howrey to collapse?

I propose another alternative for BigLaw – Death by a Thousand Cuts. The vast majority of firms will not implode, but instead will fade slowly to black.

Why do I say this?

Law firms, for the most part, act like sheep. They keenly watch the actions of the other sheep and then match them. As we have noted previously on 3 Geeks, most innovative ideas at firms are met with the response: “What are other firms doing?” The result is that firms don’t break away. Instead, they move as a herd.

Alongside the Sheep Factor is the Financially Conservative Factor. BigLaw firms love to brag about being debt free. The point being is that most firms are not in a “Dewey” situation, where their finances are in bad shape. Instead, they will experience profit pressures at the margin. The profitability of their work will slide over time. So instead of facing a cliff, they face a relatively gentle slope.

They will then react in one of two ways (per the Sheep Factor). First they may just accept declining profit. At a former firm I repeatedly heard partners say “Maybe we have been making too much money.” Those partners may be perfectly fine with slowly declining (high) incomes.

The second option will be right-sizing the firms. This will likely take the form of fewer equity partners: be that through de-equitization or smaller incoming partner classes. In this scenario, profits may be maintained or even enhanced, but there will be a smaller ownership pool. So effectively theses firms will shrink to maintain profit.

In either case, these firms will not be in much danger of imploding. They will pay their bills and make partner distributions. Their market share will be shrinking, but there will not be catastrophic collapses.

Of course firms whose financial fundamentals are not in shape should be concerned. But I would venture a guess that after Dewey, most firms took a hard look at those numbers, tightened up their lateral policies and further limited their debt exposure. So there may not be many firms facing a cliff.

Which leads us to our Death of 1000 Cuts – which greatly lowers the entertainment factor of a Death Watch.