Why law firms will not survive disruption, unless… How are legal market disintegration, legal service specialisation, legal service creation, digital innovation, virtualization and market power shift linked together? And what has all this to do with digital natives…?

The legal market is slowly disintegrating, mainly driven by service specialisation and new service creation. The power in the corporate legal market is further shifting away from law firms, the legal market suppliers, towards inhouse counsel, the legal market buyer.

Today’s technology trends push companies to adopt aspects of digital innovation and virtualization. On top of that, a generation of CEOs and legal counsel will retire soon, followed by digital natives: A new generation of company managers born after the internet of things became commonplace. Guess how they will want to interact with their legal suppliers… Let s take a closer look at each of these elements.

DECOMPOSING LEGAL WORK AND BEYOND

In our first white paper on the Legal Innovation Matrix, we addressed the general trends in the legal industry: The overriding
trend points towards specialization in one or more of the following areas: network, know-how, software and platform.
This trend is made possible because of increased modularity of legal services and know how: Legal work can be increasingly decomposed into its constituting components (popularly labelled unbundling). The technical term for this is Vertical Market Disintegration.

The consequences of this market disintegration are far reaching. Firstly, it allows new players to focus on a subset of tasks previously managed within the law firm – i.e. service specialization. Secondly, it allows for new players to reengineer legal work flows and processes, creating new ways of service delivery that combine elements of two or more of the Legal Innovation Matrix’ quadrants – i.e. service creation.

Service specialisation can be found in many shapes and forms. Rising niche law firms focus on one aspect of legal know-how. You could also refer to software tools, focussing on one specific task and one task alone, processing a multitude of documents for review. Legal process outsourcing is another example. Specific parts of the legal value work, are being outsourced to low cost alternatives, operating profit margins on labour cost arbitrage. Think also about for example legal spend management software for corporate clients.

Service creation is a bit more new. It can be found for example in the strategic direction pursued by the likes of Riverview Law and Axiom in the common law area. Their strategic goal (not where they are today) seems to direct them to reconfigure and redefine the way in which corporate clients deal with their legal work and interaction with internal and external stakeholders.

A thorough decomposition and reassembling of people, knowhow, software and platform aspects is required to come up with an easy to use and intuitive new way of instructing and managing legal work.

KICKING IN OPEN DOORS

Most of the legal work carried out by lawyers is not highly technical. Additionally and to a varying degree, some or all parts of that legal work actually do not require specialized legal skills to be carried out.

Now, most lawyers will disagree.

They will most often rebut this statement by arguing that in their practice: contracts, legal documents, legal advice; requires their specific expertise and, also often argued, every case is different and requires a tailored approach.
By now, initiatives such as Riverview Law and the Practical Law Company have disproved that statement. Moreover, in his 2013 article Quantitative legal prediction, or how I learned to stop worrying and start preparing for the data-driven future of the legal services industry, Dr. Daniel Martin Katz from Michigan state University explains rather clearly why that line of thinking is wrong. However, resistance to commoditization within law firms remains high.

DIGITAL INNOVATION

Digital innovation has three key characteristics: (i) reprogrammability, allowing a wide array of functions, (ii) homogenization of data; separating the content from the medium and (iii) its self referential nature, creating positive network externalities, reinforcing the digital innovation (Yoo, Henfridsson and Lyytinen, 2010).

The e-book is a text book case of a digital innovation.

In the legal industry, contract building engines such as the one developed by Smartlaw in Germany, serve as a good example. Because the contract is digitized, the client can play with the contract, add clauses, import it and embed their logo, (reprogrammable), use it over and over again, wherever and whenever (homogenization). It creates an innovative new way of serving clients, reinforcing the wave of digitization of complementary products (self-referential).

VIRTUALIZATION

Closely linked to digital innovation is virtualization, which is in essence the digital online (full or partial) translation of what are currently mostly physical processes. For example, checking your bank account used to require a physical visit to the bank.

Today, you can check your account details anywhere anytime, provided you have internet access.

When virtualizing processes and services, a set of key questions should be reviewed:

(i) How should virtual processes be designed;

(ii) how will people use these virtual processes and (

iii) what will be the consequences of this virtualization (Overby E, Slaughter S.A. and Konsynski B., 2010).

For example, when considering providing automated online employment contracts you should
ask yourselve the following questions:

1. Full virtualization of the experience or will we keep a physical check?

2.Are we going to fully automate or merely virtualize?

3.Should we design it ourselves or will we set up a Joint Venture with an IT provider or LPO company?

4.How will clients use this service?

5.Will their behaviour differ when faced with the physical or virtual process?

6.Will they accept the shift in responsibility for tasks from law firm to client?

7.When will they use them, i.e. to complement our physical service, as a substitute?

8.Will this a . Improve efficiency? b . Enhance access? c . Improve quality? d . Strengthen our brand?

MARKET DISINTEGRATION: SO WHAT?

That would be our first question as a managing partner of a law firm: So what? Well, let us take a step back.
What happens inside the law firm black box? Law firms operate a simple leveraged model, based on hours x hourly rate + mark up, the so called billable hour. With the growing pressure on price, a multitude of consultants and software providers have thrown themselves into the field of what is called AFA or Alternative Fee Arrangement consultancy, trying to solve the issue of pressure on price or the more-for-less dilemma law firms increasingly face.

One of the outstanding market references on this matter is Ori Wiener’s High impact fee negotiation and management for professionals. Although paramount and instrumental, the application of and search for AFAs only lays bare the visible part of the wound, not the illness itself.

The real problem lies hidden within the underlying business and management model. There are 3 key problem areas.

1.The law firm business model is inherently contradictory
The leveraged business model is inherently contradictory with the increasing market demand of more-for-less.
Put differently, when you introduce efficiency into a normal company environment, you reduce cost and thereby hopefully also increase your margin. When you introduce efficiency into a law firm leveraged business model, you reduce revenue. Understanding this dilemma is important. If you wish to change the service delivery model, you need to first address the underlying business model. If this cannot be done from within the existing structure, maybe then you need to look at setting up hedging structures.

2. The law firm management model does not facilitate change management easily
Additionally, law firms sometimes resemble an army where there are more generals than soldiers. The partner driven management model does not make it easy to introduce change. Change management is always difficult. Introducing change into a management model where there exists internal rivalry (see point 3), where there are relatively high degrees of management freedom and decentralised decision structures is even more difficult, especially when you are or have been earning above average returns for decades.

3. The law firm as a structure is in essence an empty box
At the risk of sounding provocative, what else is a law firm but a collection of expert individuals, with a support structure build around them? What are the actual core assets owned by a law firm? Most of the value can be found in the brand and the people. The overall brand consists of the sum of the individual brands of the law firm’s experts, individual and institutionalised know-how and additional marketing efforts. However, the brand can dilute and the people can leave rather easily.
Another problem arises within the boundaries of a law firm. Expertise and experience (Maister 2005) are often not shared but kept inside the intra-firm module because of what Pitelis refers to as intra-firm rivalry (Pitelis 2007). This kind of organisational modularity or near decomposability creates knowledge silos that inhibit architectural innovation (Henderson et al 1990 and Zedtwidt 2003, as cited by Sako, 2010).

Much like Kevin Spacey shows us in the House of Cards, law firms today and the way they are organized also know a high level of antagonistic intrafirm conflict: internal politics and fights. Resources (time, attention and energy) – or what Pitelis entitles slack – are diverted away from what is happening in the market and are lost in both intrafirm and interfirm competitive fights.
One result: Failure to spot opportunities creates opportunities for new entrants to capture market share and transform the way in which legal services are delivered.

INNOVATION: SO WHAT?

That would be our next question as managing partners of a law firm: Why bother with innovation?
In the short term, you would be right in asking that question. Innovating for the sake of innovation might be fun, you may even stumble upon something extraordinary, but does it add to the bottom line?

How about the long term? As stated earlier, change is already taking hold. This will increase rapidly with growing computing power, increased availability of legal know-how and with market disintegration.

Running a profitable business requires one or a combination of several of the five forces Porter identified in 1985: Control over supplier power, barriers to entry, competitive rivalry advantage, reduced buyer power, limited threat of substitution.

Today, there are increasingly more substitutors, the number of interfirm competitors has increased, the market power is shifting towards corporations and the barriers to entry have been lowered substantially.

A brand and a group of outstanding legal experts will not suffice to hold off the wave of innovation.

THE KEY CHALLENGE

Moreover, the key challenge does not lie in making the backoffice of a law firm more efficient. It lies in customer experience and service delivery, as recently pointed out again by Ron Friedman (see prismlegal.com).

However, creating a new and improved service delivery requires a fundamental shift in the underlying business model. The challenge therefore is a double one: (i) A fundamental shift in business model or the creation of hedging structures; the former is required for (ii) a successful redesign of the legal service delivery and customer experience.

It is very doubtful whether this can actually be done from within a law firm structure. Applying an ambidextrous approach – like Allen & Overy does – might therefore offer solace. It yet remains to be seen whether this will also deliver ultimate success.

As Christensen made clear, disruptive change usually comes about when market incumbents are overshooting the market (too complex a product offering), whilst new entrants provide inferior solutions, often at very low prices (and hence uninteresting margins), and often in emerging markets first on the principle of ,good enough’.

Currently, most law firms focus on decreasing costs to safeguard margins when applying innovative techniques: In-sourcing, delawyering, relocating, offshoring, outsourcing, subcontracting, co-sourcing, leasing, home-sourcing, open-sourcing, computerizing, no-sourcing.

A law firm’s focus should be redirected to how it could improve customer and client experience, which means to fundamentally question the existing business and management model.

Let’s end on a positive note: If law firms succeed in reshaping their underlying business model to improve and radically change service delivery and customer experience, they can stand a good chance to surf the perfect storm (see Cambridge Judge Business school’s Tim Bellis, The Perfect Storm, youtube).

THE AUTHORS

Felix Rackwitz (41) MBA (Cambridge), Managing Director and head of BD Tools4Legal; law firm management and global head of Business Development (15 years). Cambridge thesis on impact of innovations on law firms and lawyers. 

Filip Corveleyn (37) MBA (Cambridge), Head of R&D Tools4Legal, former restructuring lawyer (12 years). Cambridge thesis on the impact of modularity on legal innovation/disruption

Tools4Legal is a Frankfurt based company, designing and building new ways to deliver legal services for corporations and law firms. We use design thinking, follow-me home techniques to fundamentally rethink the way in which legal as a product and service can be delivered to corporate clients. Why not contact us and learn about what we can do for you?