Like many of you, I distinctly remember watching Bloomberg-TV on Monday 15 September 2008. It was unreal to see the bankers from Lehman Brothers carrying boxes with their personal belongings as they left the building for the last time. This image has since been engraved in our memory and has become emblematic for the 2008 financial crisis.
I also remember having a conversation back in 2009 with the General Counsel of one of the world’s largest chemical companies. He told me that management had asked him to reorganize the legal department and reduce the headcount. In order to save costs, the in-house team was not even allowed their annual team-meeting, so he had decided to organize the meeting in his garden and pay for the expense by himself.
Between 2007 and 2009 demand for legal services has dropped by about 7%. The ACC (Association of Corporate Counsel) launched the Value Challenge in 2008 heralding a decade of focus on the price of legal services. For law firms this was the start of an era of procurement, online auctions, and frustrating panel pitches. Ever since, we have heard General Counsel repeating prices should go down and lawyers complaining that all that seems to matter to clients was price before quality.
This crisis is different from the financial crisis
I guess that many of our readers were already a partner in 2008. Having gone through the aftermath of the financial crisis, one could be inclined to think that the current crisis might develop in a similar way. This however will be highly unlikely. The 2008 crisis was contained to the financial sector and most of the underlying economy was technically sound and in good shape. This time an almost universal global lockdown has crippled the economy, bringing it to a near standstill. Many companies have seen their markets, clients and supply chain evaporate within weeks. Without large scale government support many businesses would not survive. And even with rescue schemes the fall-out will be huge.
This is potentially the biggest economic crisis in the history of mankind. Many companies will have to fight for their existence, and some will fail. Under such circumstances it is not hard to imagine that companies will be very conscious where they spend their cash. Even though legal cost is generally a negligible share of total cost for a company, some legal practices will likely be hit very hard by the effects of the economic crisis.
Understanding the difference between Value and Price
In order to understand where the pressure on price will be the most severe, you need to understand the TGO Value Martix©. Early 2019 we at TGO Consulting have developed a model based on extensive data analysis. We looked at the value perception of companies in relation to the absolute amount paid to outside counsel for a particular matter. Plotting the results on a graph, is looks like this:
The vertical axis measures ‘return on investment’ for the client. In other words: to what extent are the legal costs part of the upfront investment for the company in order to make a profit or prevent a loss. The higher the value, the higher the return on the dollar. Down at the bottom of the y-axis, there is no return on the investment and any dollar spent only adds to the cost. Towards the top of the axis, there is an increasingly higher return on the investment: legal spend becomes relatively insignificant in relation to the gains (or loss prevented).
On the horizontal axis, we measure ‘commoditisation’. Contrary to popular belief, commoditisation has no relationship to legal complexity. The level of commoditisation is a reflection of the number of lawyers qualified to handle a matter in a particular market. The more skilled lawyers around, the less ‘special’ the skill. The question is just how many lawyers are in a market, which are qualified, in the eye of the client, to do the job. It does not matter if the matter is legally complex and the outcome bespoke. Availability of many qualified experienced lawyers means a high level of commoditisation, just an handful of experienced lawyers: low level of commoditisation.
Combining ROI (return on investment) and the level of commoditisation (in your market) in one model, the TGO Value Matrix© shows where companies perceive spending money on lawyers is good value. The higher the ROI and the lower the level of commoditisation, the less the price of legal services becomes an issue. The lower the ROI and the higher the number of qualified available lawyers in a market, the higher the sensitivity to price. In times of economic crisis understanding the TGO Value Matrix© will help you understand where price pressure will be the most severe.
Pressure on price will be felt unevenly in the market.
In the months or years to come, most companies will be fighting for their existence. Under such conditions, companies will mostly restrict their spending to those areas/matters that help them directly improve their bottom-line financial results. As a lawyer you need to understand where you are. It will make a huge difference if you are part of the opportunity or part of the costs. Being part of the opportunity, there will likely be little or no pressure on price, even in times of crisis. However, if what you do is -mostly- part of the cost, then prepare for a few rough years as there will be less work, huge competition and high pressure on price.
So how do you figure out if you are part of the opportunity or part of the costs? From the perspective of the lawyer all matters are created equal. Lawyers only look at the complexity of a matter and the amount of resources (billable hours) needed. Lawyers also work under the (false) the assumption that there is a linear relationship between time and value. If a lawyer spends twice the number of hours, the matter will become twice as expensive to the client. This would suggest that the final product has twice the commercial value to the client. This is by no means the case. Spending twice the number of hours does not mean that the commercial value is twice as high. It might even be nearly the same.
To avoid ending up in a situation where there is huge pressure on price, lawyers need to better understand how their clients makes money. Only if a lawyer has good understanding of their client’s business model, he/she will be able to understand how to contribute to the client’s bottom-line. Lawyers that focus on helping their clients grow their business will be largely unaffected by the effects of the economic crisis. Lawyers that are focusing on legal technicalities rather than on contributing to their clients’ bottom-line, will be considered part of the cost. This category should prepare for a ‘pricing winter’ and adapt their business model accordingly.