Why the current growth in law firm revenue is unsustainable.
About a month ago I had the honor of being a keynote speaker at the biggest conference for lawyers in China to date. Over 700 attendants gathered in Shanghai. The other keynote speakers were professor Ashish Nanda and professor Richard Susskind. The theme of the conference was the future of the legal profession. In one of the coming posts I will share with you what I learned during that conference. In this article I want to highlight one particular observation I had. In between the keynote lectures there were several panel discussions by leading Chinese lawyers. The first panel discussion took place after Richard Susskind’s lecture and consisted of a forum of 10 managing partners of the most prestigious law firms in the country. Without exception these were men in their early sixties. In most cases they had been, some 30 years ago, the founder of the law firms that had become today’s elite firms. These men all had achieved incredible business success. They were the true top dogs of China’s ‘Red Circle’ law firms. What really struck me however is how conservative they were. All of them defended that the old way was the right way and that there was no need for change in the future. (despite Richard Susskind’s lecture). This reminded me that ‘nothing fails like success’.
The present business model has simply been too successful
The same holds true for the legal markets in the western parts of the world. The wide adoption by law firms of time-based billing since the mid-seventies and the subsequent ‘business approach’ has made many lawyers incredibly rich. Thought leaders like David Maister have educated law firms how to maximize the earnings. No doubt that law firms are among the most successful business models in the world. So, if law firms are so successful, why should there be change? Why risk killing the goose that lays the golden eggs? It turns out the attitude of law firm leaders in Europe and the US is not significantly different from their Chinese counterparts.
In the most developed parts of the world, demand for legal services is almost flat. Looking at the market figures shows that this has been consistently the case since 2010. So for the last eight consecutive years there has been no increase in demand for the market as a whole. Surprisingly revenue of law firms has consistently been growing over that same period. Data from The American Lawyer, Thomson Reuters and others shows that growth in revenue is only down to higher rates. Average revenue growth (revenue collected) across the US market has been 5.5% for 2018. For the whole US market this means an extra 5 billion that clients had to pay for the same amount of work. It doesn’t take a genius to figure out that this is not a sustainable model.
In a flat market clients are paying $5,5 billion more for the same output
We at TGO Consulting are active in many markets across the world and our figures show that 2018 has also been a bumper year for many law firms outside the US. What we see happening in the US is happening in all developed western markets. Only increasing rates are fueling growth.
Analyzing the available data we can see the first cracks in the current business model appear. Data shows that the gap between ‘standard rate’ and ‘collected rate’ has steadily grown over the past decade. Looking at the rates of 161 U.S.-based law firms (52 Am Law 100 firms, 46 Am Law Second 100 firms, and 63 Midsize firms) the average blended standard rate (all firms, all lawyers) back in 2007 was $385 with an effective collected rate of $348. This makes in 2007 a difference of $37 or 10%.
In a decade the gap between standard and collected has doubled
Over a decade this gap has doubled to 20%. Today the average standard rate is $525, while the average collected rate is $425, a difference of $100. This might on the one hand indicate that ‘standard rates’ have been inflated, only to be able to offer the client an attractive ‘discount’. On the other hand it clearly show that clients are pushing back against the increasing rates.
Interestingly Am Law 100 firms recorded the lowest realization ratio (against standard) during 2018 at 81.1 percent, as compared to 83.5 percent for Am Law Second 100 firms and 83.9 percent for Midsize firms. Maybe AM-100 clients, which are predominantly the large Fortune 500 companies, have better bargaining power than the less professional clients of the smaller law firms?
What we see happening in today's market is that these more sophisticated law firm clients have embraced legal operations as a function and a method to better manage the relationship with outside counsel. For over half a decade some of the largest in-house departments in the world have been collecting and analyzing data on their external legal spend. Today these data collections contain sufficient usable data-points to do state of the art data analysis. Big data on every timekeeper -both external and in-house- that has worked on their matters enables these companies to identify inefficiencies and eliminate them. Law firms should be prepared for clients that will enter into a permanent dialogue with their external counsel to systematically eliminate all inefficiencies in the process. Much like Amazon uses data to eliminate inefficiencies in their warehousing and logistics. My upcoming book ‘Data & Dialogue, a Relationship Redefined’ (spring 2019) will elaborate on this trend and its consequences in great detail.
The time-based business model will crash
Here we have the squeeze that will create the ‘problem’. On the one hand clients are increasingly pushing back against the rising rates and at the same time clients have started to actively demand a more efficient way of working. Efficiency will in part come from streamlining the process (efficient workflow), meaning less time spent on things that do not directly contribute to the quality. Efficiency will also come from the use of technology enabling necessary tasks to be completed within a shorter amount of time [see our blog]. The squeeze described will eventually crash the time-based business model.
Much like the Chinese managing partners pictured before, managing partners in our part of the world are very reluctant to even discuss changing the magic formula that enabled them to earn millions. Not unlike Kodak, famously unwilling to change to digital after they had been earning millions on film for so many decades. Let’s hope lawyers turn out to be smarter than Kodak’s board at the time…