As the legal industry enters a new decade, changes big and small are taking place in law firms, which are trying new approaches and becoming more open to formerly unthinkable outside talent and services.
That’s the conclusion I draw from a recent report on the state of the legal industry, which I’ll discuss and comment on in this article, including a report link at the end.
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Thomson Reuters 2020 Report on the State of the Legal Market
Georgetown University Law Center and Thomson Reuters Legal Institute published in early January the “2020 Report on the State of the Legal Market”, their annual report revealing trends and key issues within the legal industry.
The 2020 report contrasts two kinds of change taking place
- Incremental improvements: A set of adjustments to what it calls a “remarkably resilient” law firm operating model, designed to sustain performance but not change that model.
- “Radical change”: The report suggests radical change to that operating model is necessary for future law firm success:
“…the underlying model itself is changing, that clients, non-law firm competitors and even many law firms are now operating with very different assumptions about the role law firm services should play in the legal ecosystem and how such services should be delivered.”
A decade of almost flat growth is both a cause and effect of this fundamental shift. This report graphic reminds us of the drastic drop in demand for legal services in 2008, which rebounded in 2009 through 2011—but never reaching 2007 levels—and showing meager performance through most of the 2010s. The rise of non-law firm competitors contributes to no growth—clients can and do select other providers for certain matters. But that rise has also made law firms compete harder, and some do so by adopting elements of the alternative providers.
Traits and trends within law firms
Looking across the law firm landscape from mid-size firms to the largest Am Law 100 firms, the report delves into various indicators of both growth and decline.
On the revenue side
As the primary source of firm revenue, lawyer headcount is a key performance indicator. During the last half of the 2010s, lawyer headcount growth accelerated, but not uniformly. Associates and senior/staff counsel have grown, but headcount for both equity and non-equity partners has been in negative territory since 2012. By increasing leverage (more associates per partner) and decreasing equity partners, many firms have boosted per-partner profits, despite flat growth.
On the practice area side
Regarding lawyer growth in practice areas, the leaders were:
- Technology transactions and licensing
- General corporate work
- Mergers and acquisitions
- Antitrust work
- Litigation work
As for areas of decline, patent litigation experienced the biggest loss of lawyer growth, which I think can be at least partially attributed to changes in patent law. Other declining areas were bankruptcy, regulatory work and lobbying. In our view, some of these trends are secular and some cyclical. In the 2020s, the adage “all companies are tech companies” means we should see a steady increase in IP work. M&A work and general corporate representation tend to follow broad economic trends. And antitrust is on the rise as the thinking about Big Tech has shifted in both political parties.
Overhead and expenses
The report shows (see chart below) that expenses rose in 2019, across both direct (4.7%) and indirect or overhead (4.1%) categories. Expense varied within different firm segments, with Am Law 100 firms recording the highest increases in both categories.
Looking at two specific categories of interest—marketing and library—the report shows:
- Slight decline in the rate of growth in marketing and business development and outside services. The marketing spend continues to go up, but not quite as fast in the last year as in 2018. The flat market we discussed above gave rise to more marketing spend, and continues to do so.
- Slight increase in the rate of growth of library expenses. From LAC’s work in library, research and competitive intelligence, we know that expense increases in this area are often due to price hikes for online resources. One of the biggest law library costs is subscription fees for services like Lexis and WestLaw. When I asked our resident expert in this area, VP of Spend Management Services, Robyn Rebollo, she said, “Information resource expenditures have increased due to demand of new products in the market like Kira, Westlaw Edge and others.” Library staff are a relatively small portion of the library spend. According to our Director of Recruiting, Brad Rogers, legal librarian salaries are going up, though not escalating very much. The bigger issue is that it’s becoming increasingly difficult to find these skills where they’re needed.
Worrisome trends in legal markets
In terms of potential red flags for law firms, the report lists several worth noting:
- Essentially flat to somewhat negative demand over the last decade;
- Decline in productivity that, with the exception of 2018, has become an ongoing trend;
- Higher growth rates for both direct and indirect expenses, also a trend of the last few years;
- Reliance on rate increases to drive financial performance.
Finally, the report expresses the concern that most firms have limited resources to handle any serious economic downturn, if that were to happen in 2020.
Clients continue to wield power
Seeking efficiency, predictability and lower costs, clients continue to exercise control over their legal service expenses, including the continued use of in-house lawyers for work previously and routinely done by firms.
The report cites the following trends and changes in this regard:
- Greater reliance on competitive bidding processes for major legal matters and increased guidance from corporate procurement departments and legal operations professionals.
- More vigorous budgeting, with greater scrutiny and expectations for accountability, including more use of specified requirements for items like billing, expenses, staffing and project management.
- “Disaggregation of services” supported by the increased use of virtual teams comprised of in-house lawyers, outside firms, and non-lawyer team members like project managers, outsourcers, legal staffing firms and others.
- Significant growth in the use of ALSPs (alternative legal service providers). According to the report, corporate use of ALSPs has doubled over the two-year period between the last two surveys.
In regards to ALSPs, law firms themselves have increased their own use of this resource, especially large firms.
The report also mentions the Big Four accounting and auditing firms as a growing ALSP threat on the horizon. Deloitte, PwC, EY and KPMG all have a strong presence in major global markets for legal services, except for the United States. Yet with California leading the way in regulatory reform of legal services, it’s only a matter of time before the Big Four turn their attention to US markets, where their pre-existing, senior-level relationships with corporate clients gives them a unique advantage.
Examples of legal innovation
With a focus on change, the report praises some of the innovative ways firms have been responding to the trends and new realities they face. Legal innovation is an area of particular interest to me.
One area of innovation cited in the report is the development of “captive” in-house, low-cost centers for legal-related services, used by a minority of firms, but growing in size and scope. Other firms have moved to an online delivery model for some services, like Davis Polk’s offering for Dodd-Frank regulations. Clifford Chance and Littler Mendelson have gone a step further, launching software development businesses.
Other changes are less about innovation and more about recognizing sound practices adopted long ago within the business sector:
- Increased reliance on allied professionals and specialists in firm management and operations, creating new C-suite roles in finance, HR, technology and other disciplines.
- Improved internal systems, especially in larger law firms, which are adopting new technologies at an accelerated pace.
- Expanded partnering and outsourcing of services as firms are recognizing that it’s often more desirable to outsource certain services related to their legal work. Evidence of this can be seen in the already-mentioned use of ALSPs, as well as managed service providers like LAC Group for research and intelligence support, and library services.
Regarding outsourcing, the report conveys that cost is a factor, but the desire for greater expertise and improved quality and performance were also important considerations. For large law firms, the ability to free up resources and decision-making energy to focus on their mission and core competencies is key. Smaller firms are more interested in leveraging the outsourcing provider’s economies of scale and other benefits that help level the playing field. And all our clients share the desire to alleviate as many management “headaches” as possible.
Many legal market commentators look at the data in this report and see the demise of large law firms, a coming disruption. We disagree. We think law firms continue to adapt well to the changing competitive landscape. The recent “pivot” by Atrium, a $75 million VC-funded legal start-up meant to disrupt Big Law, supports our view that firms need not worry too much about disruption. (Atrium recently announced layoffs of an undisclosed number of attorneys in a move to restructure its business to focus on software and startup advising services, like how to handle their legal work.)
To be sure, law firms should monitor competition, both from peers and alternative providers, and devise strategies to respond. This annual report is one helpful tool for accomplishing that, as it serves as a benchmark for assessing the firm’s standing and performance within the industry.
If you’re interested in exploring other ways to operate more efficiently, I invite you to contact us. Our services have helped law firms and corporations operate and compete with greater agility for over 30 years. That experience may spark ideas for your own needs and circumstances.
- Download and view the entire report from Thomson Reuters (Registration required.)