The Future of Legal Business — International Law Firms
Just few years ago, his bookshelf was all doom and gloom: Richard Susskind’s “The End of Lawyers?”, Larry Ribstein’s “The Death of Big Law,” Bruce MacEwen’s “Growth is Dead,” and Mitch Kowalski’s “Avoiding Extinction,” to name but a few … All of these academics with their catchy book titles were not exactly encouraging. Now it seems they are engaging in crystal ball gazing: “Tomorrow’s Lawyers” (Richard Susskind), “Tomorrowland” (Bruce MacEwen), and “The Future of the Professions” (Richard and Daniel Susskind). But what is this one: “Robots in Law: How Artificial Intelligence is Transforming Legal Services”? So, what does the future hold?
The crystal ball contains a startling premonition as legal market intelligence such as The Lawyer and Legal Week ask: “When will artificial intelligence replace lawyers?” Not “if,” but “when” and “to what extent” will artificial intelligence replace lawyers? The crystal ball also contains a murky picture of a shifting legal market, with new businesses emerging and potentially stealing work from traditional, brick-and-mortar law firms. Who are these “alternative” service providers? They don’t appear in the U.K. or AmLaw Top 100, so nothing for John Doe to worry about. Or is there? As Richard Susskind says, “the competition that kills you, doesn’t look like you.”
So, how will John Doe find out? Who has the answer to today’s questions? To know the right questions would be a good start. There are many John Does out there who valiantly navigate their firm through heavy weather and turbulence. We at the Bucerius Center on the Legal Profession, a think tank at Bucerius Law School in Hamburg, have spoken to many of them. Our Center does research and analyzes legal markets in order to provide market participants with knowhow and knowledge regarding the best practices of law firms and in-house legal departments. Here is what we talk about when we spend time with the John Does:
Law firms should focus on three core areas when it comes to setting up a plan for the next three-plus years. Such an approach may be timeless, but it must constantly be updated as the changing market environment leads to different conclusions. Law firms have to:
- Deal with their strategic positioning;
- Focus on client service (the what and how of legal service delivery); and
- Make sure that their partnership structure is well aligned with the strategic goals of the firm.
Focusing on these three core areas is sufficient, but what about legal technology? Innovation? Profit sharing? Governance? Mergers? Each of these is important, but first things have to be put in perspective. Just grabbing a buzzword — e.g., “innovation” or “profit sharing” or buying some clever technology — has nothing to do with strategic goals and leads to aimless activism without any success.
Before discussing the core items, one has to understand that all three topics are applicable for each type of law firm, be it a global player, a boutique, an international firm, or a category killer. The questions are always the same, but the answers are not. The most important topic is strategic positioning; hence, we will spend more time on this subject.
Strategic positioning has a lot to do with knowing oneself and understanding the dynamics of markets in general, not just legal markets. Law firms tend to look at themselves as something special and unique; actually, they aren’t so special. The legal industry can learn a lot from other industries. A useful way to understand how the legal market has changed shape since the financial crisis — and what it could look like in 2025 — is to analyze market data from 2007 until today. However, rather than overly focusing on each firm’s turnover and profitability on a year-to-year basis through endless listings, we prefer to compare movements of certain groups of firms. This is not a new method of looking at legal markets. While John Doe may feel comfortable observing his national market, the global market is part of the industry analysis that John Doe must carry out to determine his strategic position.
In 2007, following an analysis carried out by McKinsey, one could identify five different groups of law firms:
- The global elite (e.g., Wachtell, Slaughter and May);
- The challengers (a group of firms spanning the spectrum of Sullivan and Simpson Thacher to Ashurst and Herbert Smith);
- The middle field (e.g., Orrick, White & Case, Mayer Brown);
- The Magic Circle (including U.S. firms such as Latham & Watkins or Skadden); and
- The global law factories (e.g., Baker McKenzie, DLA Piper).
By 2013, the legal market had changed significantly, with the market for international law firms seemingly split up in two major segments: the elite segment and the global law factory segment. In 2014, we predicted that the challengers would drift farther apart, with the top performers joining the global elite and bottom performers joining the middle field. This would leave the existing middle-field firms “stuck in the middle.” We repeated this strategic mapping in 2017 for the same groups of law firms. Looking at each group in turn, let’s see what has changed…
The global elite continue to be the strongest-performing group, with the highest-earning firm, namely Wachtell Lipton Rosen & Katz, recording a staggering $6.6m PEP. It may, however, be a case of the richer getting richer and the poorer getting poorer, as the difference between the highest and lowest performers now stretches to some $3m. As predicted, the challengers are drifting farther apart, with the top performers (firms such as Paul Weiss Rifkind Wharton & Garrison, Sullivan & Cromwell, or Simpson Thacher & Bartlett) joining and even outperforming some of the global elite, while the worst performers (Ashurst, Herbert Smith Freehills) are dropping below some of the middle-field firms. The middle field (firms such as O’Melveny & Myers and Orrick Herrington & Sutcliffe) has remained stable in terms of average PEP and average partner numbers. Although not as extreme as the global elite or the challengers, the gap between the highest- and lowest-performing middle-field firms is widening rapidly.
The Magic Circle (including the likes of Latham & Watkins and Skadden Arps) has also remained stable, with the gap between the highest- and lowest-performing firms spreading more slowly over time. Finally, while growth in the global law factory group (namely Baker & McKenzie, DLA Piper, and Jones Day) has been slower than for the global elite, and the PEP gap between the highest- and lowest-performing global law factories has remained stable, the number of partners has changed significantly. Some global law factory firms have significantly reduced the number of partners, making them more akin to the Magic Circle group, while others have continued to grow, resulting in a staggering difference of more than 500 partners between the biggest and smallest global law factories.
The overall result is that the global elite (plus a few challengers) are pulling away from the pack, while the global law factories (less a member or two) continue to expand. Left in the middle is a mixture of lower-performing challengers and middle-field firms. Only the Magic Circle can continue to be distinguished as a separate group of firms in this segment of the market. While these findings may help John Doe understand the changing global legal market, one crucial part of the strategic jigsaw is missing.
Reliance on the usual market data (law firm rankings such as AmLaw 100 and the U.K. Top 50) ignores an interesting movement in the legal market. A new group of players, “alternative legal service providers,” has squeezed into the picture, but who are they? As they are not brick-and-mortar “law firms,” they don’t appear in the law firm rankings and little information about them is available. A recent study on the market for alternative legal service providers estimates the size of the new market segment to be $8.4 billion annually. Although not quite matching the value of the U.S. legal market at $275 billion, it is not an insubstantial figure for an emerging market. These players are made up of a diverse group of providers, from outsourced legal work (such as document review) to insourced legal work (for example, temporary lawyers) or entire managed legal services (traditional in-house legal functions). Outsourced legal work by the likes of QuisLex, Consilio, and Thomson Reuters accounts for some 70 percent of this emerging market. This is a group of players that John Doe needs to know more about. Especially as, according the study, the use of these alternative legal service providers by corporations and law firms is strong — and is expected to grow.
The “middle of the road” firms have come under extreme pressure, and the jury is out on their future. Will they eventually cease to play a role? This depends on a number of factors. John Doe has to make a decision because there will no longer be an international “middle of the road” law firm segment. Remember the words of political activist Jim Hightower that ring true today and apply to John’s situation: “There’s nothing in the middle of the road but yellow stripes and dead armadillos.” The middle is clearly a dangerous place to be.
So, what are John’s strategic options? Move toward the global elite? Tricky — the sterling brand and sparkling client book of the Wachtells of the legal world cannot be achieved overnight. Merger? According to our crystal ball (this time in the form of The Lawyer Global 200), international expansion is not a watertight growth strategy. In fact, revenue increases in the Global 200 were mostly enjoyed by the richer firms, while merging firms tended to record drops in revenue. Furthermore, the John Does of this world are often already too large to be an attractive merger partner. Finally, maybe he should look at law firm networks: groups of firms who are balancing their independence with the ability to expand their referral network, and are able to quickly scale up in cases where size matters.
Having said that, to avoid being “stuck in the middle,” John Doe could dig up some classical strategy and follow Porter’s advice of pursuing either a cost leadership strategy or a differentiation strategy (but not both). Cost leadership without sacrificing quality in the legal services market for a middle-field firm could well be a tall order; after all, how many Ryan Air-style law firms are in the top 100? He is left with no choice but to differentiate his firm’s service offering. Although one could say that the changes to the legal market coupled with advances in technology have forced the John Does of this world into a corner, it may actually be a blessing in disguise. The emergence of alternative legal service providers is forcing law firms to view their strategic position along buy (not sell) lines. Thus critical to John Doe’s decision on how to differentiate his service offering from the rest of the field, is the answer to the question, “which legal services are being purchased, and how?”
Every law firm makes a promise to clients: “We are the best thing that could ever happen to you.”
Clients tend to smirk when they hear this; from their perspective, their relationship with law firms is difficult, to say the least. Why is this the case? It seems that too many law firms do not stick to a really simple rule: Know your client, and know yourself. In other words, know who your clients are and why they chose you.
Does that seem too simple? Right, it is that simple. Knowing one’s clients means far more than sending Christmas cards, or inviting general counsel to lunch or even dinner. It means knowing clients inside-out, knowing why their CEO can’t sleep at night, knowing what their appetite for risk is, why their numbers are down (or up), what is happening in their relevant market, and exactly how they want to receive your advice. And yes, clients are becoming more demanding. They want quality of service at an acceptable price. Like Amazon shoppers, they want to compare prices. Traditionally, when clients had a legal problem, they searched for a named law firm. Today, when they have a legal problem, they search online (yes, including “Google”). Clients are far more sophisticated when it comes to legal procurement, with clear requirements and excellent knowledge about the market. In fact, the historical asymmetry in information and expertise between the client and the lawyer is finding its equilibrium. The number of highly qualified lawyers moving in-house is increasing, and information is becoming more readily available. Not just legal information, but information about how the transaction is progressing, how the matter is being staffed, and how much it is costing — and all in real time. This means that John Doe will have to find a new value proposition for his clients.
The second bit is: What do we have to offer, and why did they choose us? Not knowing the answer should make managing partners extremely nervous. This is the current cutting edge of competition in the legal market. Legal technology offers John Doe the differentiation toolbox that he needs to design his new service offering. He doesn’t have to replace his associates with robots. Legal technology offers solutions for everything from predictive analytics to simply providing a more efficient platform for clients to interact with their lawyers. Firms who are able to differentiate themselves from their competitors by offering the client additional services, such as legal project management and legal data analytics, are able to survive — at least until a competitor decides to replicate those services.
Part of this exercise is innovation, by means of product innovation (which is what we know as creativity) and service innovation. We all love to receive better service, day by day. Clients do, too. The client’s increasing expertise, coupled with the new service offerings of the alternative legal service providers, means that John Doe’s focus on client service must target the what and how of service delivery: which services (legal and non-legal) does the client want to buy, and how does the client want to receive them.
Regarding product and service innovation, many articles and books have been written on these issues. There are so many ideas out there to better your client service in order to put yourself ahead of your competitors. Just go out and start doing it. The only stumbling block for John Doe is persuading his partners to invest in this new buzzword…
Alignment of Partners
It is odd, but whatever type of firm we talk to, they all claim to have and maintain a partnership structure.
Even those firms that have up to 1,000 partners (who don’t know one another and who need name tags at their partner meetings in order to differentiate themselves from the service personnel) hold themselves out as partnerships. We are afraid this is an endless source of misunderstandings and causes strategic, structural, and cultural mishmashes.
What do we mean by “the partnership model”? It is something very simple: two or more people joining forces to pursue common goals with a view to achieving profit. That’s it. Very successful structure, very profitable, no hierarchy, easy to handle. This system has two core attributes: peer group transparency and peer group pressure. Without this, a partnership is not a partnership; it will then be more of a barrister’s chambers (by means of the U.K. system of independent barristers sharing offices and infrastructures) rather than a partnership.
Obviously, the partnership model has lost its supporters. In 2012, Stephen Mayson predicted the extinction of this model — quite rightly, from his point of view: As long as partners do not share a common vision and common strategic goals, they remain in a status of a rather unorganized group of sole practitioners, with no long-term future. Jonathan Molot’s paper, “What’s Wrong with Law Firms,” is the last nail in the coffin for the partnership model: The “short-term” nature of the partnership model stifles much needed long-term investment and will eventually lead to its demise.
But these conclusions must be nuanced: The partnership model is useful but not always applicable, and the weaknesses of this model are more often connected to the improper handling of the model rather than to the model itself. Laura Empson’s recent and extensive research into leadership in professional service firms confirms that despite being “smart” people, professionals often don’t lead in the way we expect them to. The senior partner of one of the world’s leading law firms is reported as saying that “leadership just sort of happens” — not quite what one would expect from a successful partner.
Despite its drawbacks, the partnership model remains, according to Empson, the optimal legal form of governance for reconciling competing interests. We would hesitantly agree with her, but only for certain law firms. It does work in practice; look at the premium segment of the legal market. For these law firms with, say, up to 100 partners, the traditional partnership model is the only conceivable structure.
What about the law factories? Law firms with offices all over the world are more like a corporation and should structure themselves accordingly. While traditional partnerships do not need anything like genuine management, law factories can’t do without it. That also applies to Swiss Vereins — this structure was sold as something that could do without global management, but in reality no Swiss Verein has a long-term future without a management structure. This has consequences for those who are called “partners”: no veto rights and no right to deviate from the firm’s strategy. It is not a majority versus a minority of partners; it requires partners to put the firm’s interests over and above their own personal interests. You don’t like it? Go and choose another firm.
Finally, the business of law firms, be it a traditional partnership or a law factory, has nothing to do with partnership models. The firm’s IT, HR, marketing, and other service departments have to be organized and managed like a corporation, even in traditional partnerships.
And this is it for John Doe. Three simple topics to focus upon: market position, client focus, and structure. This should be the starting point for the firm’s plan to make sure it is still there in three years.