Much ink has been spilled over law firm’s broken business models and the need for change.
While this issue is not new, law firms have been facing an increasing amount of pressure to improve their operations as of late, as competition and segmentation intensify (two phenomena that are also eroding firms’ profitability and even driving some to the point of closure).
While the issue of price pressure has been hotly debated in legal circles for a number of years, few firms have taken concrete action. This seems concerning given the clear long-term shift towards a demand-led market and the increasing adoption and creation of disruptive legal technology solutions.
Even for firms that acknowledge price pressure and that have addressed inadequacies in their existing business models, the level and rate of their responses have been slow. Typically, responses have involved developing short-term solutions rather than undertaking a more comprehensive and considered review of how to develop a new sustainable model.
Given the current state of affairs, we thought it would be useful to explore the following issues:
- how the law firm business model is defined;
- how business models create value for clients and the firm;
- what key issues are driving firms to rethink their business models;
- what common pitfalls firms face when rethinking their business model; and
- what other changes may be required for firms to optimise their business models in any market.
The ‘Business Model’ Defined
The business model describes the way in which a law firm operates. It is the collection of processes and systems directed at making the firm competitive and profitable. In other words, it determines how a firm creates value from its work by generating revenue.
The business model is predicated on having a competitive strategy that defines where the firm seeks to compete (now and in the future) and what the competitive conditions are in that market position. This determines the design and functionality of the business model in order for the firm to succeed. Alignment between the two is critical.
In order for the firm to generate sustainable profit and therefore create value for itself, the business model must simultaneously create value for its clients. This requires the firm to understand what its clients value in the services it provides and determine how to deliver these services at the right price and within the appropriate cost structure.
The value that clients derive from legal services (and the price they are prepared to pay for them) differs from client to client and across different markets and practice areas. Changes in the client’s operating environment or its risk profile also impact this dynamic relationship. As such, the firm’s business model needs to be adaptable to these.
There are two series of related activities in this regard.
The first is a series of activities that supports client value creation. These include client targeting and business development processes (ie, who is being targeted and what the value proposition is), client management processes, delivery of services (including project management), as well as pricing and revenue flows.
The second is a series of activities that supports the way in which value is created for the firm. These include work processes (ie, how people go about doing the work), staffing structure, the level of skill required to complete different tasks, as well as work and performance management. Underlying these is a need to review recruitment, training and people management processes.
Both series of activities underpin the architecture of any law firm business model and are increasingly major targets of efficiency improvements through technology (reference The Role of Technology below).
Drivers of Change
Competitive conditions have long been a feature of the global legal market but the pace of change brought on by competition has been rising significantly in recent years. Much of this is being driven by clients’ demands for different pricing approaches and service delivery methods and their demands for lawyers to have a better commercial understanding of their businesses.
Varying responses to this have led to further segmentation of the legal market.
Downward price pressure particularly in highly competitive markets like Hong Kong has resulted in deeper discounting without fundamental changes in the ways in which services are sold, generated or delivered. Hence, the old (cost plus) model based on increasing hourly rates and therefore price as costs have risen, is under intensifying pressure as firms can no longer offset costs in the same way. The result is an erosion of profitability.
This has created the need to change the business model, including the firm’s approach to pricing.
Changing the business model is not an exercise in cost reduction or containment per se. Efficiencies are a consequence of better processes. However, in the absence of systemic change, most firms continue to discount and seek to increase utilisation in order to offset increasing costs.
Rethinking the Business Model: Pricing Approach
The Role of Technology
The technological developments in law firms are, to a large extent, a consequence of the client pressure on pricing. Absent this pressure, the adoption of new legal technology solutions would have likely taken much longer.
The growing intrusion of technology into the legal market place (particularly in the generation and delivery of services) is a fundamental driver of change as well as a key part of the solution.
Technology is now at a point where it can be applied in actual legal work processes, undertaking tasks that lawyers have traditionally performed. Artificial intelligence systems are also available and firms are starting to employ this technology to carry out due diligence in M&A work. These systems are based on cognitive computing that map human thought processes to a computer programme, which, in turn, learns over time as it processes a task and (crucially) eliminates errors. In addition, the use of predictive coding has been in wide use in e-discovery projects for some time, significantly reducing the processing time for these tasks. Adopting these forms of technology requires a significant investment cost, something law firms have not had to face previously.
These technological developments meet at least two of the key needs of clients. First, they lower the cost of legal work while retaining the quality and value inherent in it. Second, they enhance the service delivery process.
While technological developments provide part of the answer to client pressure on law firm performance, there are some serious implications that many firms are not yet tackling.
The implications for resourcing are significant. As technology intrudes into legal work processes, the number of fee earners required to produce each dollar of revenue will decline and the type of fee earner and the skills required will change.
The pressure to adapt the business model can have unexpected consequences, particularly in cases where these are driven by clients’ needs and technology. Unless there is a clear alignment between the firm’s strategy (including its preferred future market position) and the business model, the firm can experience strategic drift. In other words, the business model can end up driving the firm’s market position rather than the other way round.
As the market continues to segment, particularly where firms are simultaneously competing in higher and lower value areas, the effect can be highly dilutive.
Few firms take a holistic approach to changing their business models. However, an optimal business model requires that a firm’s systems and processes (front, middle and back office) are fully integrated. This necessarily means reviewing all aspects of the business and creating an overarching plan that informs investment decisions, build and execution.
To respond successfully to client pressure on pricing and implement the proper technological solutions, firms should carefully consider their plans before implementing them. This reinforces the need to change the whole business model, not just components of it. For example, standardising work processes is essential. However, a standard way of doing work within the firm must be established for technology to effectively reduce the cost of providing legal services. Additionally, the work needs to be planned carefully and the time recording integrated with the plan to enable daily monitoring of the cost of the work to the plan.
This represents a huge shift inside most law firms and very few have gone this far.
One consequence of disruptive legal technology is increasing investment in different and potentially incompatible solutions across functional cost centres. Inevitably, firms (with some exceptions including in those markets where external funding including via private equity is available) are constrained by their inability to invest in the requisite solutions in one or more consecutive cycles.
The outcome is a series of buying decisions taken in isolation and without reference to an overall plan.
Working behaviours are at the heart of the business model and are invariably the hardest to change. For example, partners who struggle to delegate and assign sufficient time to managing clients and the work processes need support to alter their preferred ways of working. Any “system” must consider what behaviours are required to drive value creation (for the client and the firm) and address this as part of the work process review.
Other Required Changes
In addition to work processes, there are a number of other changes that firms should consider.
While many firms claim that they understand their clients’ businesses and industries, this is rarely if ever based in fact. A highly functioning key account management approach informs the firm’s strategic position and the business model required to create value.
Embracing workforce flexibility will enable firms to capitalise on changes in generational attitudes to the profession including approaches to recruitment, talent management, compensation and professional development.
To date, the role of the partner has remained relatively unchanged. Partners, for the most part, continue to be selected based on their technical skills. However, the expectation is that they will play a more active role as managers, client relationship managers and industry experts with implications for selection criteria and the economic structure of firms.
Firms should also consider adopting performance metrics that reflect and align with the new business model.
Tying It All Together
The changes required to meet the needs of clients will lead to a radical change in the whole way in which a law firm operates, which require firms to make fundamental changes to their business models.
This requires a reconfiguration of the recruitment, training, compensation systems and performance targets inside the firm. Every system and process in the firm will need to be examined to ensure they support the changes being made at the front end.
Changes designed only to deliver services to clients at lower prices are not sustainable if these result in lower profitability. Over time, firms that resist making these changes will become less competitive and consequently, suffer market decline.