Part II of our Business of Law webinar series with Tim Corcoran took place in November, but things have been so hectic with travel and hurricanes and holidays that I’m only just getting to the recap! So without further ado…
The topic of the second webinar was the strategic role of alternative fee arrangements, which was a natural sequel to the first session on legal project management. Tim re-emphasized that the industry has changed, and we need to adapt to the changing times.
He shared some results from Altman Weil’s Chief Legal Officer Study, the one prior to the most recently released iteration, which shows that the top concerns for clients continue to be outside legal costs, lack of predictability, and the inefficiency of the hourly billing system. The difference between in-house counsel perceptions and outside counsel perceptions can be pretty great – outside counsel tend to think that the quality of legal work should rank more highly for in-house counsel. However, in-house counsels’ perspective is that the quality of work is a given, so they’re measuring their firms on additional factors.
Tim delved into a recap of the first webinar, discussing client and law firm reactions to the economic downturn, budgeting and legal project management. For a full explanation, check out my part I and part II blog posts.
Commoditization: Shift Happens
The word "commodity" has taken on a touch connotation within the legal industry – but in the pyramid of legal services, there are a set of tasks that are repetitive in nature. Using the pyramid to illustrate, Tim showed these repetitive tasks on the bottom.
Following them are important tasks, which clients are willing to pay more for, but they’re not necessarily looking for the best or most expensive law firm. Then, there are the strategic tasks, or the "bet the firm" work – and those are where the real opportunity is. That’s what firms all seek, and they often plot their firm’s course straddling somewhere between these strategic and important tasks.
The challenge is that in the last few years, clients have determined that even the most critical "bet the company" work has in itself some components that are tactical or repetitive in nature. And over time, there will always be a shift from the strategic to the routine – what we were doing ten years ago, we’re not doing anymore because it’s become a commodity task, and clients are no longer willing to pay premium rates.
It’s a simple face of business nature – and legal services are not any more immune to this than any other industry. As Tim noted on his slide, "There is an inevitable and inexorable migration of products and services from leading edge to common place, whether the provider likes it or not."
Along with this, clients are involving additional people in the conversation, those Tim called the "arbiters of commoditization." He referred to a recent study by Dr. Silvia Hodges, who looked at the role of procurement in the selection of outside counsel. Although procurement has always been on the scene, in recent years, there has been an increased in involving them in the selection of outside counsel. Dr. Hodges study revealed that 41% of the budget for outside legal counsel is influenced by procurement.
Law firms fear that when procurement is involved that they are not sophisticated enough to understand the subtle or even massive distinctions between law firms, and they’re only concerned with finding the lowest cost provider. For the most part, however, a good procurement person is focused on finding the right provider to meet specific demands for a specific use case – this doesn’t necessarily mean the cheapest. Procurement is always looking for other factors upon which to measure providers – not just price. Unfortunately, law firms do a poor job of differentiating on these other factors.
Tim used an example to illustrate the concept of asynchronous information. Not knowing much about wine, when attending a dinner party, he would be likely to choose an expensive bottle of wine, thinking that price is a proxy for quality. His point is that there are certain markets where only one party has the information about where the value lies. In the law firm business, the shift from a sellers market to a buyers market means that the law firm used to have the information about the value of services delivered, but now the buyer has as much, if not more, information. This is why alternative fees have become so important.
Clients are using companies such as TyMetrix to quantify the role of their outside counsel. Tim showed a few examples of what these scorecards and analytics might look like, and said that the challenge today is knowing that the client has a relative sense of what they’re willing to pay, and the value of certain services, but not knowing what they know.
Tim showed a rate analyzer, provided by a company that has collected, aggregated and anonymized e-billing data over multiple years. They can now produce reports for in-house counsel that show for certain SIC codes, industries, practices, timekeepers, etc. the various ranges for billing data so that they can make benchmark comparisons against the proposals they’re receiving. This will inform their tolerance for their budget, and have a downstream impact on law firms.
In-house counsel will also be able to compare law firms over various rates, look at the trends over time, and make assessments, not only about which firms are more or less expensive, but their relative value. Clients know that an hourly rate is not an indicator that should challenge them – they’re willing to pay a high rate if they can get a good value, which is why the trending information, coupled with other analytics, is so helpful.
All of this shows that clients now have as good, if not better, information about the value of services that law firms deliver – so how do firms collaborate with them to make sure that they maintain their profitability as a law firm? Tim added that firms have every right to be a profitable enterprise, but that they need to look at their practices that are commoditized versus those that aren’t, to get a greater understanding of the value of those services. By using hourly billing for everything, firms don’t necessarily have that level of precision.
This acronym stands for Realization, Utilization, Leverage, Expense and Speed (or Speed of Collection). Tim said that these are the things that law firms grew up with – they understood that profits are a function of these elements. If we have timekeepers that are busy, and we capture that and invoice their time, and clients pay those invoices, that’s realization. On each matter that we perform, if we have the right ratio of timekeepers, that’s our leverage, and we can manage profitability.
If we manage our overhead (expenses) and keep these low, and if we bill and collect in a timely manner (speed), those factors will all reduce to that profits per partner or equity partner that firms strive for at the end of each year.
Tim likened this to our belief that home values would always rise – law firm partners grew up under a model where they believed that the only way to achieve profitability was through these metrics. However, the rest of the world embraced a different concept – the "learning curve." This is where if you’re good at something, you can continually lower your cost of delivery and achieve profits, even when revenues are flat or declining.
Tim asked the attendees to think about the challenges at a law firm – when lawyers become an expert at something, they charge a higher and higher rate. However, a client is saying that if the lawyer has done something multiple times, they should be charging a lower and lower rate. Tim suggested that it would be nice if we could reconcile these two views, and say that we’re going to be more profitable by leveraging our experience, rather than our inefficiency.
There is an anecdote about training a young elephant not to run away – if you tie its leg to a stake with a rope, the elephant will learn that no amount of pulling will free him. So then as an adult, he’s conditioned to not even try to pull the rope, and the same small rope and stake can be used to secure him. The point behind this is that if lawyers break out of the mold of how they learned that law firms make profits, they can achieve higher profitability through these methods.
Tomorrow, we’ll continue the discussion of alternative fees, and we’re also hosting our third and final webinar on contract lawyers and outsourcing, so I’ll be recapping that in the coming weeks as well!