Survival of the fittest

RBS’s James Tsolakis on why law firms must adapt

On so many levels, the business of law is changing and the velocity of change has never been greater. These changes are creating unforeseen tensions within law firms and they challenge some of the fundamental principles that have historically defined the legal profession in the UK, a profession characterised by a tradition of conservatism and consistency, which are both foundations on which the enduring stability of the profession was founded.

And just as our economy has been repositioned away from traditional manufacturing sectors and rebalanced in favour of the services sector and new technologies, so the legal profession is progressing on a course to re-engineer and redefine its business model, organisational structure, behavioural norms and key performance indicators that shape profitability and dynamics, and drive financial performance.

But why bother? Why tamper with a profession that has delivered successfully for clients and practitioners for generations? The answer lies in the changes that have emerged within the economic, business and social environment within which the legal sector exists. These changes manifest themselves in the transformed expectations, sometimes extreme in their positioning, of the profession’s many stakeholders, who include clients, partners, indeed all fee-earners, support staff and even legal students, non-lawyer investors and regulators. The changing expectations touch many dimensions of service, value, reward, quality of experience, culture, loyalty, security and financial returns. Not addressing these issues is not an option for firms trying to compete successfully at the top of their segment in the market.

Despite the significant restructuring that has taken place in the legal sector over the last six years, the process is far from complete; indeed, it has a long way yet to progress. As an example, the legal profession continues to demonstrate overcapacity relative to the demand for legal services. As a consequence, profitability has been constrained as a healthy supply of lawyers has competed for the modest level of instructions available. While this has been taking place, general counsel have been more proactively managing their relationships with law firms in pursuit of greater transparency and value, measured on many different levels. Most noticeably, law firm panels have been shrinking; billing rates have been held at historical levels with little appetite for increases; fixed fees have become more visible; and in-house legal teams have expanded, resulting in more insourcing of legal work, especially low-end and commodity work. All this has served to further erode the volume and value of instructions available to law firms.

Several important trends have emerged in response to these collective developments:

• A focus on profitability over top-line growth.
• Broadening international delivery capabilities, whether through merger, new international offices or expanded international alliances and best friend relationships.
• An increase in demand for lateral partners.
• Modification of compensation arrangements to attract and retain talent.
• Shedding less profitable clients and instructions.
• Evolution of the law firm model to embrace lower-qualified paralegal capabilities, sometimes at the expense of trainees and junior associates.
• Greater use of contract lawyers, including the establishment of contract lawyer services for clients.
• Northshoring and offshoring to enable firms to execute instructions, or some particular commodity service or lower-value component of instructions in low-cost jurisdictions.
• Greater collaboration among law firms to facilitate optimal instruction execution.
• A heightened focus on the role and power of technology in the automation and delivery of legal services.

While both revenue and profitability growth are not mutually exclusive outcomes, we operate in a market in which the investment required for revenue growth may conflict with short-term profitability goals. In response, the shift by some firms away from top-line revenue growth towards profitability growth is significant in contrasting two divergent strategic choices. The profitability growth strategy is most commonly approached as an expense management challenge, within constraints imposed by the firm’s business model. Some firms have responded with northshoring and offshoring initiatives. These enable firms to operate in low-cost jurisdictions remote from headquarters. In addition, many support staff functions have been outsourced or transferred to lower-cost jurisdictions remote from headquarters. Law firms must continue to challenge the conventions that determine their cost base and seek more cost-effective business models. Combined with this, firms need to shift their cost structure away from a heavy fixed-cost bias towards a variable cost structure that can be easily flexed according to activity levels and the volume of instructions available. By contrast, the pursuit of more profitable revenues and higher-quality instructions is less frequently embraced as part of this profitability growth strategic agenda. It does however offer significant opportunity across many fronts, and may be where firms can identify and capture significant profitability gains and high-value returns.

Not adapting to the changes taking place in the legal profession today is not an option for firms that want to compete effectively and win. As Charles Darwin neatly described in The Origin of Species: by means of natural selection, individuals who adapt to the changes in their environment are likely to survive and individuals who do not adapt are likely to fail. When one reflects on these words, their pertinence to the legal profession of today resonates very loudly.