The last recession caught a robust and in-demand legal industry unprepared, and the consequences cut deep. Deal flow of all kinds dramatically slowed, with real estate hit first and hardest. Law firms were forced to lay off staff, defer acceptances for associates, and close entire offices. Contrary to traditional wisdom, the pace of litigation, including bankruptcy litigation, did not pick up due to a lack of capital to pursue remedies in court.
Given the drastic consequences last time around, it’s only natural for firms and legal service providers to remain on the lookout for the signs and symptoms of the next recession. However, lasting changes in the way law firms deliver services to their increasingly cost-conscious clients—changes that have been in motion since long before the recession and that will continue regardless of the economic cycle—mean that the next recession will not have nearly as dramatic an effect on the industry.
These changes implemented concepts from industrial engineering, a profession concerned with the optimization of complex systems. Clients are seeking out the cheapest way to meet their legal needs by seeking out the lowest-cost combination of resources that can safely get the job done. The shift of work in-house, evolving work structure at firms, and the emergence of legal operations specialists all point to a constantly optimizing legal industry that is better prepared to weather the next recession.
In-House Pressure on Firms
As general counsel face pressure to reduce costs and increase efficiencies, more work continues to move from outside counsel to in-house legal departments. The ratio of outside legal spend to inside spend averages 60% to 40%, with 60% of the budget spent with law firms and other providers. However, since in-house legal services are essentially purchased “wholesale,” whereas law firms bill at a retail rate, the overall volume of the work being done in-house likely exceeds 50%.
This trend has pressured firms to be more conscious of their bottom line. As a result, there is an increased focus on associate performance, including utilization and realization rates. Before hiring any new associates, partners have started to conduct thorough analyses to ensure that their current resources are being fully utilized and that that there is enough work to keep a new associate busy. Partners are also more discerning than ever when evaluating the experience and qualifications of prospective lateral hires and are performing much more diligence on the skill set of associates before making an offer for partnership. To erase inefficiencies, we can expect legal departments to continue to shift work away from firms.
Alternative Fee Arrangements
Practices at law firms are rapidly changing to create leaner, cost-effective and constantly evolving organizations. Partners are billing more by alternative fee arrangements rather than the traditional hourly rate and focusing on evaluating the effectiveness of their teams.
Going forward, there may be an even bigger delta between the highest- and lowest-paid partners ($1,200 an hour versus $500 an hour), with the former being limited to the top 25 firms. The partners who are willing to charge a lower or fixed fee are going to be better positioned to get the routine work. GCs love predictable legal budgets, so pressure for fixed-fee deals will only increase. In this manner, geographic arbitrage abounds. New York general counsel use less expensive firms in Atlanta, Atlanta general counsel use less expensive firms in Tennessee, and so on.
Changes in Routine Work
Meanwhile, GCs are no longer willing to pay expensive Am Law 25 firms to do routine work, only major deals or “bet the company” litigation. Partners at all but the top-tier firms are feeling this pressure from their clients. For more routine work, GCs have started to seek strong regional firms or even reputable firms in smaller cities. The rapid expansion of labor and employment boutiques is a good example of this trend.
Another example of the ongoing pressure to optimize can be seen in the increased use of contract lawyers for due diligence, e-discovery and, increasingly, other slightly more complex work. Law firms used to be a pyramid with a big base of partner-track associates. But pressure to increase cost-effectiveness has inflicted major changes on the pyramid, and contract lawyers will make up a bigger percentage of the base of the pyramid.
Legal Operation Specialists
Legal operations specialists range from paralegals to Big Law-trained lawyers and typically have responsibility for helping a GC manage the legal budget. Their key function is to leverage technology to make internal law departments more efficient and reduce labor costs. Contract management systems, e-billing systems, templates and playbooks for negotiating standard agreements all fall under the purview of legal ops. For law firms, this means that their clients have the technology to track their legal spend in real time. So, when fee caps or project budgets are busted, law firm partners will hear about it in matter of a day or two, rather than a month or two after the bills are sent out.
The ongoing pressure to reduce costs will not stop with contract lawyers performing due diligence and e-discovery. What is the next tranche of work that can be offloaded from more expensive partner-track associates and law firm partners? Surely NDA templates can be created to allow lower-cost resources to perform initial drafts of these agreements. What about companies with high-volume, low-complexity contracts with their customers, such as cable or satellite TV companies? The list goes on. In the next few years, legal ops specialists will continue to transfer work to attorneys who are not partner-track associates.
Predicting when the next recession will hit is hard. However, when it does, the legal industry will be far better prepared to weather the consequences. Legal services are being delivered in a much leaner fashion than they were in 2006 or 2007. There is not a lot of fat in the system, so there isn’t as much to trim when activity slows. Layoffs and reduced hiring should not be as bad in the next recession as we saw in 2009. However, just as in 2009, the next recession will undoubtedly accelerate the industrial engineering revolution already underway in the legal profession. How will managing partners in the Am Law 200 react?