Joel Henning & Associates - Counseling to the Legal Profession
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A broken business model.

Joel Henning

August 17, 2009

Law firm economics are pretty simple. There are only a handful of drivers of law firm profitability: productivity (billable hours), leverage, realization, expenses and rates. It's self-evident that — for the past decade — law firm profitability increased by upwards of 10% annually and even more in some firms. But only one profitability driver was operating: unrelenting annual increases in hourly rates.

For better or worse, the current economic debacle has stalled substantial annual-rate increases and led many leaders of the profession to declare that the current law firm business model is broken and must be replaced. In the past year I haven't been to a conference where the business model hasn't been declared dead, but none of these conferences has resulted in consensus as to what can or should replace the current model.

There is a lot of talk about moving away from billable hours, but alternative fee arrangements are neither new nor making much headway. Greater use of contract lawyers, off shoring, fewer equity partners, a cutback in associate salaries and more differentiation in associate pay and promotions — are all being discussed and even modestly implemented. But all of this has been around for at least a decade, and none of it has so far done much to make clients happier either about their legal bills or the quality of the services they pay for. The conventional ideas for changing the way law firms do business are, in other words, insipid and inadequate.

So perhaps this is the time to go beyond the conventional, to push our profession in ways that are radical, so radical that they would require significant changes in our code of professional responsibility.

I have often reflected on how aspects of the American legal profession still resemble medieval guilds in the control lawyers continue to have over the rules.

Our professional leaders continue to defend self-regulation, focusing on the need to protect client confidentiality, guard against conflicts of interest, protect the public from the unauthorized practice of law, maintain the independence of the legal profession and ensure access to justice and high standards of ethics. Despite self-regulation, it's pretty clear that we have fallen short of the last goal. It's also clear, at least to me, that it no longer makes sense to regulate the delivery of legal services to individuals the same way that we regulate legal services to businesses.
Moreover, the case against our retrograde regulatory environment is relevant to our hand-wringing about legal costs and the lame law firm business model. University of Southern California Gould School of Law Professor Gillian Hadfield, a lawyer and an economist, argues that regulatory barriers keep us from reducing the high cost of corporate legal services. She suggests that — but for proscriptions against the unauthorized practice of law and our monopoly over certain legal matters — other professionals trained in a variety of disciplines could offer innovative and efficient methods of managing business relationships that now can be handled only by lawyers.

But that's not all. Regulation also keeps us from bringing in outside investors who would cast a cold eye on the inefficient and costly ways in which we deliver legal services. Although such a transformation in the American legal profession seems revolutionary, it is already taking place in Commonwealth countries including Australia and England.

Focusing on share price rather than individual productivity measured by hourly output and profits per partner could lead outside investors to make greater investments in law firms. The result might be very different service delivery, billing and compensation systems, minimizing individual performance and maximizing team, practice and firm performance. Investors would bring to bear a more contemporary suite of tools and techniques for managing the delivery of legal services. They would be astounded by the enormous duplication of efforts at law firms.

If we allowed businesspeople to invest in and join the leadership of our law firms, I suspect that more and better smart systems and processes would be developed and refined on an accelerated basis, systems that would accomplish many legal tasks beyond drafting and researching, reaching even to some problem solving. If this were to happen, the billable hour and the lawyer compensation systems grounded upon it would largely become anachronisms. Savvy outside investors would find that too many smart lawyers and too few smart systems currently inhabit our law firms.

If it would take a regulatory revolution to change the fundamental law firm business model, is there any hope? I don't know whether President Obama will succeed in his efforts to change health care, but I doubt that — whatever the outcome — his next priority will be the American system of delivering legal services. And without leadership at that level, I wonder if real reform has any chance.Joel Henning, a lawyer, is a management consultant to law firms and legal departments. He can be contacted atjfh@me.com.