Over at the AmLawDaily, Paul Lippe recently caught our attention here at Redwood Analytics with his sensational headline, (“Welcome to the Future: The 2011 Scenario and the End of Leverage,”) but we’re having trouble connecting the dots to get to Mr. Lippe’s vision for the future of the legal industry.
Mr. Lippe’s assertion: Leverage will be less prevalent, because the market value of associate work will be less than it is today. While partner contribution may be essentially the same as today, the declining value of the work of non-partners and other fee earners will reduce overall revenue for work between today and two years hence by as much as 20 percent.
We’re not convinced that firms will devalue leverage for two reasons:
1. Mr. Lippe’s hypothesis assumes that the legal work of 2011 will be identical to the legal work of 2008. We disagree.
2. What is described as the “end of leverage” is in actuality an extension of leverage. The current supply/demand dynamic between purchasers and providers of legal services does not mean the end of leverage. If anything, an expectation of reduced pricing power argues for more efficient planning and staffing of matters and a closer look at the structure of practice groups and law firms.
The Work of the Future
Whether Mr. Lippe is correct about the relative value of a piece of work today and in three years is largely irrelevant. For starters, today’s premium work is tomorrow’s commodity work. This is the case in most industries, and we don’t believe the legal industry is an exception. While partners will appropriately be compensated for their “deep expertise, and judgment about the client, the law and best practices…..” pricing power is as much about the type of law as the lawyer. This is at least in part a function of supply and demand, and will impact associate pricing right along with the partners for whom they are working.
We’re hard pressed to believe that the nature of legal work will be static over the next three years, and that there won’t be new types of work, new areas in which there will be an opportunity to become an expert, and areas of law in which the demand for expertise will return pricing power to the lawyer and the law firm.
Leverage Continues to be the Answer
Mr. Lippe points to four places that dollars will go instead of into the pockets of law firms:
1. “Clients will just flat-out spend less, drive harder bargains and get more for their money.”
Clients driving harder bargains will force law firms to produce efficient work. That means good work at the lowest cost. Alternative pricing and deep discounting does not argue for a de-emphasis of leverage as a driver of profitability. While most firms are cutting headcount through associates and staff, we believe that the smarter firms are the ones who are taking this opportunity to deal with underperforming partners as well.
2. “Some work will go to outsourcers, whether onshore or off.”
How is this not leverage? This form of leverage will continue to expand, and we acknowledge that there is work currently done by large full service firms that will be handled much more efficiently by other providers. We refer again to the fact that legal work is not static in nature. There is certainly work that is handled today by paralegals that was handled by associates 10 or 20 years ago.
3. “More work will go to contract lawyers or proto-associates not on any kind of partnership track.”
This form of leverage too will continue to expand.
4. “Some associate time will get replaced by technology.”
Nothing new here. No question, legal work will continue to evolve and technology will help firms become more efficient. This is the ultimate form of leverage.
Mr. Lippe asserts that “associate time is a pricing mechanism, not an indicator of value.” While we don’t disagree, it seems fairly clear that all fee earner time is a pricing mechanism within an hourly billing system, and that the market itself is the indicator of value. For Mr. Lippe and other proponents of the argument that law firms are on the brink of “the end of leverage” we’re very interested to learn how firms will maintain, or grow, profitability without the use of leverage. While there may be a small decline in overall leverage ratios of large firms over the next year or two, we believe this will be the result of firms being slow to make hard decisions about partners. This, surely, must be temporary. At Redwood, we’ve studied the drivers of profitability across hundreds of firms, and found that leverage is far and away the second biggest driver of firm profitability (behind revenue per lawyer). We just don’t see leverage diminishing in importance, regardless of economic factors or advances in technology. These things aren’t new.
As for the current demand imbalance between law firms and clients: as a wise man once said, “this too shall pass."
–Bo Yancey
Bo Yancey is the Director of Professional Services at Redwood Analytics. He leads a team of consultants who provide practical advice to law firm leaders interested in using analytics to manage the business of law.
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