Change still a long way off for law firm business models
COVID-19 has exposed the weaknesses of traditional firm models, writes Lachlan McKnight.
The last eight weeks have seen a raft of “strategic advisers”, “pricing specialists”, and “thought leaders” postulating that the traditional law firm business model will be “changed forever” by the COVID-19 pandemic and the resulting economic downturn.
Lawyers love reading about how they’re going to be disrupted, so it’s no surprise that many are lapping up this viewpoint. But I think the legal industry will rapidly go back to its pre-COVID-19 status quo.
A small number of top-tier firms will continue to rake in enormous profits while poorly run mid-tier firms will stay on their inexorable path to collapse. Many NewLaw players will return to posting updates on LinkedIn without actually generating much in the way of revenue (let alone profit!). This doesn’t mean that the traditional law firm model isn't going to ultimately collapse – just that it will take decades for this to happen.
A failing business model
There is no doubt that the COVID-19 economic crisis has once again demonstrated the weaknesses in the traditional law firm business model.
A complete reliance on transactional, hourly rate billing, has led to significant drops in top-line revenue over Q4 19/20 for many traditional law firms. Firms that have managed to maintain revenue over the course of this quarter are anticipating a significant drop off in Q2 of 20/21.
The continued inability of traditional law firms to productise their services has ensured that revenue continues to be directly correlated to only one input – lawyer hours. A drop in revenue immediately crunches gross margins, with traditional law firms immediately instituting rapid reductions in lawyer salaries in order to offset the decline (or anticipated decline) in revenue.
Of course, productisation takes years of iterative development effort and significant amounts of capital. The traditional law firm structure is a powerful impediment to change.
Traditional law firms are essentially gerontocracies. The senior equity partners who control the firm have a vested interest in ensuring that they can extract the largest amount of cash possible from the firm before their approaching retirement. An investment in productisation will take five to 10 years to start generating returns. It makes little sense for these senior equity partners to give up cash now to benefit a firm they won’t even be part of in a few years.
Furthermore, although the traditional law firm business model creates suboptimal results for clients and employees, it is still highly profitable.
The host of NewLaw players encouraging each other on LinkedIn with “Now is our time” status updates are slightly delusional. “Value pricing” is not ultimately changing how legal work is produced. Only a significant investment in productisation can do this, and the only way to achieve this is to invest in building out a product and tech capability over a prolonged time horizon.
Most NewLaw providers are just either microbusinesses generating less than $200k a year in revenue, or small boutiques doing no more than $3 million. The owners of these firms are largely focused on generating an income for themselves, and they’re not looking to build institutional value in their businesses.
The ‘future’ is decades away
The traditional law firm business model, which has been around, effectively unchanged, for over 100 years, will ultimately collapse under its contradictions. This will happen when a new type of legal service provider emerges, with a massive balance sheet, a willingness to invest in product on a 10-year time horizon, and a desire to get to a huge scale ($500 million+ in top-line revenue in Australia). This will take decades.
Lachlan McKnight is the CEO of LegalVision.