The future of law firm profitability

In ten years time, law firms will function in a very different manner from the way they do today. In particular, profitability will be affected by the fact that some practice areas will become more price-sensitive and clients will be more demanding. Norman K. Clark of Altman Weil Inc explores how firms will be able to counter these trends by making the most of new technologies to boost profit levels.

A guided tour of the law firm of 2010

If we visit a successful law firm in the year 2010, we may not immediately recognise what we see:

First of all, the law office will appear to be more like the communications centre than a traditional place of business. There will not be as many people there as we saw in a law firm of the 1990s. We might not see many lawyers at all, even in the largest firms. Wireless and Internet-based communications technology will allow lawyers to be wherever they need to be to serve clients best. As a result, few, if any, of the lawyers will have permanently assigned rooms. Instead they will be provided whatever on-site space and support they need when they need it.

It will look as if the support staff are running the business. In a very real sense, they will be. At the same time, whole support departments such as accounting, human resources, and information technology, will have disappeared altogether.

Like their clients, law firms in 2010 will increasingly purchase their professional services directly over the Internet. For example, on-site management, technology, and marketing consultants will have largely been replaced by self-facilitating service modules that the firms will be able to download and implement at a fraction of the price charged by traditional consultancies.

Many of the traditional organisational divisions, such as the real estate and litigation departments, will have seemingly disappeared. Most lawyers will belong to multiple teams and groups. Many of these groups will be organised around industry sectors or even specific clients.

Not only will organisational boundaries within the firm have blurred, but traditional distinctions between the law firm and in-house lawyers in client organisations will also have faded. Lawyers will still deliver legal services to clients, but they will work in teams with professionals from other disciplines. Flexibility and continuous communication, not structures, will characterise law firm organisations in 2010.

Shifting the profitability focus

Where will law firms in 2010 find the greatest opportunities to improve profitability? Market maturation will continue to make many practice areas more price sensitive and many clients more demanding. The pre-1990 approach to law firm profitability – i.e., increase profits by increasing rates and turnover – will become harder for most firms. Clients simply will not pay ever-increasing rates for the same work. Hourly rates may actually fall in high-volume practice areas, which will have become even more competitive. Clients will expect more from law firms, but will not be willing to pay more to get it.

The law firm of 2010 will have to look elsewhere for profitability. It will have to look to the ‘second line’ – operating costs.

Most law firms assume that it is inevitable that operating costs will increase. But the most successful law firms in 2010 will have discovered that they can use technology to drive costs down, thereby enhancing profitability. Internal communications and knowledge management systems will reduce fee earner time required to produce many, if not most, legal products and services. Law firms will also discover that they can outsource entire administrative and management functions to an Internet-based provider, at lower cost and with more consistent quality than in-house resources could ever provide.

What will be the impact? The law firms that are most innovative and creative in their use of technological capabilities – especially the Internet – will experience quantum leaps in profitability. The Altman Weil Survey of Law Firm Economics reports for 1995 through 1999 record that most US law firms, for example, experienced net income that ranged consistently between 55.3 per cent and 56.7 per cent of gross turnover. By contrast, it will not be unreasonable for the same law firms in 2010 to expect net incomes equal to 65 per cent to 70 per cent of gross turnover.

This dramatic jump in profitability will not come from ever-increasing rates. Successful law firms in 2010 will have shifted their focus to cost management, using technology to drive down operating costs throughout – and out of – the firm. Moreover, many of the most powerful cost management strategies will be based on technology that is largely available today.

We have no choice

The growth of electronic commerce has produced three ominous implications for law firm profitability.

First, the Internet has removed client ignorance as a cost centre. Clients are no longer willing to pay for information that is already available at low cost or no cost on the Internet.

Second, electronic commerce drives clients toward self-service. They are no longer willing to pay high fees if they can download the information they need from a website and do the work themselves.

Third, the Internet and electronic commerce have combined to reduce the price of information. Information has become a commodity on the Internet, even legal information. If your firm does not provide it at no cost to clients – or even the general public – your competitor will. Law firms will need to overcome their fear of cannibalisation of their stock in trade.

These impacts leave little choice. Law firms must also exploit the opportunities that electronic commerce and the Internet provide in order to meet these challenges. Several strategies have already emerged and show great promise for law firms of all sizes everywhere.

Telecommuting

Beginning in the late 1980s, businesses discovered that they could reduce costs by allowing some of their staff to work at home. Telecommuting could lower fixed costs such as facilities and equipment, which, after compensation, are the two largest cost items in most operating budgets. Telecommuting also became a favoured strategy to provide additional work capacity at substantially less incremental cost.

Telecommuting caught on quickly in many businesses. As it did, the stereotypical telecommuter quickly shifted from the worker who, still in his dressing gown and slippers at eleven o’clock in the morning, shuffled into his spare bedroom to switch on his computer and work two or three hours before shifting to video games. Today, the typical telecommuter is the computer-bearing ‘road warrior’, who travels from client to client, returning to the office as infrequently as once a fortnight.

Today’s telecommuter can be defined as someone who spends more than half of their time working somewhere other than in the office, and who uses the Internet as their principal means of communicating with their company or with their customers and clients. At one large US telecommunications company, telecommuting among managers grew from 8 per cent in 1994 to 29 per cent by the decade’s end. Telecommuters have also been shown to be more productive than their colleagues at the office, by as much as 20 to 25 per cent.

By 2010 law firms will have moved a substantial number of their fee earners out of the office. Internet-based communications technology will allow law firms to deploy legal talent wherever necessary to serve clients most effectively. Some fee earners will work from home; others may work on-site at client offices. As bandwidth and communications speeds increase steadily over the next ten years, even fee earners in remote locations will be able to provide the same responsiveness as their colleagues in the law firm’s offices.

One of the overlooked benefits of Internet-based communications is that it provides lawyers and clients with an almost infinite variety of organisational structures and delivery systems to meet the precise needs of each client at the lowest cost.

Application service providers

Average technology costs per lawyer have continually risen. Faster and more complex chips, less expensive memory, and more demanding software have forced most law firms to play a continuous game of ‘catch up’.

Application service providers (ASPs) provide an attractive alternative for law firms. Software resides on servers at the ASP, not in the law firm. The ASP is responsible for updates, maintenance, and help desk functions. Best of all, an ASP can provide a complete package of services for a fixed monthly fee. This provides a cost predictability that most in-house technology functions can only hope to approximate.

Law firms who use ASPs generally report a high level of satisfaction with the service and support they receive. Some say that ASPs are even more responsive than in-house support.

By 2010, the ASP model will probably become the dominant model for providing office applications, maintenance, and support to law firms of all sizes. Moreover ASPs will give small and midsize firms economical access to state-of-the-art sophisticated applications, such as case management, knowledge management and accounting. They will also provide support at a level of responsiveness and accuracy that exceeds what is observed in most law firms. Law firm technology will have moved off-site, and will dramatically cut a significant cost item. It will also close the ‘technology gap’ that currently separates the largest firms from small and many midsize ones.

Data warehousing

If applications can be moved off-site to an outside vendor, why not data files? Most lawyers instinctively recoil against the idea of sensitive data being stored outside the law firm. In fact, data warehousing services provide a level of reliability and security that few firms could economically approach. Data is stored on locked servers in locked rooms, under the toughest levels of physical security and restricted access. Few law firms can afford similar security.

Knowledge management

Successful law firms will not prepare documents in the traditional ‘search and copy’ method that most firms use today. Document management software, document assembly applications, and expert systems will slash the amount of lawyer time needed to prepare even the most sophisticated documents. Lawyers will no longer have to rely on their memories, or those of their partners, in order to locate precedents and templates. Everyone in the firm will have immediate and accurate access. Moreover, these technologies will enable law firms to delegate sophisticated document drafting functions to associates, paralegals, and even support staff.

There will be at least three profit-building effects from this. First, by speeding up document production, law firms will be able to take on substantial amounts of additional work with little if any additional staff. This extra work will be virtually pure profit. Second, by reducing the cost, measured in fee-earner time, of document production, law firms will be able to widen margins for fixed fee work. Finally, since partners will be able to delegate sophisticated document drafting functions that previously only they could perform, they will have additional time freed for more higher-value work, as well as for more client development.

Outsourcing

Successful law firms in 2010 will have shed most of their traditional administrative and management functions, transferring them to highly skilled and specialised external vendors. Almost any support function will be delivered over the Internet, including:

· Accounting

· Benefits

· Case management

· Filing

· Human resources management

· Marketing

· Management consulting

· Network administration

· Payroll

· Performance management and evaluation

· Professional development and training

· Risk management

· Software management

· Technology management and support

Law firms will not have to wait until 2010 to take advantage of these opportunities. Most of these outsourced services are already available, many of them delivered directly over the Internet. By 2005, even highly sophisticated management services, such as evaluation of merger acquisition opportunities and strategic planning will be delivered online and facilitated in-house at a fraction of the costs currently charged by outside vendors.

Why wait?

Law firms do not need to wait until 2010 to begin to take advantage of the profit-building opportunities that electronic commerce and Internet-based communications technologies will provide. Most of the technology described in this article is already on the market. By 2002, law firms of all sizes will be able to acquire sophisticated management and administrative services, custom-tailored to the unique needs and characteristics of the legal profession, at a fraction of the current cost of performing these functions in-house or contracting them from outside vendors. Firms that start to take advantage of existing technologies today will be in a much stronger profit position tomorrow, while delivering high quality legal services at highly competitive prices.

Norman K. Clark is a lawyer and a shareholder in Altman Weil, Inc., an international management consultancy for law firms and corporate law departments. For further information, contact Mr. Clark at nkclark@altmanweil.com.