Will 2020 unleash a long-awaited wave of legal innovation?

Law firms offer a bundle of services tied tightly together, and most lawyers think of this bundle as a naturally integrated offering.  But innovators have long believed that the legal services bundle is actually composed of a series of largely unrelated capabilities, and the true flowering of legal innovation will arrive only when that tight law firm bundle loosens and, perhaps, finally comes apart.

To take some specific examples, consider whether a firm that establishes people, processes, and technology to execute the activity in each yellow cell in the above graphic would be expected to be equally proficient at either of the two activities to its right.

Reading left to right, these activities have essentially nothing in common except the underlying matter.  What holds them together is the firm’s ability to insist on a tightly bundled offering.  The innovator’s observation is that no single firm will ever be able to carry all of them out to the highest standard, and the innovator’s belief is that law firms will succumb to superior people, processes, and technology furnished by alternative legal providers in each of the areas above.  In this scenario, clients will turn to “best in breed” solutions in lieu of the integrated law firm offering, forcing firms to accept third-party services into the bundle and unleashing an era of rapid innovation.

This all sounds very good in theory. But what about in practice?

Earlier attempts at unbundling

Perhaps the first aggressive effort to unbundle Big Law came from LRN.  We now know LRN as a leading provider of ethics and compliance services, but its name actually comes from its first business: “Legal Research Network.”

LRN’s original idea — in the late 1990s — was to offer corporate clients a superior alternative to the legal research and expertise element of the Big Law bundle.  Clients would buy legal research a la carte from LRN, since LRN could easily produce legal research more cost-effectively than Big Law did.  (Taking aim at the cost of associates in Class A office space surely seemed like easy pickings at the time.)  Clients would then pair LRN research with other services bought a la cartefrom law firms and other providers to assemble a full-service offering of best-in-breed solutions.  Fully realized, this model would have unbundled Big Law.

It didn’t happen.  LRN was the first notable demonstration of just how deep and wide Big Law’s economic moat is.  LRN led its forces into the then-unoccupied territory of compliance training,  never to return to the fortified city.

Consider how hard the attack on Big Law would have been.  The first angle of attack might be to approach the law firms and suggest that they reduce their reliance on associates, substituting a variable-cost service instead, perhaps with a mark-up to clients, perhaps passing it through at cost.  This conversation is a non-starter, as anyone who has worked in a large law firm can understand.  If for some reason the idea makes it to the management committee, getting consensus will be impossible.  Who is going to abandon reliance on the efforts of trusted associates and junior partners who represent enormous sunk costs?  Perhaps in theory Big Law associates are inefficient, but in real life they have names, are just a short walk down a very expensively carpeted hallway, and are the main profit levers of the firm.  As to variable versus fixed costs, law firms have little difficulty reducing investments in staff when the need arises.

Rebuffed by law firms, one could then approach the general counsel of major companies and suggest that they force the unbundled arrangement upon their law firms.  At that point, the full scope of the law firm’s economic moat will become apparent.  GCs will immediately recoil at the extreme social awkwardness of the proposed conversation between them and the law firm partner:  “I’m not dumping you — I just want to bring someone else with us to the prom.  You know, all three of us.”

Big Law is not amenable to novel polyamories; this conversation will almost never happen because the GC will refuse to have it. Cf. Post 008 (discussing culture compatibility has one of the lynchpins of successful innovation adoption); Post 098 (innovation adoption worksheet that scores cultural compatibility).

Tying and bundling

But suppose it does—the GC attempts to force a concubine into the relationship.  Quality law firms at that point can, and will, simply insist that all third-party providers must be to their liking and that as much work as possible is to be done by their own people.  What they seemed to be selling a la carte turns out to be a tight bundle, a tying arrangement in which the scarce and valuable partner’s time comes paired only with approved accessories: namely, a flotilla of associates and junior partners.

The market proof that this is a major profit lever is simple: a second-year associate at an AmLaw 20 firm who for personal reasons moves to Madison or Cincinnati to join an AmLaw 200 firm will see his billing rate drop by more than half.  If he hangs out a shingle himself, his natural hourly rate will fall to (or below) the cost of production.  It’s two short and easy steps from associate lunches at Morton’s to subsistence farming.

In economic terms, the decrements in his billing rate are a direct measure of the value of tying his efforts to an AmLaw 20 partner, an AmLaw 200 partner, or no partner at all.  Sure he went to Yale, but outside of the law firm bundle, he’s not quite worthless.  His value is in the reputation and specialized expertise of the more senior lawyers for whom he works, and which — if he stays at the firm — he will gradually come to embody.

Affronted law firm partners can produce as many rationales for their very expensive associate-partner tying arrangements as the client has time to hear (some readers will believe they have heard them all, but trust me, there are more).  The true reason, however, is that the firm has market power and that is that.  Evidence of market power is easy to see: does the demand for the partner’s services exceed its supply?  If it does, she can turn down clients who won’t buy the whole bundle, and turning down work is the ultimate market power.

(I should say here that “market power” and “tying arrangement” are terms often misunderstood by American lawyers to be illegal.  Market power is the precondition to earning a profit.  It’s only when you have too much that there’s an antitrust problem, and no law firm comes remotely close to having that kind of market power.  Similarly, tying arrangements are perfectly fine. Only in rare cases do they cross a legal line.)

After two decades of varying entrepreneurial efforts, the unbundling of Big Law still mostly hasn’t happened.  But traumatic change often takes place “gradually and then suddenly”, to quote Hemingway.  2020 is a rolling earthquake — and it’s only June! This year may ultimately rival 1968 for tectonic disruption.  Will economically stressed clients turn at last to an alternative legal services industry hardened by 20 years of survival under harsh conditions?  If they do, it could finally usher in The Great Unbundling.

A lethal unbundling for universities?

As we consider this question’s implications for the legal profession, we may want to keep in mind the situation in American higher education. Colleges now face what could be a lethal unbundling event set to begin in less than two months.  Students and donors at residential four-year universities pay a high price for a prix fixe menu of unrelated services: teaching, attractive landscaping, research, food, housing, football, academic counseling, examination, certification, musical conservatories, student affinity groups, theater programs, mental health care, LEED-certified architecture, career counseling, alumni networking and much more.  This is unique to American colleges; many fine European universities offer only the core of this bundle: teaching and certification.

Neither students nor administrators know precisely why students at American universities are willing to pay such a high price for this bundle of experiences – but they may be about to find out.  The external shock of COVID-19 has reduced comprehensive four-year schools to a thin layer of online services for at least the fall semester of 2020, and possibly the full academic year and beyond.  The next six weeks will begin to reveal how many students will continue to pay for the whole bundle while receiving only its two core elements: teaching (virtual or hybrid) and certification.  Community colleges and a range of other cheap, accredited online offerings appear to be the rational substitute.  Given the sensitivity of academic budgets to small changes in enrollment, this unbundling will be damaging to many schools and, in all likelihood, lethal to some.  The survival of the bundle may be a necessary condition for the survival of the school.

What is a bundle?

Bundled offerings take two main forms: a true bundle or a tying arrangement.

A true bundle happens when the seller has enough market power to force buyers to pay for a collection of services even when the buyer can’t use the whole bundle, or might rather procure certain parts of it more efficiently elsewhere.  A familiar (and cheap) example is the old print newspaper: we all have an uncle who only reads the comics and sports, and maybe pulls out a few coupons.  Even the most avid reader of newspapers would rarely make use of the whole bundle (except as fire-starter), but the newspaper is (or was) an all-or-nothing purchase.

Other true bundles are high-end country clubs, comprehensive fitness clubs, and amusement parks like Disney World.  In all three cases, if you want anything inside, you have to buy everything inside.

The other form of a bundle is really a tying arrangement: the purchase of one element effectively obligates the buyer to the purchase of other related, proprietary, and generally somewhat more expensive items.  Apple products come immediately to mind, but there are other ready examples.  Stadium food (no outside food allowed), car parts (“we’ll need to order that part from Volvo — ahem — brace yourself”), or add-on services like personal training at a high-end fitness club.

As mentioned above, law firms don’t present themselves at first as a take-it-or-leave-it bundle.  They account for their services in six-minute increments, for goodness sake – what could be more a la carte than that?  But as the LRN story above illustrates, when under threat, Big Law’s drawbridge goes up and the bundle is airtight.  Those six-minute increments are illusory in more ways than one.

What all bundles have in common

As different as they seem, all bundles share some common economic characteristics.

First, the tightest prix fixe bundles are also the most comprehensive, and they occupy the top of the market.  The rest of the market is partly or wholly a la carte.  Disney World is an incredibly comprehensive offering, and it is prix fixe.  Disney can do this because it has the market power, and selling a bundle is more profitable and far easier to administer than selling piecemeal.  Mid-market amusement parks are both less comprehensive and more a la carte because they don’t have Disney’s powerful draw.  Similarly, if you’re going to Mayo Clinic, you have made the decision up-front to pay for the comprehensive offering there.  Everything will be performed in-house or by approved third-party providers.  If you feel compelled to ask about price, you’re in the wrong place.  Indeed, even medical services become more a la carte as one drops down the market.

The same kind of customer decision to fully commit up-front is implied — or, at most, whispered — when hiring Kirkland or Cravath.  At the tippy-top of any market, the service is complete and there is very little haggling over price.  This suggests that the AmLaw 20 will be the last to unbundle if it ever happens at all.

The second feature of bundled offerings is that they tend to be naturally complex so that one can never quite know whether the purchase was “worth it.”  The buying decision comes down to, “do you want it or not?”

Again, consider the country club membership, the NFL game, and its eye-watering concessions, the Disney vacation, the Volvo XC90, the MacBook Pro, the major corporate software implementation.  No spreadsheet can demonstrate that these are good buying decisions.  Run the numbers all you want – it comes down to, “do you want it or not?”

And because bundles are complex and varied, there is no way to do an apples-to-apples comparison even between fairly comparable offerings.  A handy and comparatively simple example: I am writing this article with no difficulty on a $190 Chromebook.  Above me is a teenager’s bedroom that contains a small fortune in Apple products.  Was it rational to buy any of them?

The correct answer is: “I don’t really want to think about it.”  That is also the only correct answer when considering whether it was strictly worth it to hire Sidley, buy the Volvo, or go to Disney World instead of Six Flags.  The most you can do is make a pro/con list in order to claim that the decision has some sort of rational basis.

So, how do customers actually decide to buy a bundle?

Bundled purchase decisions are made on brand, social factors, and features rather than outcomes.  This means that buyers will knowingly pay radically different amounts for what appear to be similar bundles.  Not all families weighing in-state tuition at UT-Austin against out-of-state tuition at Michigan will go with the “rational” choice.  Not all families (apparently) will buy the good-enough Chromebook at a fraction of the price of an ineffably better Apple product.  It’s a gut decision with too many factors to fully account for.

A lot of this has to do with brand, which perhaps is best understood as a type of implied statement of what kind of person we are.  (I am apparently a Chromebook sort of person, and my kids, well, aren’t.)

There is, however, a tendency for complex bundles to be sold on features rather than benefits because benefits are often impossible to assess.  Thus features pile up in some markets, occasionally to the point of absurdity.  College tours, for example, do not prominently feature an ROI analysis of program cost and graduate earnings potential.  (In fact, some parents have noticed that they categorically omit such awkward considerations, even though the analysis is available right here.)  Instead, college tours pile up features: cafeteria, workout facilities, sports teams, student groups, new buildings, comfortable dorms, the occasional mention of highly-ranked programs.  Curriculum, I am reliably informed by people who run admissions tours,  never comes up.  Colleges don’t do this to mislead; they do it because they have learned time and again that a complex buying decision of this nature is based on features, brand, and, ultimately, gut feel.

A more absurd example: even something as simple as a bicycle is a bundle.  Because inexperienced buyers can’t assess what the bundle is worth, mass-market bicycles are universally up-sold on features rather than benefits.  Bike shops thus move buyers up to more expensive models by pointing out that Bicycle A has only 18 gears, but bicycle B has 20, and Bicycle C has 22.  The absurdity is that this up-sell works just as well in Illinois, the second flattest state in America, as it does in Colorado (I can attest – I’ve done the selling).

The accompanying insight is this: novice buyers are completely unable to understand, let alone pick apart, the bundle, but sophisticated and motivated buyers at least stand a chance.  They just need to figure out how to breach the seller’s economic moat, and they need to be willing to do the work of assembling the bundle themselves.  In other words, serious cyclists build their own bikes.

Do law firms sell on features rather than benefits?  Yes.  Of course, there are the arguably unimportant prestige signals like marble and exquisite furnishings in the reception area, commanding views of the Hudson River, and top-floor partner offices.  But more substantial features are the brand name law schools of the firm’s lawyers, which do not particularly correlate to performance.  See Bill Henderson, “Measuring the Value of Law Firm Pedigree,” Legal Whiteboard, Oct. 13, 2013 (reviewing performance data published by AdvanceLaw).  And more recently the furious market for former Supreme Court clerks. See Staci Zaretsky, “$400K Is Now The Official Market Rate For Supreme Court Clerk Bonuses,” Above the Law, Nov. 15, 2018.

None of these things do more than suggest the possibility of a benefit; they are features, like having 22 gears on a bike.  The reaction of a typical client is: “Wow, this is impressive.”  The question for the sophisticated client is: “Am I riding up a mountain?  What good is this?”

Why bundle?

We could imagine a world in which top-shelf lawyers don’t bundle their services at all, instead practicing without the constraints of a law firm, selling their services a la carte, and still making good money.  So why don’t they do this?

We don’t have to imagine it.  In the UK, barristers aren’t allowed to bundle their services.  They are, by rule, solo practitioners at the Bar, paid only for their hourly services.   Those services are very much in demand, and supply is constrained by barriers of education, qualification, and eye-wateringly expensive wigs. So without the profit engine of associates and junior partners, is it possible for a top barrister to make serious money?

Top barristers — “Queens Counsel” or QC — bill in excess of £2,000 per hour, and up to £5,000 in certain instances.  Without the power of the bundle, they simply roll their full value into the hourly rate.  The math works out well for them.

So why do law firms have a bundled strategy?

First, a marketing explanation: it’s more profitable across a broad range of lawyers.  A few top London barristers are making Cravath or Wachtell money at the end of the day, but the rest aren’t.  The leverage of the bundled model is hard to beat: present a united front of brand, service, and reputation, and resolutely claim that each partner is just as good as every other partner.  Barristers, deprived of such a united front by rule, cannot extract as much as a group for their services as if they were allowed to tie their services first to one another, and then to associates.  They share office space and resources at the Inns of Court, but they cannot share profits.  The American Big Law model is truly a world-class money-spinning machine in which lawyers of distinctly differing capabilities make uniformly high wages.

Second, an economic explanation: it’s more efficient.  In The Nature of the Firm, Ronald Coase asks why firms exist at all – i.e., why would a sole proprietor ever hire someone outright rather than simply contracting out for their services?  Coase’s answer is that transaction costs are considerable, and firms will form, and then grow, to the extent that the transaction costs of having paid staff are lower than the transaction costs of dealing with a third-party provider.  Coase won the Nobel Prize in Economics for this work, which was intended to explain why manufacturing firms like General Motors existed at all rather than being arranged as cottage industries.  But The Nature of the Firm is also a satisfying explanation of why law firms exist.  Lawyers who could each practice solo and collaborate on a case-by-case basis choose instead to form relatively permanent law firms because the transaction costs of working with a team of lawyers are lower when the team is used to practicing together.

Both of these explanations are probably right, but neither is timeless.  Will the bundle hold?

Decomposing the law firm bundle

Coase’s answer to why firms are bundled rather than disaggregated suggests that the bundles could simply come apart because advances in markets and technology reduce the transaction costs of contracting with third parties.  But since it is not in the interest of a top law firm to change its very successful economic model, the disruption would need to come from below — a network of innovators that clients found so compelling that they would shift the work away from traditional AmLaw firms.  That reduction in demand would erode the firms’ market power, which is ultimately the basis of the bundle.

So, is this going to happen in 2020?  Let me lay out some things to consider, and make a few predictions.

Sometimes bundles are destroyed by a single, completely superior “killer app” that takes out what may be an unexpectedly important stick in the bundle.  For local newspapers, the bundled economics came fatally unstuck with the advent of the internet.  In particular, it turned out that papers had a small but meaningful revenue stream from classified ads, which Craigslist killed almost overnight.  (If you are too young to have encountered classified ads, they were an expensive and laughably cumbersome way of selling furniture, finding a date, or doing anything else that you can now do easily, instantly, and for free on Craigslist.)

The unbundling of local newspapers was accompanied by a flourishing of innovation — pure-play sports websites, weather.com and its competitors, and news of all sorts covered in dozens of new ways.  To be sure, something valuable in local journalism has been lost.

So one question is whether legal innovators are poised to offer a vastly superior solution to just one stick in the Big Law bundle?  This alone will do nothing; it will have to be paired with a client’s willingness to force uncomfortable and unfavorable conditions upon their law firms, and the firms’ inability to resist.  If the 2020 crisis deepens, we might see some large clients willing to push this deep, and this hard. And likewise, and we could see firms with sufficiently soft economics that they allow it.

But it comes down to market power, and market power is all relative: the relationship of supply to demand.  Firms can easily reduce the total supply, normally on the back end of a particularly rough series of performance reviews across the firm.  The lawyers cut loose do not then become available in the market to do the work, as much of their value was in the tying arrangement with the rest of the firm. As a result, they’ll have limited success just hanging out a shingle to start engaging in complex regulatory, transactional, or litigation work.

So, will firms really lose enough market power that they will consent to unbundling?  I doubt it.

The market power flows from the fact that elite firms have demonstrated experience in unique and high-value areas of legal work.  That experience resides in a relatively small number of key players across the firm, paired with the rainmaking powers of an even smaller number of key partners.  Everyone else is expendable, so supply can (and does) easily constrict to meet demand and keep market power relatively high. Indeed, this explains why Kirkland’s lateral strategy has been so difficult to peer firms to counter, see, e.g., Miriam Rozen, “What Does Kirkland’s Lateral War Chest Buy? A Lot,” American Lawyer, Apr. 20, 2018, as they are reluctant to cross the cultural chasm of admitting the true market value of their most powerful rainmaking partners.

On this view, another implication is that the firm could consent to be unbundled while commanding nearly as much from the client for doing considerably less, a la the London QC barrister.  This is a sort of asset-light strategy that we haven’t seen any major firms pursue.  Perhaps the chaos of 2020 will have some firms or even free-floating practice groups dive into this sort of model in earnest.

Whatever happens, when a bundle is disrupted, it reveals what you’re really paying for.

Unbundling in the near future

In this final section, I’ll make some predictions about the near-future of unbundling, starting with higher ed — where we will have our answers in a matter of weeks — and then turning to law. We can date these predictions to late June of 2020, and we’ll know in a few months if I was right.

  • Current students at elite colleges, after making a great deal of noise about who should pay for what, will concede that they are paying big money for a credential and the rest is nice-to-have.  Most of them will pay up and get it over with.
  • The same goes for law and medical schools, where the bundle was never as comprehensive to begin with, and it is even clearer that students are paying for a credential from a legally mandated gatekeeper.  They will pay up.
  • Incoming Freshmen or 1Ls, finding themselves in a different bargaining position, may wisely choose to take a gap year or collect credits more cheaply, but young lives will not be put on hold forever, and again, the credential is the thing.  The schools will not lose their market power that fast.
  • Middle-market colleges and universities, however, have neither the market power nor the powerful credential: we will see unbundling, retreats to a la carte, a wide range of hasty innovation, and economic chaos in this broad middle-market.  Many weak schools will fail, and in the chaos the families who can afford it will go up-market, making the elite schools even more powerful than before.

I lay out these points relating to higher ed because they parallel what I believe will happen to Big Law.

  • All clients will keep existing matters exactly where they are: inside the full-service law firm bundle.  When we consider that the vast majority of client spending takes place on matters that originated 4-8 quarters ago, the immediate effects of 2020 will be minimal even if the world comes apart.
  • In some practice areas where only a few law firms can even purport to do the work — common in financial services and regulatory work — clients are as stuck with the status quo as law and medical students are.  Nothing will change because the relative market power will not change.
  • Clients initiating new major matters could choose to experiment with innovative approaches, particularly in the middle market.  Such clients might go with the AmLaw 200 rather than the AmLaw 20, and the talk in the market is that this rational move is now happening in earnest.  Disclosure and plug: AdvanceLaw is a former employer, they work with GCs to help facilitate better decisions of just this sort, and they are feeling the momentum right now.
  • The most vulnerable AmLaw 200 law firms, however, will not see work coming down from the AmLaw 20, and instead will see accelerated erosion from below as clients put further pressure on commodity work.  Unbundling will be a part of that, and these firms will struggle to keep the bundle intact.  As they retreat and shed staff, their lawyers will do less work in the bundle, collaborating instead with third-party innovators who perform legal and non-legal tasks more efficiently.

If all this happens, the remaining question is “Will this unbundled service suite move up-market, and how fast?”

In both law and higher ed, the effects will not be as immediate as doomsayers now claim.  Most university revenue does not come from the Freshman class. Likewise, legal matters take time to generate real revenue.  The performance of a firm in 2020 is largely a reflection of matter initiation in 2018 and 2019.  So the unbundling may come but look for an extended period of erosion lasting through 2025.