I get a lot of questions about legal market data. Today I attempt to explain one of the most frequently asked questions: why demand and pricing seem to be uniquely uncoupled in legal markets.
By and large, 2021 was a year of anticlimactic letdowns. In a sloggy, tiresome, gradual sort of way, most of us realized that the ravages of COVID would not be defeated in one fell swoop.
One exception has been the trade news coverage on Big Law’s bonanza. In August, Thomson Reuters Peer Monitor rated Q2 of 2021 a record-breaking quarter in its proprietary index of law firm performance. (Notwithstanding the battery of disclaimers and historical context provided in the fine print, many industry observers decided that this misleading picture is indeed worth a thousand explanatory words.)
The context (given but largely lost) is that Q2 of 2020 was a historical anomaly. As taken against 2019 levels, law firm performance through the first half of 2021 simply represents a recovery to pre-pandemic levels. By the end of Q3, the PMI is firmly back within business-as-usual ranges as associate compensation increases dampen profitability:
If a “back to normal” narrative feels unsatisfying here (and it probably does), that perhaps helps explain how we arrive at the dominant storyline of 2021: 🔫 THE! 💰 WAR! 💸 FOR! 🤑 TALENT!! 💣
(That Big Law is at its core still a people business is a nuance that is often lost. In my view, legal talent is a worthy topic that merits more ink. That said, I suspect much of the commentary will overindex on how and where the money is flowing, so I will offer a contrarian view in Part II of this #BadData series.)
But the main course today is a discourse on #BadData as it relates to demand. I dig a little deeper than is customary into the Peer Monitor Index and the underlying metrics that drive it: demand, productivity, rates, and expenses. Along the way, we will encounter some of the oldest riddles about the legal markets and why they seem to behave without reference to the laws of economics.
💁🏻 Flashback to Econ 101 🎓
For the unfamiliar, here’s the shortest explanation I can manage on price elasticity of demand. For those of you who remember the basics, I’d still ask you to bear with me, because I promise this discussion will be relevant to our examination of legal markets in 2021.
In classic microeconomics, “demand” represents the total quantity of goods consumers are able and willing to purchase at a given price. It is this tight coupling between price and sales volume that makes demand a critical consideration for strategists and marketers. The apparent absence of this coupling fuels a considerable level of client complaints every year when law firms raise their rates (and it is always good fodder for #LawTwitter to decry the irrationality of legal markets).
Where the y axis represents price and the x axis represents quantity, a steep downward slope indicates that a good or service is relatively price-inelastic: essentially, material increases or decreases in price translate to relatively smaller changes in quantity sold, meaning price is less (or even not at all) important in the decision to purchase. Conversely, a shallow downward slope indicates that a good or service is more price-elastic, where relatively small changes in price can lead to significant swings in quantity sold, meaning price is more (and possibly very) important in the purchase decision.
🥳 Fun Examples of How Demand Actually Works
🧂 The classic (ancient?) example of a price inelastic good is salt. ⛽ A modern day example would be gasoline. Both these goods are price inelastic for similar reasons: they are considered necessities to current buyers and there are no great substitutes. 🚬 Tobacco and drugs 💊 are also price-inelastic, because they are addictive.
Most luxury goods are price elastic, because they are categorized as discretionary rather than necessary purchases. There are counterintuitive exceptions, such as the lipstick effect: during downturns, like the one we are in, consumers who can no longer afford big-ticket purchases, such as new cars, will still allocate some of their limited dollars to small indulgences, like brand name lipstick.
What 💄 Lipsticks & Cars 🚗 Can Teach Us About 2021
The lipstick effect is a worthwhile tangent because it illustrates very clearly how brand equity plays out in real markets. Brand equity can be measured by the price premium a brand can command for its products as against a generic competitor.
- Today, a tube of Revlon or Cover Girl lipstick can be had for about $4 to $7. Chanel’s core line of lipsticks goes for $45 a pop, meaning that Chanel’s brand premium in the beauty category is about 8x to 9x the mass market brands.
- Among mid-size SUVs, the Kia Sorento is probably a good bargain pick, with 2022 MSRP ranging from $29,500 to $34,500. The Volvo XC90 ranges from $49,900 to $70,600 and a Porsche Cayenne will start at $67,600, but with performance and hybrid options the sticker price pushes all the way up to $165,000. Suffice to say the brand equity for Porsche is something around the 4x neighborhood.
The lipstick effect reminds us that absolute dollars absolutely matter.
- For a relatively small item like a lipstick, Chanel’s 8x premium only comes out to $40. In about two decades of wearing lipstick, I have never seen Chanel lipstick on sale (although Chanel, like all prestige brands, will deploy bundling as a pricing strategy, often around some holiday, to offer gift sets that seem like a bargain). But that brand equity – and the competitive strategy – holds across all of Chanel’s categories: beauty & fragrance, fashion & accessories, watches & fine jewelry. Since the pandemic began, Chanel has continued its policy of raising prices once or twice a year. In its accessories category, Chanel’s most recent price hikes ranged from 11% to 16% for its most iconic (most popular) handbags, which now range from $8,000 to $10,000. Strategically, this puts Chanel within striking distance of the Hermes price bracket. At mid-year, Chanel forecasted double digit sales growth as compared to 2019. (Incidentally, did you know that Kirkland sometimes raises their rates twice in one year?)
- For a big-ticket purchase like a car, even a 2x premium is a much tougher pill to swallow, even when the economy is booming. This explains why luxury cars are relatively price elastic, and why local dealers will flex down from the MSRP at the end of slow years to move sluggish inventory off their lots. (Of course, this isn’t happening in 2021 or in 2022 because the number of consumers rediscovering their love of mobility after sheltering in place and the supply chain disruptions arising from the pandemic have resulted in demand far outstripping the available supply.)
🆘 Urgency (Must-Have Now) vs 🎈 Luxury (Nice-to-Have, Whenever), Plus ⛓️ Captive Markets
Cars also make for a good illustration of what makes a purchase “discretionary.” Most people who live in suburbs would consider their car a necessity, and indeed, economists would classify gasoline as necessary for those same consumers.
- Urgency is a situational but material factor in whether purchases are necessary or discretionary. If your car is running but you’d like a nicer ride, that’s a discretionary purchase that can wait. If your car is so old and broken down that it’s only good for the scrap yard and you need a vehicle to get to work, you’re subject to the current supply crunch of a slightly insane car market.
- If you own an otherwise perfectly satisfactory car that guzzles gas at 21 miles per gallon, you’re likely not happy about gas prices ranging from $4 to $5 per gallon – but you’d be part of what we call a captive market for add-ons. You could consider a change to a hybrid or electric vehicle to reduce your add-on spend, if you have the cash to upgrade in a buyer-unfavorable market. Another example of a widely-abhorred add-on that held markets captive were the brand-proprietary ink cartridges for home and office printers. In both cases, savvy consumers need to consider the entire cost of consumption at point of purchase (most people don’t).
Legal Market Demand: We Keep Using This Word 🤔
The questions I get most often about legal services demand are below, along with my short answers. (I’ll give some longer answers below, but I’ve decided to stop burying the lede.)
- Is it actually flat, or up, or down? It’s up. Like, a lot. (See Posts 216, 218 for extensive detail on the silent explosion of demand; also see Post 277 where Jason Barnwell discusses the imperative to industrialize legal evolution.)
- If demand was flat for most of the Great Recession, how can law firms raise rates every year? It wasn’t, and because they should. In nearly every plausible scenario, a decision for a firm to hold rack rates flat in any year is a decision to forfeit. (Oh yeah. Shots fired. I said it, and I’ll defend it… but not in this post.)
- If clients have more available substitutes like insourcing or ALSPs, doesn’t that mean we are in a buyer’s market where clients have more power? Yes, but with so many caveats that my answer is not really. Clients who avail themselves of substitutes certainly have more bargaining power, because they have demonstrated the willingness to walk away and because the hard work of sourcing and vetting alternative options gives them a fairly in-depth understanding of which parts of their legal spend wallet actually have viable substitutes and which do not. These clients also understand with some specificity the switching costs (political as well as financial) involved in such a transition.
Underlying all these questions are more fundamental but nebulous questions. 😒 Why doesn’t the legal market make sense? 🤔 Why doesn’t it work like other markets? 😖 Why doesn’t it obey the laws of economics? 😠
There are no short answers to those questions, but here’s my best attempt. I usually operate on the assumption that the legal market probably does work pretty much like every other market. I’m not going to prove it today (not with numbers at least), but I’ve generally found that the legal market makes as much sense as any other market. And as the lipstick and car examples above show, the laws of economics are more like patterns that are subject to a number of situational variables (although eminently sensible and tractable, there are a lot of these variables in play in any market… including legal markets).
But the trouble is mostly that we have #BadData. And we have bad data because (a) we keep not collecting the data we would need for useful stuff (😰 because it would be so much work!); (b) we keep collecting the sorta-useless data we’ve been collecting for years (😜 because we need it to make historical comparisons that aren’t all that meaningful or reliable!); (c) we call our data stuff it isn’t (🙄 we’ll get to this in a minute).
⏲️ What Do We Count When We Talk About Demand in Legal Markets?
In legal markets, “demand” is measured by the total billable hours worked by all timekeepers in a given period. As reported by Thomson Reuters and Citi-Hildebrandt, “demand” tallies up every billable hour worked by every junior associates and senior partner in their sampling pool. Usually, the total is not reported, as both TR and Citi prefer to report on percentage change of this measure, typically comparisons to the previous year (although this year, I expect to see comparisons to 2019 as well as 2020).
At first blush, this seems like an okay proxy measure for “sales volume” as used in classic microeconomics, but it’s really, really not. (Not even close.)
The way we measure demand in legal services would be akin to the following
- Adding up all of the hours spent by all of the engineers, mechanics, and factory workers to manufacture cars each year;
- Ignoring any defective cars that were partially built then discarded;
- Ignoring surplus cars made but not sold;
- Ignoring all variations from manufacturer to manufacture arising from differing procedures or equipment used;
- Comparing the total hours year-over-year;
- Using those comparisons to project whether demand for cars went up or down.
But let me give some disclaimers. Both TR and Citi work with enough firms that their sample size is good. Within the parameters of their research, they can only work with the data those law firms collect. They both publish some of the longest running analyses and commentaries on legal markets and in so doing perform a valuable service.
The fact remains, however, that most analyses of legal market economics lack fidelity and leave a lot of room for misinterpretation. Here are the main reasons we are #DOINGITWRONG when talking about legal services demand:
- Hours ≠ the units clients buy.
- Rates ≠ the price clients pay.
- Leverage matters (like… a LOT).
- “Legal market” isn’t one market, because “legal services” isn’t one product.
- Law practices, once defined and sorted into a tractable list, follow a product lifecycle, pretty much like any other good or service.
🤦🏻 Hours ≠ the Units Clients Buy & Rates ≠ the Price Clients Pay 🙅🏻♀️
Equating total billable hours to total units sold would be illogical (🖖) if one gave the slightest thought to how the purchasing decisions actually happen in legal services. Notwithstanding the volumes that have been written about the many iniquities of the billable hour, the time-and-materials model simply describes how clients are charged, not what and how they buy.
How Lipsticks & Cars Shed Light on Legal Buy Mechanics
Most corporate clients hire outside counsel to fulfill two rough but distinct enough needs: (a) in episodic mandates when extraordinary events occur and specialist expertise is required or (b) in flow-oriented engagements to obtain advice, counsel, or representation, typically to support business-as-usual operating activities.
The widely-decried but persistently industry-wide practice of agreeing to a schedule of hourly rates is one of mutual convenience, particularly for the benefit of buyers at scale (large- and mega-cap corporations). One consequence of this practice is that it has allowed inside counsel to avoid the inconvenient and enormously daunting task of finding out the exact composition of the latter BAU bucket. Increasingly, corporate law departments have put in place convergence programs or preferred provider panels to rationalize their loooong list of legal service providers. An immediate benefit has been to get volume discounts and rate freezes on this very large and very mixed bag of legal matters. Through the Great Recession, those discounts and rate freezes have been powerful enough levers for corporate counsel to respond to the ever increasing scrutiny on overall legal spend and their performance as stewards of corporate resources.
But corporate clients pay for this shortcut in other ways:
- For any company that spent roughly $50m in this bucket in 2021, most leaders of the legal function would be hard pressed to discern with any degree of precision how much of that spend is truly necessary or discretionary, nor how much of it is truly urgent now or could be deferred to a later budget period without introducing net-new risks or expense to the company’s financial and strategic objectives. (A bit more on this question of timing, later.)
- And for the companies that are a bit further along on the convergence journey, some are learning that spend consolidation often creates bilateral buyer-supplier dependencies, with switching costs getting higher as preferred panel firms become entrenched. Thus, the realities of managing millions in legal spend make the theoretical question of bargaining power a bit trickier and more nuanced than they might seem on a Porter’s Five Forces map.
Consider again the lipstick example. For a given household, the largest ticket expenses are usually housing, healthcare & insurance, and transportation. Although food & personal spending do add up to significant categories, it would be a rare marriage that survives the minute scrutiny of <$50 purchases whether these purchases are lipsticks, baseball cards, XBox Live credits, Jo Malone candles (4x the price of Trader Joe’s) or Jeni’s Splendid Ice Cream Pints (>2x the price of Ben & Jerry’s). It is easier for a family to apply rigor when shopping for a mortgage or a lease, choosing a health care plan, or selecting a car. In the bucket of episodic mandates, the typical Fortune 500 company probably sees a reasonably small enough number in a given year to apply greater rigor than in the intractable BAU bucket.
The Cream Rises to the Top (But It’s Clients Who Must Separate the Cream from the Milk)
For the biggest deals and biggest cases, we see the price inelasticity every Big Law partner dreams about — but in reality, only a few firms benefit. Even sophisticated general counsel with mature panel programs usually put a lineup of the heaviest-hitting firms through their RFP paces, sometimes in front of the board, in a theoretical search for the best counsel money can buy. This is a prudent thing to do, but is more often an exercise in the politics of limiting personal exposure rather than a signal of true rigor in the selection process. These mandates often go to one of the usual suspects in a well-documented flight to reputation as a poor proxy for quality (or arguably depth of relevant experience as a better proxy for quality).
Cravath and Wachtell are easy historical examples, but Davis Polk, Paul Weiss, and Kirkland are probably the ones to beat in this category now, along with a roster of sector specialists with regulatory depth in areas that have a strong tech or life sci bent. There’s no real question as to whether these A-list firms are the best qualified, but there are at least two fair questions to ask. The first would be whether the mandate at hand really merits a “price is no object” buying approach; another would be whether their quality differential merits the price differential relative to the many firms in the next price bracket. Both questions remain firmly within the domain of inside counsel.
AFAs Can (but Often Don’t) Change the Game
For relatively but not ridiculously big deals and big cases, the combined efforts of ACC and CLOC have established sufficient expectation that law firms should establish a budget that is reasonable for the given scope, along with a plausible theory of budgeted hours and staffing mix attached to each phase of work. However, law departments and law firms alike have been famously bad at the shared challenges of defining scope, communicating when that scope changes, and executing on the established plan.
It is, of course, much simpler for clients to ask for an actual price, which is a dollar amount attached to the service being sold. For many M&A transactions and litigation mandates that fall short of the much-coveted “bet the company, price is no object” designation, this is indeed what should happen (and in 2021, it increasingly does happen). One externality of this shift is that law firms take on the fee risk of getting the fixed fee quote wrong. This might explain why Citi-Hildebrandt reports that over two-thirds of law firms plan to increase their roster of pricing specialists, making them the hottest staff hires in the law firm game.
One unintended and non-obvious consequence for clients in the wider adoption of fixed fees is that they will take on the quality risk of hiring the cheapest option. This is why value-conscious clients should take at least a cursory interest in which law firms are simply giving deep discounts or which are seriously investing in true efficiency drivers across staffing mix; best practices in KM and LPM; and holistic adoption of best-in-breed practice technology that is truly to integrated into a redesigned approach to production (rather than as bolt-on showpieces).
A Timely Sidebar on the Peak Load Problem
While we are on the topic of shifting financial risk from client budgets to law firm balance sheets… Some of the demand surge we are seeing in 2021 is a depiction of legal markets functioning as they should. In April of 2020, most clients put on ice or slowed way down nearly all legal work that wasn’t mission-critical, and some of them asked for deep extraordinary discounts to the work that did go forward.
In doing so, clients exercised their prerogative to shift a considerable share of liquidity risk to their outside counsel, who mostly operate on a cash basis, during a time when liquidity concerns were widespread in every market. I point this out only because it is a rare and clear illustration of what I’ve called the “peak load problem” and its attendant economics.
- Through the uncertainty of 2020, most law firms absorbed these risks and turned to austerity measures to manage the potential hit to their cash flow (at times to a chorus of criticism and charges of greed).
- Fast forward to a quicker-than-expected economic recovery, many companies got more acquisitive and rushed to avail themselves of new M&A opportunities in the market, which served to further heat up an M&A recovery that would have been hot enough from the pent-up 2020 deal pipeline.
- This all set up the current stampede of associate bonuses, compensation adjustments, and other means to stem the bleed of associate burnout and churn.
- The abrupt shifts in M&A deal flow is a perfect illustration of the peak load problem and clients’ role in creating short run fluctuations in demand. In the short run, clients who really wanted to get deals done in 2021 did (begrudgingly or otherwise) pay premiums just as law firms are now handling out plum bonuses and raises to the associates who grind most of the hours on these matters. In 2022, I expect those pricing premiums to hold for deal work, at least until deal volume wanes again to somewhat normal levels.
The crux of the peak load problem is that this type of volatility risk is always priced into law firm rates. Law firms manage recruitment, training, utilization and payroll for a dizzying array of specialist capabilities, and they take on the financial risks of matching that supply to uncertain demand, year in and year out. This is another reason that head-to-head cost comparisons of inside and outside counsel are unhelpful and misleading.
The M&A associate supply crunch also reminds us that as much as we generalize about lawyers, not all lawyers are fungible. It does take 4 years to make a 4th year deal lawyer; you can’t take 4th year litigators, drop them into complex deals, and expect everything to go swimmingly (although in time, certainly lawyers can cross over into other practice areas). When legal markets are defined properly and on timelines that matter to clients, supply turns out to be much more fixed, particularly when demand proves to be much more volatile and fluid than expected.
Leverage Matters (a LOT)
Typically, inside counsel are tasked with holding last year’s dollar spend flat, reducing it by x%, or limiting its increase to y%. At the end of the day, clients care more about the dollars they spend in the aggregate and less so about the total number of hours it took a given firm to finish the job they were given.
On the hourly rate model (as well as the many AFA models that are simply hourly rates in drag), the actual price for a tranche of work is a function of three inputs: (a) rates; (b) hours; and (c) leverage. Productivity leverage is a ratio of non-partner hours to partner hours worked to complete a given tranche of work, and it remains the most underrated driver of the final price paid by clients on episodic mandates still transacted on the billable hour. Further, leverage patterns give a much more telling picture of each firm’s perspectives on what results in the best outcomes on a per-matter basis as well as in the training and development of associates. Clients who select firms simply on rate levels are not truly value-conscious shoppers, and any law firm that is not actively monitoring and managing all three has no real controls in place for quality, consistency, or profitability.
For the sake of simplicity, let’s compare two hypothetical firms submitting blended rates for an M&A matter. Which seems more expensive?
|Firm A||Firm B|
If you said Firm A, you’d be right…. by about 5% or so on a $150,000 price level. The rate structure of each firm would probably imply Firm A is more aggressively pedigreed; the white-glove partner-heavy model is one more favored by the Second Hundred. The question of which approach is always, often, or necessarily superior is beyond the scope of this discussion, but my point remains that Firm A isn’t always, often, or necessarily that much more expensive than Firm B.
It’s for this reason that I think the current trajectory of client-side procurement and pricing roles are likely to have limited and sometimes adverse impact on the value conversation. Some of biggest of the Big Banks, Big Oil, Big Pharma, and Big Tech companies deploy buying tactics that further uncouple rate-setting exercises from meaningful examination of what work is needed by the corporation and which suppliers actually offer a unique or at least superior value proposition. I have no doubt such tactics are effective in near-term efforts for spend reduction. However, price sensitivity does not always lead to buying practices that are value-discerning or value-conscious.
Hot takes that paint all law firms or all lawyers with the same broad brush get lots of clicks, especially in a news cycle about rate or compensation hikes. As much as it might feel true to think all of Big Law is inefficient or all Big Law partners are overpaid, reductive views often mislead in serious ways.
“Legal Market” Isn’t One Market, Because “Legal Services” Isn’t One Product
In a fond flashback to my very first post on Legal Evolution (Post 51), the graphic below tells a story that isn’t often made clear in our annual review of law firm performance. Market-wide rollups make for good headlines because they are simple. In these instances, we often oversimplify to the point of misrepresentation whenever we combine a wide variety of things that are not very much alike.
In most years, TR and Citi both include some level of practice area splits when reporting or forecasting demand changes. This level of granularity is helpful but falls far short of providing a meaningful representation of the lived experiences of those who buy and sell legal services for a living.
Gravity Is Unrelenting & Most Forces in Most Markets Push Prices Down
In 2022, no law firm paying tier-1 or 2 market salaries with Class A office space overhead seriously expects to turn a profit on corporate entity management or small box leasing. Nevertheless, they each hide in large buckets of “Corporate” and “Real Estate” work where demand is said to be soaring this year. The market for SPAC IPOs and takeovers is a distinct one in every meaningful way from corporate entity management. In most cases, these markets have different economic buyers, even within one legal department, and the agreed rate levels should and likely do reflect material differences. However, billable hours worked on both types of matters are commingled under an over-large practice umbrella, simply because both types of work are done by lawyers who think of themselves as corporate lawyers.
The legal industry’s penchant for lawyer-centric organization of its services on offer also serves to obscure the nature and value profile of the work being bought and sold. Counter to the prevailing narrative that this opacity in legal markets serves the sell-side artisan guild at the expense of corporate clients, I actually believe it hurts both buyer and seller of legal services.
Pockets of similarly commoditized work reside in every single practice area. A handful of firms have built the centralized utilities like captive ALSPs to handle high-volume work conducive to standardization, leaning more intensively on process and technology to lean out the costs. However, many law firms still provide these services at deep discounts and likely at cost if not at a loss. Some firms do so on a hopeful theory that attractive pricing and superior quality on low-level mandates will nurture the coveted “institutional relationship” that will provide access to more price-inelastic mandates of higher consequence. (In theory, this makes sense, particularly in response to buy-side convergence efforts. In practice, it is a tough needle to thread, requiring an extraordinary level of coordination in a firm’s business development and relationship management as well as a collaborative culture underpinned by a well-designed compensation scheme.)
Other firms simply lack the internal financial and operating controls or the governance structures required for intentional selection of clients and mandates, especially where individual partners are incentivized to bring in as much revenue as possible without regard to price sensitivity or profitability potential. (One tragic second-order impact of these dynamics can be seen in the novella-length bios of some Big Law partners who join every task force and specialty team fielded by the firm. I once saw a partner bio that listed 23 distinct practice areas, from which I concluded that he could not possibly be a serious practitioner in any of them.)
Our Long Data Nightmare Has an Obvious Fix… but Obvious ≠ Simple and Simple ≠ Easy
In our #BadData nightmare, we are persistently stuck pricing the practitioner rather than the work. This is a shared problem with a shared legacy of responsibility. In the current state of play, most corporate clients lack a data-informed command of their legal spend wallet. Without clients making clear decisions on how much and which part of their wallet is necessary versus discretionary, most law firms lack concrete incentives to sharpen their strategic thinking about what kind of business they want to run and what type of brand equity they will pursue. As a result, most law firms languish in the muddy middle of simply wishing to become the type of firm entrusted with price-inelastic work, but without the boldness required to establish and defend such a strategic position. (After all, it takes some chutzpah to charge $45 for lipstick when lipstick can be had for as low as $1, and one has to be resolute as well as bold to hike a $7,500 price 15% for a handbag during a global economic downturn.)
What is sorely needed in the legal industry is some level of standardization in the service catalog, deployed in tractable codesets across client-side e-billing and matter management systems and firm-side finance stacks with some attention to interoperability. SALI are working on this and their work is very promising. The optimist in me believes this will happen in time, but the realist in me knows it will be a long, long time (perhaps in a galaxy far, far away), primarily on the basis that I know financial systems implementations and codeset normalization remain among the most painful and politically costly exercises for law departments and law firms alike.
In the meantime, both buyer and seller are stuck in an annual ritual of rack rate kabuki. In the pricing arena, I’ll venture two specific predictions:
- In 2022, most law firms will push hard for double-digit rack rate increases.
- Within three years, I expect clients to push market rate discounts on preferred panel programs from 15% to 20%.
(Happy Hunger Games! May the odds be ever in your favor.)
Law Practices Are Subject to the Product Lifecycle, Like Any Other Good
So what else is likely to actually happen to legal markets in the near future? The easiest prediction of all: 30 to 40 firms will position themselves to win the next decade by beating the pack to the pockets of demand growth. Of these pockets of demand growth, a few will turn into lasting cash cows that will cement the next generation of leading firms.
In Post 071, Bill summarizes Patrick McKenna’s practice lifecycle model, which posits the following:
“Legal work moves along a time continuum that starts with lawyers building relatively lucrative practices by becoming experts in difficult and emerging areas of law. Yet, at some point a substantial portion of that practice area becomes relatively mature. Notwithstanding one’s level of mastery, the market is filled with other lawyers with a similarly deep skill set. As demand flattens and starts to decline, what was once a cutting-edge area of practice becomes a commodity.”
McKenna’s model takes for granted a key observation that eludes most legal market observers: competition for demand happens at the practice level. While Kirkland gets a lot of ink and might come first to mind as dominant global elite firm, Davis Polk probably rules the roost when it comes to high-end financial regulation and Covington may field a stronger life sciences bench. When clients identify a heretofore unanticipated need for super-elite outside counsel, they are rarely searching their mental hard drives “for the best global firm.” It’s far more likely that a bank might run afoul of the SEC or a big pharma company is staring down the barrel of a prolonged tussle with FDA, in each case, Davis Polk and Covington would likely be ahead of Kirkland in getting the coveted first call.
Financial regulation and securities litigation were two examples of “mature” practices McKenna gave in 2018. I like this pairing because the juxtaposition gives a sense of range in length of the practice lifecycle as well as the potential range in price elasticity. Many factors shape how long a practice can stay tony enough to command price premiums, but two controlling variables are:
- Business value at stake for the client in a typical matter
- Availability of truly viable law firms with must-have expertise and experience
Bill added the key insight that innovation works differently in different stages of the cycle, noting that much of the innovation talk in the legal industry overindexed on efforts to improve quality, cost & delivery of established legal solutions. (I’d add a note that the Type 1 innovation lever identified by Bill exists primarily to prolong the timeline for law firms to harvest profits from stagnating and price-pressured service lines. In essence, Type 1 innovation works by tinkering with the cost structure of these service lines to keep them economically viable on a traditional law firm platform. This can work but it is not easy; law firms could also exit those practice areas, but that is not easy either.)
In contrast, Type 0 innovation requires lawyers to scan the horizon and apply their legal expertise to changing PEST conditions. In early stages, Type 0 innovation is mostly about opportunity spotting and in that sense I agree with Bill that “[v]irtually any lawyer has the intellectual tools to do it.” But for conceptual opportunities to turn into sizable new businesses, other intellectual tools are needed: market sizing, business modeling, strategic alignment, landscape analysis, go-to-market design, and most importantly financial modeling. (On that basis, I can’t agree with Bill that this exercise requires “zero additional training.” As my friend and colleague Casey Flaherty once said, “modern law is a team sport,” and I’d argue that Type 0 innovation requires a firm to field a fairly strong business team across strategy, competitive intelligence, practice development, practice operations, marketing & business development.)
As examples of emerging practice niches, Bill cited “synthetic biology” and “virtual reality” in 2018. Fast forward 3 years, and I think both are on the cusp of crossing over into the growth phase.
- Genome editing pioneer CRISPR is currently trading at $73. Research in this area continues to push forward with many potential applications, particularly in food production and pest control, with knock-on R&D advancements in nanotechnology required to refine editing techniques. (Among law firms, Goodwin Procter is one of the winners of the race here, handling CRISPR’s 2016 IPO and follow-on offerings.)
- Facebook’s recent rebrand into a “metaverse” company has given some concrete shape to what work and life might look like in a VR-enabled world. Cooley is a likely frontrunner in this race, but expect a stampede of law firms into this area in short order.
The graphic below reproduces McKenna’s model, which charts a typical product lifecycle demand curve across 4 stages: emerging, growth, maturity & saturation. I’ve added some notes at the points of inflection as to what usually happens on the supply side as well as a second curve that roughly represents the availability of price premiums.
In 2021, I’d include weed and SPACs as growth practices, although with very different market sizes and competitive landscapes, although both are likely to garner wide attention across Big Law in the next couple of years. For the absence of doubt, SPACs are a much bigger market with orders of magnitude greater scope and scale for high-end law practices serving the types of strategically attractive clients who make their own living by moving huge sums of money around.
To the surprise of no one, five firms have gotten the drop on everyone else for SPAC takeovers: Kirkland, Latham, Weil, Skadden, and Davis Polk. with Kirkland, Latham and Skadden edging out on deal count but Weil and Davis Polk with the edge on larger deals. Notably, Kirkland, Latham, and White & Case all have 100+ SPAC IPOs under their belt, suggesting that IPO capabilities and an eye for emerging opportunities converged to establish early mover advantage to build strong SPAC M&A pipelines. (Burnett, Grace, “Top SPAC M&A Legal Advisers Led by Kirkland and Latham,” Bloomberg Law, April 1, 2021).
What Does “Better” Look Like for Big Law in 2022?
I’ve said more than once on Legal Evolution and elsewhere that bigger isn’t better, better is better. (I am compelled to mention it once again because the TR and Citi annual reports almost always suggest that bigger firms are faring better in demand generation, which many readers take to mean that bigger is better.)
But what does “better” look like?
The above examples should give a sense of what it means for firms to be “better” at the opportunity spotting and go-to-market that comprise the crux of law firm strategy. These firms face better odds for greater pipeline stability and profitable revenue growth (and very likely a more favorable position in the lateral market as a result of superior financial results).
Does all that really make a firm “better”? It depends on your definition and your point of view. Next time on #BadData, we’ll take a look at the lineup of law firm performance metrics to make sense of what’s happening to the law firm as a workplace and career platform. Yes, that includes associate and partner compensation.
🙏 Thanks for reading (as always) and see you next time… in 2022. 🎊