The essentially stagnant growth in demand for law firm services (as described above) – a condition that has more-or-less persisted for the past six years despite signs of strengthening in the economy as a whole – reflects to some extent a slow but ongoing erosion in the law firm percentage share of overall legal market spend. This in turn is evidence of a continuing segmentation of the market for legal and legal-related services, a segmentation that may over time adversely impact the financial performance of many law firms.

As we have noted in prior Reports, at least since the onset of the recession in 2008, law firm clients have increasingly demanded more efficiency, predictability, and cost effectiveness in the delivery of the legal services they purchase. In the main, however, law firms have been slow to respond to these demands, often addressing specific problems when raised by their clients but failing to become proactive in implementing the changes needed to genuinely meet their clients’ overall concerns. As a result, increasingly clients have chosen to “vote with their feet” by reducing the volume of work referred to outside counsel and by finding other more efficient and cost effective ways of meeting their legal needs. This trend continued to be evident during 2015.

Decline in Law Firm Share of Total Market

In recent years, law firms have lost “market share” of overall legal spend to corporate law departments (as a result of decisions by corporate general counsel to keep work “in house”) and to alternative service providers. In its 2015 Chief Legal Officer Survey of some 258 corporations, Altman Weil found that 51 percent of respondents reported increasing the internal budgets of their law departments, while only 25 percent reported decreased in-house spending. By contrast, 44 percent said they had decreased their outside counsel budgets, while 32 percent reported increasing them.

Significantly, every Altman Weil survey since 2011 has found more law departments decreasing their spend on outside law firms than increasing it. Looking forward, 40 percent of respondents indicated their intention to decrease their spend on outside counsel within the next twelve months, while only 20 percent predicted an increase.

At the same time, corporate clients have been increasing their spend on alternative service providers, also to the detriment of law firm market share. During 2015, 16 percent of the respondents to the Altman Weil CLO Survey reported that they had increased their budgets for such outside vendors. While such expenditures currently represent a relatively small portion of overall law department budgets – 6.1 percent in 2015 – the outside vendor slice is growing. In 2012, it accounted for only 3.9 percent of law department spending.

The increased market share of outside vendors reflects a proliferation of non-traditional providers of legal and legal-related services. Once regarded as an insignificant sliver of the overall legal market, such non-traditional providers have now established a firm foothold in several service areas once dominated exclusively by law firms. This market shift is documented in a lengthy report recently issued by the Center for WorkLife Law at the University of California, Hastings College of Law. In it, the authors identify five different models of new entities that are reshaping the delivery of legal services in certain segments of the market: (i) secondment firms that provide lawyers to work on a temporary or part-time basis in client organizations; (ii) law and business advice companies that combine legal advice with general business advice of the type traditionally provided by management consulting firms; (iii) law firm “accordion companies” that provide networks of trained and experienced lawyers to meet short-term staffing needs in law firms; (iv) virtual law firms and companies that typically drive down overhead by having attorneys work from their own homes; and (v) innovative law firms and companies that typically offer specialized services under special fee arrangements or service delivery models that differ significantly from traditional law firms. The report describes 44 such new model firms currently operating in the United States and Canada. While many of these organizations are relatively small, some are not. Axiom Law, for example, a law and business company based in New York with 14 offices worldwide, has over 1,200 employees. And Bliss Lawyers, a secondment firm based in Boston, has a national network of some 10,000 lawyers.

While many of the alternative service providers described above are focused on the lower, more commoditized end of the legal services market, some have successfully penetrated the higher end by offering highly experienced lawyers to assist in specialized areas of practice. This focus on specialized services is the same approach being taken by the large accounting firms. In the late 1990s, these firms attempted to diversify from auditing and tax services by expanding into both consulting and law. The foray into the legal market was temporarily cut short by the Enron scandal that took down Arthur Andersen and resulted in new regulatory restrictions like the Sarbanes-Oxley Act. Over the past decade, however, changes in the legal market have prompted the large accounting firms to move back in. As explained in a recent article in The Economist:

The recession following the 2008 financial crisis prompted businesses’ general counsels to rebel against the padded bills they get from the law firms they use. In the same decade, several countries passed laws opening up their legal industries. Britain and Australia authorised ‘multidisciplinary practices’ . . ., which let attorneys share profits, without restriction, with members of other professions.

So, the Big Four moved back in, buying small law firms, poaching partners from others and recruiting on campuses. With the flexibility to offer discounted, fixed fees, they started to win lots of corporate legal work. In recent years the quartet’s combined legal revenues have grown at double-digit rates.

In some jurisdictions, the accounting firms have actually acquired and control law firms, while in other places they have formed collaborations or offer legal-related services that do not constitute the formal practice of law. Their strategy has not been to offer a full range of legal services, but rather to focus on specialized services that complement the services their organizations already offer – e.g., immigration, labor and employment, compliance, commercial contracts, and due diligence activities. One consultant has estimated that, measured as a proportion of the combined revenues of the ten largest law firms in each country, the aggregate market penetration of the Big Four accounting firms into the legal market currently ranges from 4 percent in China and 6 percent in Britain to 20 percent in Germany and 30 percent in Spain.

The combined effect of all of these forces has been a slow but steady erosion of the market share controlled by traditional law firms. Not surprisingly, the erosion began at the lower end of the market with legal process outsourcing firms skimming off routine but lucrative document review and e-discovery functions. It has now spread, however, to more middle-market activities as alternative service providers have amassed networks of experienced lawyers to assist clients through secondment arrangements and have developed increasingly sophisticated software to streamline “pattern recognition” functions traditionally performed by lawyers (such as the drafting of standardized documents or the review and management of contracts). In some cases, the services of non-traditional providers – particularly highly qualified specialists – are being called upon in connection with the most important matters of corporate clients.

This is not to suggest, of course, that law firms are on the brink of extinction. Firms at the highest end of the market will always be sought out for critical bet-the-company work. And there remains a substantial market for firms that can provide highly professional and creative services to help clients navigate their way through difficult disputes, create new and innovative financing vehicles, or provide bench strength for handling a large and complex litigation or transaction. But the range of activities that only traditional law firms can undertake will continue to narrow as alternative service providers become more expansive in their capacities and as software development increases the automation of once heavily labor-intensive activities. To prosper in the newly segregated market, law firms will need to seriously address the inefficiencies and unnecessary costs that have become deeply embedded in the way most firms operate. As The Economist noted: “[L]aw firms that are sub-scale and inefficient risk ruin. The Walmarts and Amazons of professional services are at their gates, and the legal industry’s halting pace of creative destruction is set to accelerate as a result.”

 

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