Solving the Profitability Problem

Topics: Billing & Pricing, Business Development & Marketing Blog Posts, Client Relations, Corporate Legal, Legal Managed Services, Peer Monitor, Thomson Reuters

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While overall demand for legal services is increasing, the share of corporate legal department spend going to large law firms is declining. The recent Great Recession redefined the approach corporate counsel employ in allocating legal spend. Corporate legal departments got innovative by necessity—finding high value in specialty law firms, bringing more work in-house, and by “right-fitting” certain high-volume, process-oriented tasks to alternative legal services providers, like Pangea3, UnitedLex and Integreon. Today, even as the legal economy has improved, these cost-saving practices remain, creating a new normal in the legal industry. As pictured below, these non-traditional players have grown and reallocated a share of the legal spend.

The Problem: Market Competition Squeeze

With large firms competing for a smaller market share, it has become a buyer’s market. Firms are feeling the effect of rate pressure and many are becoming unable to profitably service their largest clients. Corporations with the greatest legal spend are able to use their buying power to keep rates nearly flat from year-to-year and to demand deep discounts and risk-shifting alternative fee arrangements from their outside firms. As a result, law firms have continued to see a decline in their realization rates. In fact, according to Peer Monitor data, billing realization fell from 93.5% to 86.7% over the 10-year period from the first quarter of 2005 through November 2014, while collected realization declined from 92.7% to 83.0% during the same period.

This is an observable reality. As law firms review their portfolios of clients, many firms can identify the classic unprofitable client, one that has locked in rates since 2012 and used the sheer size of its spend to refuse rate increases. Much of their work is done on a fixed-fee basis, and those fees also do not change much year-to-year. As a result, the firm sees rock-bottom margins and realization from this sizable client, but it cannot push back and risk losing the client altogether.

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Over the past 10 years, many large firms have responded to this mounting pressure by repeatedly discounting fees, struggling to slash their expenses (often sacrificing the very efficiencies that in-house counsel seek), and hiring alternative, lower priced timekeepers who invariably keep busy at the expense of unused partner and associate capacity—all in an attempt to hold onto their piece of the corporate legal spending pie. Ultimately, this can lead to the firm losing not only profits, but its top legal talent and largest clients.

The Solution: If You Can’t Beat Them…

So, in summary: corporate clients have been able to leverage this new economy to apply even greater rate pressure on law firms to control costs further. Giving rise to this new economy are three primary factors—specialty law firms, increased in-house capacity and alternative legal providers—which are eating into law firm market share.

Two of the factors applying this pressure are mostly beyond a law firm’s influence and control. Large law firms cannot do much to stop the flow of work to highly valuable, competitively priced smaller specialty firms. And large law firms have yet to compete with the efficiencies realized by law departments when they keep more work in-house.

But the story need not end there. The third market factor, alternative legal managed service providers, can be leveraged to improve law firm profitability. Consider the classic unprofitable client from earlier. Rather than risk losing the client or trimming margins even further, a law firm might consider reducing its overall cost of representation by limiting the relationship to high-value, profitable work that justifies their billing rates, and redirecting much of the repetitive, process-oriented project elements to a third party who is able to perform these tasks more efficiently and cost effectively.

For the firm, rather than committing substantial cost to meet these process-oriented needs (a fixed expense that may go unutilized between projects), it can instead adapt to the peaks and valleys of client demand. For the corporate client, the overall cost of representation decreases while the true value of its spend with the law firm increases. It is the rare win-win scenario.

By partnering with cost-efficient alternative services providers, firms can better serve their corporate clients by reducing their clients’ overall spend, increasing the quality of representations, and making clients more profitable for the firm. Perhaps most importantly, this realignment encourages lawyers to return to the true, high-value practice of law.

Edward Sohn, a Senior Director of Client Services with Thomson Reuters Legal Managed Services, and Sabrina Nordquist, a Legal Solutions Consultant with Thomson Reuters Legal Managed Services in Atlanta, are co-authors of this blog post.