CanaryCoalMineHyperbole aside, the legal industry is going through change and not handling it particularly well. Each year we get another crop of surveys telling us what the industry looks like, and the game is to piece together the bits of data and try to tell a story. This year is no different. So, I’m going to piece together some data from four sources and see if they tell any story: Altman Weil2015 Chief Legal Officer Survey,” Citi Private Bank’s Law Firm GroupReport on Financial Performance,” Process Excellence Network “Special Report: Aligning Strategy With OPEX To Drive Sustainable, Enterprise-Wide Transformation,” New York TimesGraying Firms Wrestle With Making Room For Younger Lawyers.”

Altman Weil 2015 Chief Legal Officer Survey

The 2015 Survey doesn’t deliver any earth-shaking news, but then again it doesn’t have to. It confirms some trends that say a lot about where corporate law departments are headed.

CLOs say they are undertaking efficiency initiatives. The two biggest initiatives say a lot more about what they aren’t doing. CLOs cite implementing technology and reorganizing internal resources as the biggest and most valuable initiatives. For some reason, I can’t shake the visual image of an automated process for rearranging chairs on the Titanic.

When compared to the efficiency initiatives other areas within corporations have taken and maintained for years or even decades, the initiatives within law departments seem small and meager. The reason why appears when we look a bit further.

Law departments are achieving their cost savings largely through bringing in-house work performed by large law firms, down streaming work to paralegals and other paraprofessionals, and sending bits and pieces out to low cost legal service providers. Put simply, law departments are playing a very strong game of labor arbitrage.

Why have a $500 per hour lawyer do work when a $250 per hour in house lawyer can do it? And then, why not move work from that $250 per hour lawyer to a $150 per hour paralegal. Of course, the next step is to move the work outside to a contract lawyer or LPO. As long as the general counsel can push labor costs lower, she can stay ahead of the budget curve. Without a single step towards efficiency, the cost savings can be significant. As the Survey reports,

“Forty-two percent of law departments report shifting work from law firms to in-house lawyer staff, and 34% are shifting work from in-house lawyers to department paralegals and other paraprofessionals. Twenty-five percent of law departments report using contract or temporary lawyers and 15% outsourced to no-law firm vendors to control costs.”

The Survey goes on to state that 68% of law departments are receiving fee discounts, 60% are using alternative or fixed fee arrangements, 39% are reducing the amount of work sent to law firms, and 32% switched to lower priced law firms. A whopping 91% of law departments are either increasing staff (38%) or staying the same (53%). Put all this together, and you get more work being done by lower cost service providers combined with clamping down on the amount spent on high hourly rate outside lawyers.

Citi Private Bank’s Report

What are these law department changes doing to the law firms? According to Citi, demand for large law firm services has slowed and expenses have increased. Citi is projecting that 2015 revenue and profit growth will fall short of 2014. The slowing demand matches with what the general counsel are saying: law departments are sending less work to their high hourly rate outside lawyers (though M&A and big litigation remained strong at the beginning of the year). On the expense side, law firms have been shifting work from lower cost associates to higher cost senior attorneys driving up compensation costs.

Dig a little deeper, and the numbers yield a richer story. Almost all of the revenue growth at the firms comes from rate increases. On the expense side, much of it is driven by compensation, in large part due to heavier reliance on more senior lawyers. Other data supports this trend. For example, the annual National Law Journal survey of large firm staffing shows that these firms increasingly are built from senior attorneys (income partners, senior counsel, etc.) with the associate ranks shrinking.

Process Excellence Network Special Report

Every other year, the Process Excellence Network publishes a report on the “state of the industry.” PEX is a network of professionals who run operational excellence programs. Process excellence is the broad category that includes lean thinking, Six Sigma, and many other improvement disciplines. The PEX survey is the most extensive look at what is going on globally, crossing industries and departments.

The 3rd Biennial Report, published in 2013, showed an increase in process improvement use by law departments. However, the 4th Biennial Report just published shows a substantial decrease. Other departments showing substantial decreases include customer service, call/customer contact center, finance, general business operations, and IT. R&D, distribution, manufacturing, and procurement show increases.

Overall, it is clear that operational excellence remains extremely strong in organizations with almost 40% planning to increase their operational excellence staffs in the coming year and about 30% planning to increase their budgets (with another 51% seeing flat budgets). While individual areas are up or down, the strength of operational excellence remains impressive. The question, then, is why law departments would decrease their emphasis on process excellence? I’ll address that question in my story.

New York Times Graying Firms

Let’s start with the punchline, citing the Altman WeilLaw Firms in Transition Survey,” “at nearly two-thirds of the biggest law firms, partners who are 60 and older control at least one-quarter of the firm’s revenue.” Boomers rule. They have reacted to declines in spending by corporations by cutting costs. But, as every corporate manager knows, you can’t cost cut your way to success.

Many firms are trying various strategies to break out of the pack, but the simple fact remains that those who have the most concentrated control of business and, therefore, the most power are lawyers within five to ten years of retiring. If you just came off a major recession and are trying to rebuild your retirement nest egg, and if you have about five years to do so, would you take a risk and significantly change your legal service delivery model? Probably not and that is what the data shows. In fact, the Altman Weil Chief Legal Officer Survey shows that general counsel rate law firms 3 out of 10 at seriousness about changing their service delivery model.

My Take On The Story

At first glance, you might think the story is that lean thinking has peaked in the legal industry and now is on the decline. Perhaps it didn’t take or lawyers found it just didn’t work for what they do. While that would be an easy story to tell, I think it would be wrong. In fact, I’ll go a bit further and say we should look at the numbers coming out and see the canary in the coal mine. They tell us we are on a wrong path that, without change, will lead to some unpleasant times ahead.

This is the story I see. The legal profession demographics mirror the demographics generally in society. We are part way through the cycle of baby boomers retiring (or at least reaching retirement age) and we still have the remainder to work through the system, the ones born from 1956 through 1965.

These boomers and their colleagues control the legal universe, for the most part.

As the boomers move towards retirement, they have little interest in taking what they perceive as risky steps to change a 150-year-old legal service delivery model. Clients may not be sending as much work to large law firms, but the firms aren’t cratering (slow to no growth and gradually increasing expenses don’t put a firm on the edge of failure).

In corporate halls, the graying population is a bit less pronounced, but not absent. General counsel, as with executives generally, tend to be younger on average than equity partners controlling large books of business in law firms. Still, general counsel tend to come from the larger firms and share the same risk avoidance gene as their outside counterparts. If there is a way to get where they need to go which requires less risk, they will gravitate to that approach.

For general counsel, that path of less resistance has been to push hard on the labor arbitrage model and ease up on efficiency initiatives that require more work. Consider that the average tenure for a general counsel at a large company is around seven years, and you can see why a general counsel may look for ways to get a “quick fix” on costs and let the future take care of itself.

A general counsel can lower her costs quickly by taking the following steps: (1) keep more work in-house, (2) push work from lawyers to paralegals to free up lawyer time for the work kept in house, (3) bring on lawyers at a much lower cost than using outside lawyers, and (4) sending some work outside to very low cost providers (contract attorneys and LPOs).

Without touching an efficiency program, the general counsel can significantly drive down costs-for a short period.

Next, add in a dollop of technology. All the other departments in the corporation are trading labor for tech, so the general counsel won’t face much resistance (assuming the costs are manageable) going that route. Since most law departments, like most law firms, are well behind on the technology curve even relatively simple technology can give a department’s efficiency measures a nice boost.

Contrast that approach with a meaningful efficiency program using an operational excellence methodology. The law department employees will be against change, the approach – while common in other areas of the company – will look strange to in-house clients, and there will be some small or non-existent successes mixed in with the large wins. A process excellence program requires sustained effort. Finally, you won’t get support from your outside lawyers and many of your peers will wonder why you took this path instead of the easier labor arbitrage path.

Clearly, a general counsel might think twice before going to process improvement.

All this makes sense, but this is why I think this labor arbitrage trend does not bode well for anyone. After an initial reduction in costs (which may take a few years to fully bake in to the law department’s operating model), the law department will see the savings plateau. The law department’s headcount will have increased, and the CEO and CFO will start asking why the company has so many lawyers and other paraprofessionals. If you don’t think this will happen, check with your colleagues in IT and HR. They saw this happen many years ago.

The general counsel will be in a difficult position. She will need to increase productivity, but she won’t have the option of simply reducing hourly labor costs. One approach could be technology. But, having failed to embrace technology much earlier, the general counsel will be playing a game of catch up. In the meantime, the market will have moved ahead with combinations of technology and other service providers who can address the legal needs of corporations. Check with the Big Four accounting firms as this is where they are headed. Or, talk to the Bulgarian company I spoke to earlier this year. They already provide this type of service in Europe and are looking at entering the US market.

Law departments will start shedding lawyers. The timing won’t be pleasant for many of these lawyers, who will have reached the mid-point of their careers. Other companies won’t be hiring, leaving those newly disenfranchised lawyers with fewer job options. At the same time, many predict that once the baby boomers retire from the law firms, many firms will have difficulty continuing on. Millennials will have command of the workforce (75% of it by 2020) and won’t be interested in using high hourly rate outside counsel for legal work.

The combination of in-house downsizing and law firm splintering (as The New York Times called it), could be an ugly one-two punch.

We do have a canary in the coal mine. Instead of overlying on labor arbitrage, we could transition to more efficient law firm and law department operations using process excellence methodologies. This would reduce operating costs while at the same time allowing attorneys to re-tool their practices to more strategic focused, valued-added work. It will take more effort and foresight. But, combined with efforts such as legal predictive analytics, could yield much better outcomes for clients. Of course, then we would have to decide that practicing law is about our clients and not about us, another topic for another post.

From the Editor: SeytLines will be taking a holiday on November 26th. The next post will be on December 3rd.