Innovation in the legal services industry is frequently driven by client demand. Over the years, large corporate clients, in particular, have had a substantial impact on the way law firms handle core matters, such as billing and staffing. Recently, large clients have established new varieties of financial and practical requirements that legal service providers must meet to ensure continued patronage.
Industry observers point to a number of areas where clients have had an impact, including stratification of legal services, changes to billing structures, and service level agreements. The State of the Legal Profession symposium discussed these and other issues impacting the legal profession on Friday, April 18, 2008 at Stanford Law School.
Stratification of Legal Services
The stratification of legal services is one example of client-driven innovation. Compelled by clients' budget and profitability concerns, contemporary legal services have been differentiated into three distinct types of matters:
- "Outsourceable" matters, such as document review and standard contracts.
- "Running the Business" matters that are deeply ingrained into how businesses work, like intellectual property, compliance and employment issues.
- "Betting the Business" matters that are critical to the success of the company, such as antitrust or securities litigation, bankruptcy, or IPO.
This hierarchy has an implicit value attribution, whereby matters that can be outsourced have a lower value, because, arguably, they can be performed by anyone with fundamental legal training. Clients therefore expect these kinds of legal services to cost the least out of the different layers of service.
At the top of the hierarchy, Betting the Business matters include not only major transactions and litigation, but also knowledge of how to work government agencies or understanding how a case will be positioned in the media. Consequently, these services are priced in accordance with the perceived value. As Gordon Davidson, Partner and Chairman of Fenwick & West LLP remarked, clients are willing to pay law firms top dollar for "narrow expertise borne out of years of experience."
Mark Chandler of Cisco Systems, Inc. noted that in every industry, including legal services, the cost model (what is paid for a service) and the value model (the value provided by that service) have to be mutual. "This mutuality creates low cost solutions," he stated. "As you differentiate legal services, you move to cost-value models where it doesn't make sense to pay first year associates $160,000 to train them."
Large Client Case Study: Cisco Systems, Inc.
Cisco's relationships with multiple outside law firms illustrate the way in which corporate clients are affecting changes to legal industry billing practices.
Like many large corporations, Cisco faces a broad spectrum of legal issues, which in turn, direct its selection of outside counsel. Brobeck, Phleger & Harrison was initially Cisco's principal counsel. Upon the firm's collapse in 2003, Fenwick & West began its representation of Cisco. Fenwick now performs all of Cisco's M&A work using the value billing method. Other "Bet the Business" matters, like appellate work before the U.S. Supreme Court, are handled by Mayer Brown LLP. Morgan, Lewis & Bockius LLP handles all of the company's commercial litigation, while Axiom, a "new model" law firm, covers much of Cisco's "Outsourcable" and "Running the Business" matters.
In-house legal teams are business units with the responsibility of delivering results while meeting budgets. Most General Counsel are under considerable pressure from CFOs to forecast and control legal costs. Chandler believes that over time, the percentage of money spent by a company on legal services should, in theory, go down. In many cases, such budgetary constrictions have led Cisco to require value billing from its outside firms.
Value billing can be defined in different ways in the legal context. The basic idea is that a firm prices its services based on an understanding of the client's goals and perceived value of reaching those goals. The usual result is a predefined fee for a specified legal service.
The prevailing hourly billing method, under which law firms charge for "actual" time expended on a matter, has proved too unpredictable for corporate budgetary frameworks. Ironically, the widespread use of time billing was a client-driven change from the 1960s, when insurance companies induced law firms to abandon the then-prevailing value billing method in favor of hourly billing. This change now appears to have come full circle. As James D. Holzhauer, Partner and Chairman, at Mayer Brown stated, "The hourly rate system's time has come and gone."
In Chandler's view, value billing ensures that legal work is performed and staffed efficiently. A firm can benefit from value billing if it can complete work under budget. There are, of course, risks and consequences for overworking a matter. As a result, firms are encouraged to operate with both eyes on operational efficiency.
Attorney staffing management, or determining which lawyers work on which matters, is one measure a firm can take toward reaching operational efficiency. The Stanford panel discussed the phenomenon where many corporate clients (not Cisco) urge their firms not to match first year associate salaries. If the firm does match salaries, clients will then direct the firm not to staff first-fourth year associates on their matters. As junior associates frequently receive on-the-job training, clients feel they are unfairly bearing the cost of training.
Chandler is quick to point out that, "If there's no demand for $160k junior associates, firms will find other ways to do the work." Incidentally, Cisco does permit its outside firms to use contract attorneys to staff their matters.
Applying Non-Legal Industry Principles to Law Firms
In addition to influencing predicable and efficient fee arrangements, Cisco applies other technology industry principles to its relationships with outside law firms. The service level agreement (SLA) is one such example.
SLAs are routinely used in the tech sector to guarantee things like network reliability and 99.99% uptime. Cisco, however, requires SLAs in its agreements with outside law firms. Instead of covering technical hosting downtime, the law firm SLA addresses the interplay of attorney response time, matter resolution, and cost.
In return, the outside firms are encouraged to advise Cisco on how to be a "better" client, in terms of communication, prioritization, and other matters aimed at increasing efficiencies related to the SLA. "Flexibility on both sides is required," Chandler said.
Several of the Stanford panelists referred to a downward trend currently being experienced by many mid-sized firms. According to Holtzhauer, "Mid-sized firms that try to do everything for everybody are falling by the wayside."
Larry Kramer, Moderator and Dean of Stanford Law School, echoed this sentiment, stating that, "The only place left for mid-sized firms is the niche market."
Discussion of this topic was largely anecdotal, however, and it is unclear: 1) whether this trend is even a trend at all; and 2) if it is a trend, whether it is client-driven.
Davidson scoffed at the notion. "The demise of the mid-size firm has been predicted for many years," he remarked. "Now they're saying mid-sized firms are doing well." With 250 attorneys, Fenwick & West is considered a mid-sized firm.
Clients are continuing to drive significant change within the legal services industry. By applying non-legal industry business principles to relationships with outside law firms, large corporate clients are directly affecting areas like matter stratification, attorney staffing, and billing. Interestingly, these changes are impacting other, more personal aspects of the legal profession.