Calling the electronic discovery business competitive is an understatement. Technology is moving very, very rapidly. Commoditization of processing and production has arrived and downward price pressures abound. Pricing models are in a constant state of flux. Keeping the competition in your rear view window is not easy and requires constant attention to the market around not only price, but solution. Many of those that have just one solution in today’s market are struggling. Today's law firms are considering how they might bring in electronic discovery, some have already gone there, and many are beginning to go down that path. Lawyers are increasingly being called upon to stand up and defend the discovery process. Technology is dramatically impacting traditional law firm revenue components such as review. Technology is rapidly and directly impacting the traditional billable hour. So, law firm’s interest in bringing discovery support services in-house is not just about an effort to capture “ancillary” service revenue. These have been the very challenges, however, with the litigation support business since the days the first copies were made. Like case law, the past and precedent are our teachers. The opening article to this Caveman series, we discussed how we’ve seen this all before. Many law firms have, and will continue to bring in support services, despite all the evidence suggesting that most firms can't justify the expense. We discussed the Legal Copy, Inc example from the 80’s. LCI, is but one of many such examples of a copy company started by a law firm in an effort to both capture revenue and gain control. In the 90’s many law firms brought in scanning. The 10’s and beyond has seen more firms now tackle the much more complex electronic discovery and related services.
The Business Model
After getting past IT Infrastructure challenges associated with bringing technology in-house, one is confronted with one of those “institutional” challenges that, frankly, have kept the litigation support industry alive and thriving since the days of the first copy machine. The business model of running a law firm does not fit with the business model of running a services support company. Law firms are already under considerable pressure to move to alternative billing arrangements for their legal services. In January 2009, in an article “Billable Hours Giving Ground at Law Firms”, the New York Times, as have many publications before and since, declared the billable hour for legal services on life support. Yet, here we are, more than two years later, and the billable hour is alive and well, albeit, under attack.
“The last two or three years you’ve really seen a movement away from hourly billing,” said Martin Fantozzi, co-managing director of Boston-based law firm Goulston & Storrs. “That having been said, hourly billing is still the norm.” MassLive.com; Jay Shepherd says the clock is running out on lawyers billing by the hour. Published: Monday, February 21, 2011, 3:32AM
In the beginning, Howrey did just fine with its new approach. Turns out, however, that changing how you bill clients is not as simple as it sounds. Setting aside the fact that you must know how to pick winners, you must be successful with those winners. One can’t forget that a law firm is a business with business rules that are not so easy to change.
“Unlike corporations that operate on an accrual basis, it’s hard to adjust from a cash base on your business to an accrual base where you are deferring significant amounts of revenue into future time periods. Once you make that adjustment, I think it works. But the adjustment period is difficult. Partners at major law firms have very little tolerance for change.” “What Else Happened to Howrey? Here’s More From CEO Ruyak”; WSJ Lawblog; March 10, 2011, 5:20 PM ETThe legal industry is notorious for being resistant to change, particularly large firms with many partners or shareholders. Whatever you call them, partner or shareholder, these lawyers are owners of the business and have a say in how the business should be run, as it should be. “Partners at major law firms have very little tolerance for change”, former Howrey CEO Bob Ruyak recently said to the Wall Street Journal (WSJ). [i] Although some do and will, few lawyers question the need for change. The hourly billing has been firmly entrenched for decades. As many now know, there were many reasons for the demise of Howrey. Among those reasons, in an effort to meet the demand for billing arrangements other than hourly, Howrey chose to dive headlong into “contingent” and performance based arrangements that were not exclusive to the plaintiff’s side of the bar. Howrey was then competing with firms like Susman Godfrey LLP, who pioneered decades ago commercial litigation performance based fee arrangements, like the reverse contingent fee (RCF). What is an RCF, you might ask? Longtime Susman partner Barry Barnett, the man behind popular legal blog, Blawgletter, explains RCF:"
"By way of example, if the law firm and client agree that a patent infringement case exposes the client to potential liability of $10 million, the RCF would equal a percentage -- 40 percent, say -- of the difference between $10 million and any lower amount that the client pays in settlement or as a result of a judgment. If we zero out the plaintiff, our fee totals $4 million -- .4 x ($10 million - $0) = $4 million. Negotiating an RCF presents unique challenges. The hardest part probably is arriving at the benchmark number. The law firm will want to use the plaintiff's demand as the starting point, but the client will prefer to begin at bupkes. Unless some reliable methodology for assessing exposure exists, the discussions may lead nowhere." “How to Negotiate a Reverse Contingent Fee”; Blawgletter; 25 January 2008.There are also the cultural issues that must be overcome.
"It used to be that lawyers just had to write briefs, memos, and letters. Then in the nineties (the ironic ones, not the gay ones), lawyers started writing emails. Now, social media has opened up a whole new world of words for lawyers. And pictures and videos too. But lawyers are conservative, wedded to tradition and bound by precedent. Turns out that lawyers have been a little slow in embracing Web 2.0." "Partners”; The Client Revolution; by Jay Shepherd; 11 January, 2010.
As has been widely reported, Howrey also decided that it had to stem the decline of the billable hour associated with litigation support services around document review."Lawyers and law firms fear that if they stop keeping timesheets and stop tracking hours, they will make less money than they do billing hourly. And clients, especially in-house lawyers at larger companies, fear that without reviewing detailed time entries in stupefying legal invoices, they won't know if they're getting ripped off." The Client Revolution. “Hourly Billing is Dead.”
“We had a very strong business model that carried us from 2008 to 2009, that was based on large scale cases, that we thought we handled efficiently, because a lot of those cases involved a lot of discovery, particularly document discovery. We created a whole portion of the firm to handle that efficiently- using staff attorneys and sometimes temporary people, computer systems and facilities. Along came some companies that were “offering to do this work less expensively at a lower price,” he said. “A big part of our business was shifting and we started to make corrections. It’s a major change in the business model for large-scale litigation,” he said. “What Else Happened to Howrey? Here’s More From CEO Ruyak”; WSJ Lawblog; March 10, 2011, 5:20 PM ETThe troubling trend, however, is that despite what history is telling us – law firms are going to be hard pressed to compete with non-law firm service providers - partners and shareholders at major law firms continue to seek to bring services “in-house”.
"More troubling, however, is the fact that the industry seems to have learned nothing from such episodes. Reading the legal press and legal blogs, you find the same uncritical acceptance of the wisdom and inevitability of firms becoming larger and more global, the same acceptance of the free-agency model, the same acceptance of a world in which firms are held together by nothing more than a collective determination to increase profit per partner." Why Howrey law firm could not hold it together. The WashingtonPost.com; Monday, March 21, 2011; 8:43 AM“Many lawyers may not be good enough businessmen to pick the right price, said Mr. Krebs, of the Association of Corporate Counsel…. The difficulty is, we don’t really know what it costs us to do something,” he said. But the biggest stumbling block to alternative fee structures may be the managing partners at law firms, who will have to overhaul compensation structures to reward partners and associates for something other than taking a long time to do something.
“I don’t think law firms have completely come to grips with that issue,” said J. Stephen Poor, managing partner at Seyfarth Shaw in Chicago. “But they need to start coming to grips with it very quickly.” "…Lawyers are having trouble defending the most basic yardstick of the legal business — the billable hour." New York Times; Billable Hours Giving Ground at Law Firms;The Better Way - SmartSourcing
As has been previously discussed here and by many commentators, many of the reasons that law firms want to bring discovery support services in-house are sound. They want to capture the revenue, rather than seeing a third party receive that revenue. They want to keep the relationship with their customer rather than allowing outside service providers in on that relationship. They want control of the discovery process. All valid reason that by an large are not supported by the business model. There are dramatic peaks and valleys in revenue from a litigation support business. There are enormous IT and personnel expenses that are fixed, whether you have the business or not. Most firms simply cannot justify the expense when they take a hard look at the ROI. There is a better way.
What if you were able to accomplish the goal of capturing revenue, gaining control of the discovery process and maintain that relationship with your corporate client? There is that way and it is called SmartSourcing. There has been considerable buzz of late about “the Cloud”. The Cloud, of course, has been around for decades. It is nothing more than outsourcing data hosting as well as services to a company that hosts the data for you and provides you with control of those applications just as if the hardware and software reside in your own data center. The law firm does not have to build and maintain a multimillion dollar data center that is required today to host sensitive client information. You don’t have to manage flux in staff – your “cloud” provider will manage that for you by either helping you staff on your premises, provide that additional surge of human power when you need it, and not having to pay for it when you don’t. You will pay for storage space once, with the ability to re-use that space as old matters go away and new matters arrive. With the traditional per GB pricing, complete outsourcing requires paying for a GB with each new matter. You don’t have to keep up with market pricing, your SmartSourced provider will keep up with those for you and help you build into delivery of those services a profit or “breakeven” margin (depending on your business model).
Determining the right mix of in-sourcing and out-sourcing – SmartSourcing – simply makes good business sense. Lawyers can then focus on being lawyers and not focus them, or their staff, on managing a litigation support business.
[i] “What Else Happened to Howrey? Here’s More From CEO Ruyak”; WSJ Lawblog; March 10, 2011, 5:20 PM ET
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