News just in: “It will come as a shock to many to hear that Humpty Dumpty (also known as the traditional law firm business model) has taken a tumble. Worse still, all the king’s horses and all the king’s men couldn’t put Humpty together again. Yes, it’s true: however you look at it, Humpty is well and truly scrambled.
How could this happen? Well, sources close to the wall from which Humpty fell, say that although he was close enough to the wall to see the writing, he hadn’t actually read it.”
In many ways, the traditional law firm business model has been an accident waiting to happen. For me, a business model is a statement about how the firm coordinates four elements to structure the business and deliver its strategy. They are (a) creating value for clients; (b) resourcing the firm to create that value; (c) financing the firm to secure those resources; and (d) producing and distributing returns on the investment to make it all worthwhile. (For more, see Mayson (2010) Business models in legal services or visit the Downloads section.)
In terms of these four elements, the traditional law firm business model can be expressed in summary as: (a) using a cost-plus, time-based, lawyer-focused charging structure (which often bears no relation to value to the client; (b) a lawyer-driven human leverage model with as many resources as possible internalised within the firm; (c) finance provided by internal equity (partners) and external debt (banks and asset finance) – though much of the internal equity is often also the result of bank lending – and all managed within a partnership structure and culture characterised by confused roles, disdain for professional (that is, effective) management, and inefficient decision-making; and (d) returns created by growing turnover (rather than managing for profit) with rewards extracted entirely as income, usually within 12 months of earning them.
The message that Humpty missed was that, on all four elements, the traditional law firm business model is broken. So to those who say, “If it ain’t broke, don’t fix it”, I say: it is broke, so get on with fixing it as quickly as you can.
On the first element, creating value for clients can’t be done on a cost-plus model, time-based pricing, or where creating value is confused with adding value (most clients really don’t care about legal updates). But negotiate a better deal or outcome for them, or make their personal or business lives easier, and then you’re on track. Understand where the firm sits in the supply and value chain, and who else is claiming part of the value paid by way of fees for legal services, and then work out where the real value lies to the client and deliver it.
For the second element, neither employing lots of qualified lawyers to do things lawyers don’t have to do, nor using people to produce bespoke outcomes when technology or processes could give more consistent, reliable or cheaper results, represents a sensible route to 21st century resourcing for productivity and cost-efficiency. Nor does insisting on doing everything inside the firm when outsourcing or joint venturing are viable alternatives.
The third element relates to finding feasible sources of investment. When firms have been removing under-performing equity partners (who want their capital back) and postponing promotions (and so not admitting new sources of capital), internal equity capital is in shorter supply and debt capacity is constrained by the reduction of people to back the borrowing. Although banks have not stopped lending to law firms, debt is not so easily available and now tends to come with stricter terms and covenants than it used to. Alternative financing (including external public debt as well as public and private equity) should not be lightly dismissed with a wave of the hand and “we don’t need it and we don’t want it”. Maybe firms don’t want it; that doesn’t mean they won’t need it. And it doesn’t mean they’re fit for investment when they do decide they need and want it.
Law firm governance and structure also need reworking to provide better decision-making processes, more disciplined businesses with skilled and effective managers (I don’t much mind whether they are lawyers or not so long as they can do the job), and more attractive vehicles for investment, recruitment and retention. The professional partnership is an increasingly inappropriate vehicle for this. In business terms, professional partnerships are really not that special, and maybe it’s time we stopped exempting them from the requirement to incorporate when they have more than 20 partners (though in Humpty’s case, it will need more than a shell company to fix the problem!).
Finally, the returns need improving and re-thinking. Any business that takes its entire returns as current income is completely missing the point of being in business. Effective business models will differentiate income and capital returns, short-term and long-term rewards, and salaries, bonuses and dividends (whatever labels are applied to them).
And so the breaking news story concluded: “It is remarkable that Humpty Dumpty was able to stay on the wall for so long, and his downfall certainly represents the end of an era. We can’t say that he wasn’t warned. The writing is still on the wall, and it’s not too late to avoid falling off and creating a mess. But then you know what they say about needing to crack a few eggs to make an omelette. The future certainly needs a new recipe.”