Is the BigLaw business model sustainable?

This is the question that I was recently given five minutes to answer! This post is intended as a more expanded response. It begs some prior questions about what we mean by ‘BigLaw’, ‘business model’ and ‘the BigLaw business model’. But [spoiler alert] the short and long answers are the same: it doesn’t look like it.

Introduction

I’m not the first to look at this question, but let’s deal with the definitional issues to begin with. I’ll unpack what I mean by ‘business model’ as the post proceeds. However, my notion of it is derived from a 2010 paper of mine, and involves four elements: creating value for clients; resourcing the firm (to deliver that value); allocating the returns (from resourcing the business to deliver value); and financing the firm (to resource it appropriately to deliver value and generate sustainable returns).

Business models only work if each of these four elements is aligned with the others, and all of them are aligned to a longer-term strategy for the business and the market in which it operates (or intends to operate). I would contend that these four elements are the same for all types of business: I’m just applying them to the particular context of law firms. Note that this approach to business models does not easily reduce to a single word or phrase – it’s a combination of elements. Nor is it equated with, say, ‘LLP’ or ‘corporate’ as a description of the model.

The ‘BigLaw business model’ has its origins in the larger law firms (hence ‘BigLaw’), but it is no longer confined to them. In this sense, the label is more about the nature and application of the business model than it is about scale. This post is not therefore about all large law firms or, indeed, even necessarily about large law firms.

I have worried about the sustainability of the law firm business model for a number of years, but particularly in the larger firms. That concern was heightened recently by a comment in The Times:

“I’m a junior lawyer … in London. I get paid around £135k a year. They don’t pay us well because the job is good – they pay us well because the job is awful…. I still wish I’d listened to the many voices telling me not to do it. The job is extremely stressful and all-consuming and involves dealing with unpleasant people on a daily basis…. If you are a bright young graduate considering this path – find something else to do! Unless you have vaguely sociopathic tendencies, in which case you may thrive.”

This struck me as a shocking comment to see articulated in public. It begs a question: what sort of business model leads to such views? And then add into the mix the well-reported instances of burn-out, mental health concerns, and substance abuse. We have to pause and ask what is going on – from a commercial, human, social, psychological, regulatory and ethical point of view.

Can a business model that generates such reactions and consequences be sustainable? Should it be? Let me take each of the four elements in turn, see what the ‘BigLaw business model’ typically entails, and consider whether alternative approaches could lead to something better.

Element 1: Creating value for clients

This is the most important aspect of any business model. In my experience, it is also the least well understood in law firms.

The BigLaw business model at its core still tends to equate value with the cost of time plus a mark-up. But value for the client cannot be found in time-based billing. Client value can only be assessed by reference to the outcomes for the client; time is simply a reflection of the input of a lawyer. Only very rarely will the two ever equate – and even then never as a matter of correlation.

Client outcomes will look at, for instance, securing a sale or purchase (on or ahead of time, with minimum fuss), the final terms of a deal (better than they might otherwise have been), the price or settlement agreed (higher or lower than expected, depending on the client’s role in the transaction or proceedings), or relationships that have been retained or repaired through the legal process (not irreparably torn apart by the adversarial or antagonistic behaviour of a lawyer). These outcomes, and others, go to the very heart of the reason why the client needs legal advice or representation in the first place.

Client value in this sense should not be confused – as I find it so often is – with ‘added value’. Too frequently when asked to describe the value they create for clients, lawyers will tell me that they take their clients to dinner, sporting or cultural events, provide legal updates or training, or send staff members on secondment to a client organisation. These don’t go to the heart of why the client needs legal advice or representation. True, they might be part of building or maintaining a relationship that induces the client to choose or stay with one lawyer or law firm rather than another. But they happen on the periphery of specific legal needs, rather than being derived from their core.

Nor is client value the same thing as value for money.

A challenge for law firms here is the increasing fragmentation of client demand. Buyers of legal services are faced with ever more options and are becoming much more discerning. Niche specialists (in law and beyond) can chip away at the fuller or sclerotic service offerings of their larger competitors. In-house legal departments have a different make-up and purpose now than they did 10 or 20 years ago; they also face greater internal demands for unbundling legal services and for demonstrating return on capital employed. Alternative legal services providers can offer more options to clients for, say, discovery, project management and litigation support, document generation, predictive analytics, and so on.

The inconvenient truth is that, if law firms had been as close to their clients as they claimed to be, and if they had been consistently creating value for them, there would simply have been no room in the market for the emergence of these alternative competitors. A $14 billion sub-sector did not arise from nowhere.

The reaction is then often that the firms didn’t want to keep this ‘low value’ or routine work anyway. (It often isn’t either.) But firms cannot constantly keep moving themselves up the value chain in response to competition. That would just result in more firms competing for relatively less work.

The final awkward truth is that value creation requires innovation and the integration of different types of inputs (on the latter, see Element 2). Neither is typically encouraged in law firms. And innovation (or competitive advantage, for that matter) cannot come from asking, “Who else has done this?”.

Element 2: Resourcing

The BigLaw business model is still predominantly built on human resource (rather than, say, on technology or process). Not only human, but still predominantly legally qualified. The focus remains on building the ‘pyramid of leverage’. The difficulty here is that building a pyramid of lawyers can create scale, but it does not easily lead to economies of scale. As the firm gets bigger, the cost base goes up.

This business model therefore has a significant majority of its cost base tied up in lawyers’ remuneration. Every year, we hear how the large law firms electively bid up the cost of new and young lawyers (in some cases now above £100,000 in London, and $200,000 in the US). By constantly ratcheting up either or both of the number of lawyers and the amount they are paid, the business model effectively turns a variable cost into a quasi-fixed cost.

Law firms need to take a step back. In providing more valuable client outcomes and experience, they could benefit from reconfiguring and combining a different mix of tangible and intangible resources. Thinking about the different contributions that a broader range of resources – human, social, technological, organisational – could make to drive value and efficiency, particularly through technology, process and the enlightened use of people who are not lawyers. They should also rethink the balance between internal and external resources.

One thing seems clear: less than we think needs to be done internally by lawyers. It is trite to describe law firms as ‘people businesses’. Many different types of business can be labelled that way. But there is often an important distinction that should be made in relation to the respective contributions of ‘people’, and these can determine the essence of the business.

For example, a people business can be knowledge-intensive, process-intensive or labour-intensive. These are fundamentally different types of ‘people businesses’, and most law firms would describe themselves forcefully as the first. Nevertheless, a proper focus on process would lead to a different conclusion, employing different people, and developing and rewarding them on a different basis. I’m not suggesting for a moment that law firms should substitute from one type to the other – it’s almost certainly not an either/or choice – though they should probably leave scope in their considerations for an emerging fourth type: the technology-intensive business.

Element 3: Allocating returns

In all businesses, the ‘economic surplus’ that they generate is the result of many different types of contribution. The discussion of Elements 2 and 4 should highlight the range of actual and potential contributors. And yet in law firms, the only ‘return’ that gets a look-in is net profit. Even this overlooks the economic reality that net profit is in fact a return to partners’ labour, to capital employed, and to business risk. The BigLaw business model rolls everything into a single return, measured as PEP – profit per equity partner.

PEP is a short-term, income-only, fully extracted and probably tax-inefficient concept. It is also rife with perverse incentives relating to personal productivity, objectionable notions of ‘client ownership’, internal competition and under-investment. As I said on a previous occasion, this business model:

“pays out too much money, too quickly, as income, to the wrong people, for doing the wrong things. It makes no meaningful assessment of who has actually created the wealth of the business, reflecting income and capital growth, over any period of time. It is a short-term income extraction model that benefits a select few people disproportionately and inappropriately.”

Equally intriguing – in a strange way – is that when making a profit in a law firm becomes harder (because of falling revenue or rising costs, or both), the focus is not on managing for profit but switches to managing the denominator: the number of equity partners sharing in the available profit is reduced so that PEP can still go up even if revenue or profits are flat or declining.

It is not surprising that precious few law firms of whatever size have any capital value (public market flotations remain the outliers). To achieve that would require observable medium- to long-term sustainability: a business that could continue to function well independently of the personal productivity of the partners; sharing economic returns with others (such as investors and staff); and taking a mix of returns (income and capital, current and deferred). All the things that the BigLaw business model does not countenance.

Element 4: Financing the business

The BigLaw business model relies principally on internal equity (longer-term capital contributed by partners) and external debt (overdrafts and short- to medium-term borrowing, often for equipment or indemnity insurance premiums). In many cases, even the ‘internal equity’ is financed by external debt through bank loans to new partners.

Not surprisingly, the income extraction that I described in Element 3 often leaves firms struggling with cash flow to meet its debt repayments, to invest for growth and innovation, to repay capital to retired or departed partners, or to cope with unexpected shocks (such as losing a client or team to a competitor, recession, or a pandemic). This can easily lead to an over-reliance on yet more short-term debt through overdrafts. In other commercial environments, this would lead to concerns about (and measures of) working capital adequacy, and detailed consideration of the right mix of financial capital.

Admittedly, the legal structure of partnership reinforces such short-termism – often aided and abetted by the tax system and regulatory restrictions on alternatives. Financing options are definitely constrained by legal structure, governance arrangements and decision-making processes – particularly where decision-making is further hampered by conflicts (and coalitions) among and between rainmakers, practice areas, offices and generations.

A full range of capitalisation options would consider debt and equity, both internal and external, whether wholly or partially private or public, and both short-term and long-term (typically matching short-, medium- and long-term financing to, respectively, short-, medium- and long-term financial obligations).

It is of particular concern when lawyer regulation constrains the financing choices open to law firms, denying them ‘normal commercial’ options. This self-imposed constraint often derives from a misguided and unevidenced belief that ‘non-lawyers’ will interfere with lawyers’ professional obligations.

Alternatively, it is derived from an equally misguided notion that “we are a profession, not a business”, as though that is an either-or choice. Lawyers sell their services: that is a business. Yes, it is one subject to particular and additional obligations and commitments, especially to the rule of law, the courts and to professional independence. But this just means that law is a profession and a business, and the relevant aspects of the latter need to be incorporated rather than dismissed.

Conclusion

Too often in law firms – large and small – one finds fragile and fleeting coalitions of interests, driven by short-term individualised incentives and internal competition. Far from the elements of these firms’ business models being aligned, only rarely (if ever) have they even been considered, either separately or collectively. There is no, or insufficient, focus on value for the client; too much dependence on lawyer input; returns disproportionately assessed and appropriated by ‘net profit per equity partner’; and over-reliance on external debt.

So no: on the face of it, the BigLaw business model is not a recipe for sustainability. On certain, self-selected metrics (such as turnover, numbers employed or PEP), many law firms will appear to be successful – sometimes phenomenally so. This does not mean that their business model is successful or sustainable.

I am more than happy to concede that there is a group of ‘elite’ law firms for which the conditions for success might well be different. These are firms that demonstrate a very high level of specialisation, have a particular expertise and reputation in managing complexity and coordination of legal needs (particularly in cross-specialisation and cross-border issues), or are retained, for instance, for bet-the-company litigation and similar high-stake issues. In this context, ‘elite’ is not inevitably the same as ‘BigLaw’; equally, it is also not necessarily true that their business model is as robust as it could and should be.

Over the years, we have seen many instances of previously ‘successful’ large law firms failing and collapsing quickly. In essence, this can usually be attributed to one or more of hubris, a culture of individualism (with weak commitment to ‘the firm’), and too much debt. Or, put another way, their fall can be attributed to a flawed or non-existent business model.

The elements of a business model can exist without a firm realising it: many unspoken assumptions, habits and practices will define – if only by default – a firm’s approach to value creation, resourcing, returns and financing. Far better to identify and articulate what these are so that the underlying business model can be tested for its validity, robustness and sustainability. Too many firms are currently operating with a blindfold on.

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