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Wednesday, September 29, 2010
New Paradigm in Legal Industry
A recent report by a well-known law firm consultancy predicts flat consumer demand and pressure on billing rates will cause an overall job loss of about 17,500 lawyers over the next five to seven years.
What does this mean for the overall business economy? In short, it means that if you have gone to a "mid-sized" or "large" law firm you have gotten cheaper legal service...and often of a lesser quality.
I believe the traditional paradigm of the large law firm -- sometimes referred to as BigLaw (one word) -- has been on the wane for a long time. The reasons are not merely the economic uncertainties of a recession and the continuing credit crunch which shows no signs of abating. Many established middle-aged (and older) professionals and business owners have experienced not just one, but two major wealth-destroying events in the last ten years: the bursting of both the Internet company bubble and the residential real estate bubble,
Economic behavior is best studied by looking at the behavior of the owner class. Business owners -- and in the legal profession this means "law firm partners" -- must preserve their own assets. Law firms have become risky business ventures. Let's see why.
As with many businesses, law firms' revenue side has come under pressure from reduced consumer demand, clients rejecting standard billing rates or, in an increasing number of cases, refusing, delaying or unable to pay bills when due. The key here is not what you charge; it's what you collect. Many clients are also delaying or foregoing using lawyers to solve certain problems, just like many patients will refuse to go in for elective plastic surgery but will still pay (and pay top dollar) for heart surgery. The decline in demand for all professional services at certain price points (indeed, as with any service) may be compared with the view of getting certain types of medical treatment; absolute necessities will still be sought after, but all other matters may be viewed as elective and paid for accordingly.
Meanwhile, the expense side has continued to grow (certainly outpacing the rate of revenue growth), reflecting not just growing insurance costs but also pressured by bad decisions or bad timing such as long-term office leases signed when there were expectations of further growth (which often have evaporated) and at space-per-office-square-foot rates that were "market rate" in the middle of the last decade but which are now substantially above current market rates. It should be no surprise that there are reductions in overall headcount, replacing certain staff with cheaper alternatives, and even substantial reductions in income and equity distributions to partner-owners.
Incidentally, none of these pressures have resulted in better legal advice. The opposite is occurring, as all providers of the advice become increasingly distracted.
The "owners of the means of production" (that is, the partner-owner class) is distracted by the needs to generate new paying business (often to replace lost or non-paying business, and just as often to remain as a partner-owner) while its wealth is often tied up in the equity of the law firm. This yields the different pressure, and the huge risk, from non-diversification of investment assets and is just as risky as having one's 401(k) plan assets invested in only the stock of one's own company. Additional pressures come from anticipated cost increases next year -- from the gradual mandates of ObamaCare and insurance premium increases -- and the anticipated net income decline stemming from the expiration of the Bush-era tax cuts at the end of 2010. The bottom line for the ownership class: Several factors will likely drive net income down, perhaps substantially.
As for the workers, the employees, anyone who is not an owner, their efforts will be increasingly consumed by the needs to keep one's job, look out for replacement jobs and conserve their own resources during the continuing economic uncertainty. The economic pressure felt by the ownership class will cause firms -- as with most businesses -- to try to control and reduce costs whenever possible. This means attempting to get cheaper workers, and cheaper lawyers, especially if any decline in lawyer quality can be hidden.
These economic trends indicate that small business owners, entrepreneurs and other individuals are likely to receive worse service from their professsionals -- their lawyers, accountants and doctors -- and that even if their invoices show a savings, those savings are most likely to result from this worsening quality of service. There is no reason why professionals will not cut costs the same way restaurants do: by using cheaper ingredients.
The foregoing analysis illustrates how the legal profession is really no different from any other type of service industry. It's only in the midst of the current climate, when twentysomethings with Harvard degrees cannot find paying jobs requiring a college degree,
The entrepreneurial, consumer class needs to be very alert to the decline in lawyer quality. There are many small firms with two or three lawyers which can and often do provide top-notch services at much more affordable rates. On the other hand, there are a growing number of firms which are relying on being the cheapest provider, and a closer inspection shows an economic model that relies on cutting every corner possible to remain in business. The general public should be wary of the latter.
Eric Dixon is a New York small business lawyer and has been a member of the New York bar since graduating from Yale Law School in 1994. He is the president of Eric Dixon LLC. He is available for comment or consultation on this and other legal, strategic and management issues at 917-696-2442 and by e-mail at edixon@NYBusinessCounsel.com.