Beyond the zero sum game in buying and selling legal services

Graeme Johnston, Molly MacGregor and Eric Eck / 8 August 2024

 

Perhaps the most important rule in management is, ‘Get the incentives right.’

Charlie Munger, American investment manager

Businesses’ efforts to control spend on legal services have seen many developments over the last fifty years. Many things have been tried. But law firms have, on the whole, managed to generate ever more revenue and profitability.

One major reason for this is that you need to run to stay still. The complexity of legal work has increased greatly. More laws and more aggressive enforcement. More complicated economies, societies, documents and legal structures. More cross-border aspects. More data generation. All translating into more to cope with, and more risk if you fail to do so effectively.

Some of the cost control methods introduced have, no doubt, had some effect to control costs. But aspects have generated

• their own, substantial transactional costs – more time which has to be spent, more specialist tools for doing so, even whole new roles,
• higher rather than lower fees as action and reaction have played out into unintended consequences over the years.

This article seeks to summarises how we got here, and two particular types of change we envisage as likely in the coming years. One is a “zero sum” way for law firms and clients: more profitability for the former continuing to translate fairly directly into more cost for the latter; cost-saving for the latter tending to translate into lower profitability for the former. The other is a way in which both sides can do better. The reality will probably be a mix of the two. We’ve also explained how what we are doing at Juralio is relevant to this.

Two clarifications

There are two things we should make clear at the outset:

• The first is that our focus in this article is on reasonably complex work which will continue to need significant skilled human input, even as specific elements are increasingly automated. We know that this statement begs questions of what and how much will be automated, but that’s a topic for a separate discussion.

• The second is that the growth of legal spend and attempts to control it both need to be understood in terms of the United States, whose law firms account for around half of the world’s legal spend (those of the United Kingdom are a distant second). But the same phenomena have spread elsewhere over time. The tendencies are global, even if the details are local.

A brief history of B2B legal cost control

Efforts by large businesses to control their legal spend in the last few decades of the twentieth century included

1. 1. Requiring time breakdowns (shadow billing) as a check on the fixed and value-based pricing which was normal until the 1960s in the United States, and much later elsewhere.
   2. Insourcing work to lawyers employed directly by the company
   3. Having those in-house lawyers manage the buying of external legal services

Responses from law firms in the same decades included

1. 1. A trend towards a time-based pricing model for much B2B work
   2. More conscious management of alumni relationships and secondments as methods of ensuring that firms were well placed to be instructed on favourable terms

Over the first quarter of the current century we’ve seen more of that plus, from corporates

1. 1. Widespread expectations of for daily and sub-daily narratives and (sometimes) use of codes to describe time recorded on matters
   2. A focus on negotiating down hourly rates
   3. Increased use of corporate billing guidelines for law firms, defining what can and can’t be charged for and what reporting is expected
   4. Ebilling software to support analysis of that additional information and enforcement of the guidelines
   5. Greater use of offshoring and nearshoring for some kinds of work
   6. Greater use of panels, competitive tendering and RFP processes (including involvement of procurement or at least specialised staff within legal) as an effort to disrupt what may be regarded as excessively cosy relationships between individuals

Responses to that from law firms have included

1. 1. A tendency to incentivise high chargeable hours, by a combination of hourly charging, shadow billing and internal chargeable hour targets (mostly transparent, sometimes less so)
   2. Adoption of artificially higher ‘standard’ hourly rates which seek to price in elements of performative % rate discounting and time write-off
   3. Facilitation of time recording by ‘passively’ capturing it from an individual’s use of applications such as MS Outlook and suggesting how it maps to a matter and how to describe it
   4. A tendency around billing guidelines once internalised (as they are typically attempts to regulate the details of how chargeable time is spent and reported rather than putting absolute quantitative limits on it)
   5. Continued investment in secondments, alumni programmes and other relationship-building activities
   6. Professionalisation of teams to handle the RFP and panel processes in ways that emphasise a firm’s strengths

In recent years, we’ve also seen developments such as

1. 1. Individuals being assigned in corporates to reviewing and cutting down time-based bills as their job, for the purpose of reducing spend
   2. Outsourced services to do the same
   3. At law firms, increasing investment in reviewing and improving bill narratives at for the purpose of defending time entries when challenged

Inevitably, we are also seeing efforts to use language models to automate bill narrative drafting on the selling side (to capture what was done in a way that is both accurate and fits with billing guidelines – some tensions may foreseeably arise) and to assess what it all means on both the buying and selling sides. 

No doubt the lists of action and reaction could be elaborated further. But you get the picture.

Where we are now

Stepping back, discussions we have with people who have to cope with a world of time-based billing reveal frustrations such as

• The amount of effort and cost involved in operating the time-based system, both for the lawyers (at law firms and in-house) and in terms of the necessary software and human roles involved in more systematic time critique
• The increasing recognition that, without changing the way is articulated, managed, priced and incentivised, more and better data might be interesting but just doesn’t really help that much, in a practical sense

There is, of course, considerable fixed or capped pricing going on in certain market niches including in some B2B for large businesses. But one important ongoing development is the increasingly aggressive use by some corporates of “reverse auctions” to extend the extent of such fixed pricing and to keep it down. This typically involves

• A sharing of bid amounts between law firms for a particular scope of work in an effort to drive pricing down
• The names of bidders are typically not shared, so firms are unable to be sure whether a lower bid is from a “lesser” firm – though clients reserve the right not to go with the lowest bid

Our impression from major “high end” B2B law firms we’ve spoken with is that such reverse auctions are mostly seen as a necessary evil – something they may feel compelled to take part in it for work which they want for relationship, credentials, training or team utilisation purposes. But with an expectation of generating their real profitability elsewhere.

Possible futures

We expect that considerable time-based charging will remain as:

• for smaller matters in which only one lawyer or a small team is involved in a limited way, it’s sometimes just not worth the time to fix a price – the spend is just not material
• for really large matters, those incurring legal spend at corporates on high value matters often don’t care that much about cost control

However, we also think that there will be a continuing squeeze on that second category of work, with a combination of economic and technological forces being likely to push law firms towards a greater adoption of fixed pricing for entire matters or on a phase-by-phase basis. That’s the basic direction of travel.

But there are different ways this can come about. The first way is defensive and zero-sum in nature. The second way is smoother and ultimately a better path, we suggest, for both clients and law firms so far as more complex, higher margin work is concerned. They’re not mutually exclusive – a mixture of both is likely, but the extent to which the mix tilts one way or the other has definite implications.

Possible future 1: more of the same

The first element of the future is for buyers to continue to seek to reduce their use of law firms and to grind down price by extending the methods just outlined, that is

• Time-based billing and retrospective cutting-down with increasing use of tech
• Reverse auctions extending further and over time leading to lower prices

There will undoubtedly be a lot of each of these. But they each have serious limits.

The retrospective cutting-down approach still has significant costs and is anyway an imperfect remedy for weaknesses in planning and active management 

The reverse auction approach requires more effort up front (to scope work and choose a bid). It also tends towards a more transactional, more commoditised approach rather than one where the firm has the client’s long-term interests in mind. 

In addition, it doesn’t really work for larger, more complex and unpredictable work, as the scope and time spent depend so heavily on what is discovered, on what other parties do or both. Fixed pricing of such work can still be done, but only on a phased basis once scope has become sufficiently clear – but that requires active planning and management and at that stage, once the firm is already involved, subsequent phases are not realistically susceptible to a reverse auction process

Also, as a warning of how things may play out, we have long seen the limits of reverse auctions play out in other industrial contexts. There’s a well-understood game which involves low-balling an initially under-scoped project then, with the customer locked in and the know-how in the contractor’s hands, making money from the re-scoping and follow-on work. Attempts to apply fixed pricing to more complex work in law likewise risk generating the next round of games unless there is a deeper look at how work is done and communicated.

Possible future 2: better management of legal matters

A very different possible future is for law firms and corporate legal to give closer attention to articulating the process (including work required, outputs expected, milestones and so forth), reporting on it in a more accessible and automated way (so that scope creep with budgetary implications can be seen and discussed much earlier, for example) and learning from experience more consciously. 

This would involve things like

1. 1. Understanding the phases, work and outputs (deliverables) involved in matters of a particular type, and in this particular matter
   2. Helping clients to understand what’s required early and to choose whether to have it done, thereby reducing the risk of retrospective rejection of pricing
   3. Using that better mutual understanding to distribute work in the broader ecosystem, for example within the client organisation, automating, outsourcing to someone other than a law firm and simply accepting some risks (e.g. limits on due diligence when acquiring a business)
   4. Developing pricing approaches which can work for both sides, by having greater clarity as to what’s really needed and valued (or not)

The benefits can include

1. 1. Fewer disputes, write-offs and payment delays; translating into better relationships and profitability, but also more predictable pricing
   2. Less transactional cost in managing billing guidelines, time recording, time reviewing, negotiation of write-offs and all the rest
   3. Less transactional cost in having to set up reverse auctions 
   4. Happier teams who have to do less of the tedious administrative work and who are incentivised to be productive in the normal work sense, rather than in the very odd sense which legal market intelligence providers have encouraged for recent years (by defining productivity in terms of the number of chargeable hours per lawyer)
   5. Payments to law firms can be released more quickly on reaching a milestone which the client values, thereby improving cash flow to the firm and releasing both parties from the tiresome dance of invoice, delay and negotiation.

These benefits can in mature hands (with the emphasis on relationships and long term client value) be shared to generate higher profitability for firms and better controlled budgets for clients.

How Juralio fits with this

Juralio is focused on making the things we’ve just outlined much easier to achieve, as opposed to being unattainable. And it handles them dynamically, so that indicators arising in the reality of a matter with budgetary implications can be seen and addressed quickly, rather than waiting for them to show up in WIP and billing figures (by which time the damage has been done).Juralio’s not confined to law firms either. Businesses can use it to define how they want particular types of transactions to be handled and reported on, at whatever level of process detail is appropriate in a particular context. Law firm involvement can be managed in a way which is clear, efficient and respectful of both sides’ needs. 

Juralio can in short help with better, mutually beneficial relationships rather than continuing with the familiar games and counter-games.

You can also integrate Juralio with the software in which work gets done, knowledge is stored, and the financial aspects of work are handled (e.g. law firm PMSs, corporate accounts payable systems and HR / resource or vendor management systems).

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Image of apples and pears cropped from photo by Jacob Kapusnak on Unsplash