GC's May Be Complaining, But Do They Really Want Change?

Over at LegalOnRamp there's an interesting discussion underway about the extent to which GC's do—or don't—seek genuine innovation in the way BigLaw provides services.  I'm taking the liberty of republishing it here (with permission of Paul Lippe, the CEO of LegalOnRamp) because at the moment LegalOnRamp is invitation-only.

It was kicked off by Ron Friedmann:

General counsels complain about large law firms: too costly, bad service, and clueless about the clients’ businesses. After the failure of GC’s many attempts to fix the problem, regulation is surely the solution. 

This simple and easy idea struck me last week when I heard a panel of GCs address the Strategic Technology Forum in Lisbon, hosted by LegalWeek. Their anger at firms was palpable. CIOs have their own frustrations: few partners or clients use the innovative systems they create. The despair all around caused me to think about the market. Consider the many steps GCs have taken that have had no impact on outside counsel:

• Countless law departments have voted with their dollars, switching firms, and privately and publicly explaining their quest for better value. Yet large law firms refuse to budge.
• Rampant standardization has failed. The standard documents of ISDA (International Swaps and Derivatives Association, Inc.) is only one of hundreds of instances of clients coming together to simplify and standardize. Yet bills continue to mount.
• The Tyco arrangement with Eversheds, which introduces various metrics and carefully crafted payments to illicit [sic: elicit] particular law firm behavior (link to Legal Week article), is only one among many such agreements. No market impact.
• Law departments have invested heavily to create best practices, for example, how to manage outside counsel, checklists for transactions, empirical studies on reducing discovery costs, and regularly using risk analysis in litigation. Law firms ignore these well-document guidelines and every effort at enforcement.
• Law department frequent use of non-lawyers and lawyers in India has no affect.
• Large law firms have bid up the price of talent, shutting out the ability of law departments to hire.

Alarmed at large law firm recalcitrance, I consulted my economist friend Madam Smythe, who told me: “On first glance, the legal market looks competitive. The scores of large, global law firms with good reputations should not fool you. Once a company retains a firm, a mini-monopoly ensues; just one bite at the apple - then switching costs skyrocket. It’s diabolical. I’ve run the numbers: law firms are natural monopolies. They have too much market power, which they use artificially to raise rates and corner the market on talent.”

Out of my commiserations with the plight of the poor GC, suddenly, the solution emerged: regulation. Corporations should engage lobbyists to spur federal oversight of the monopolists. The lobbying cost is a small price to eliminate large law firm monopoly rents. Yes, GCs, who have tried every trick in the book, can finally rest - regulation will rescue them.

Now, Dear Reader, if you're inferring that the "modest proposal" title and Ron's reference to his mythical "economist friend Madam Smythe" mean the piece is tongue in cheek, I suggest you ask Ron.  But the substance of the GCs' anger, frustration, and resentment is something worth taking seriously, and the discussion that follows generally did just that.

David Johnson, a professor at New York Law School, chimed in next:

Ron Friedmann suggests in a recent blog post that large law firms should be regulated because they abuse some kind of "natural monopoly" power.

With all due respect to Ron, who often has interesting outside-the-box thoughts regarding the profession, and even though I'm not sure how serious he is, that's crazy talk.

It is not even good economics/antitrust analysis. Sure, switching costs may be high once a company gives a big chunk of business to a firm, but firms are always competing at the margins for new clients, so their practices are constrained by that competition. There is no way the government would be convinced that law firms gain whatever "power" they have other than through skill, foresight and industry. It is even unethical for a firm to leverage any power it has as a result of high switching costs into other markets.

Nonetheless, there may be a seed of an idea insofar as companies could come together to articulate some best practices compliance with which might be made a condition of entering into a new relationship with any firm. And there is no reason why every company has to bear the burden, alone, of "enforcing" such standards and monitoring compliance. So maybe there is a way for the client side of the market to collectively increase the costs to a law firm of "switching away" from adoption of some set of practices that companies generally agree should be followed.

That would be a different, and far more efficient, form of bringing some "regulation" to large law firm practices.

Paul Lippe then provides a schema around which to organize the discussion:

I understood Ron's post to be somewhat facetious in the spirit of Swift's essay http://en.wikipedia.org/wiki/A_Modest_Proposal, but it does raise an important point. I first became a GC in 1988, almost 20 years ago. There is little that was said in Portugal that is different from the critique offered in 1988. So, is it

A. The critique is invalid, the legal market works the way it should, and GCs should stop whining;
B. The critique is valid, things take a while, and now we'll see change;
C. The critique is valid, but the structure of the Legal market impedes change;
D. Regulation is the only answer; or
E Other.

Among others, I invite my friends Gillian Hadfield, Bruce MacEwan and Jordan Furlong to respond, and perhaps Gillian can share a little about her upcoming event(s)appropos of these issues.

Thanks Paul

Jordan Furlong, editor-in-chief of the Canadian Bar's chief publication, votes for Paul's option "C:"

Ron's Swiftian turn -- Bruce would appreciate the reference to "Madam Smythe" -- seems appropriate to the situation. Swift's satire was grounded in his very real outrage and frustration, and while the stakes aren't as high as in 18th-century London, I can appreciate that GCs must sometimes feel like giving up the fight in despair, powerless to make any progress towards more effective business relationships with their law firms.

But while hardly anyone would really endorse government intervention, that unlikely outcome might still prevail if firms don't watch themselves. Law firms are nowhere near as wealthy and influential as their biggest clients, and provoking or prolonging a fight with entities way above your weight class is foolish. Populist lawmakers + corporate campaign contributions + widespread anti-lawyer animus = a lethal combination. Lawyers receive a lot of protection from their status as unique, independent professionals who constitute a significant pillar of a free and democratic society. But if they operate less as professionals and more as complacent businesspeople in a rarefied marketplace, they court serious danger.

I think we're closest to position C on Paul's list, and fundamental structural obstacles invite equally fundamental intervention. But the legal profession still possesses, for now, the ability to reform itself and dictate more attractive terms for a new relationship with clients. I'm not terribly optimistic, though -- there's not much leadership on this point evident in the organized bar right now.

Gillian Hadfield, a professor of law and economics at USC, brings to bear the heavy artillery of competitive market analysis to argue that it's the very complexity of law—a condition created and maintained by lawyers—that is responsible for the "low level of competition:"

Several years ago I wrote an article that argued that the underlying structural feature that generates a low level of competition in law (both over price and product) is complexity. (This is in a Stanford law review article called The Price of Law available at my website https://works.bepress.com/ghadfield) Complexity creates specialization, ambiguity, difficulty judging and comparing legal quality etc. So the question becomes why does law stay so complex, indeed become increasingly complex over time?

Here I think the problem is the regulatory structure of legal markets--which are among the most heavily regulated in the economy. It's just that the regulation is supplied by lawyers themselves through bar associations and the judiciary. The complexity of law is attributable, I think, to the closed nature of the markets here: without the ability to form corporations, seek venture capital, attract innovators who have not been through the training process of lawyers, it is very hard for the market to spur the only real type of change that can reduce complexity and cost and that is innovation in the underlying dimensions of legal inputs.

Why do we need a rule to determine a contract dispute that takes 100 pages of appellate opinion to explain, for example? Why do we need millions of documents to resolve a patent dispute? Why do we need 400 page agreements to effect a transaction (to respond to the complexity of legal rulings real and anticipated?) These are the underlying dimensions of demand. The smart innovator in law, if they could exist, would figure out how to meet legal needs -- for assurance in a contract relationship or protection against risk re-allocation or assessment of liability exposure or ownership of a patent--with a more streamlined product. Until there's a return for innovation and pressure to innovate--because of the risk to established firms that their modus operandi is about to become obsolete--little is likely to change.

Next up is yours truly.  In an attempt to be even-handed, I decided to take a swipe both at the GCs (questioning the sincerity of their desire for innovation) and at the organized bar (which is such a target-rich environment that it was hardly any fun):

Taking Ron's "modest proposal" at face value, my reaction is that it's precisely regulation that's contributing to the problem: Regulation of lawyers by lawyers and for lawyers. What might shake things up is not Congress second-guessing how to protect the Fortune 500 and FTSE 100 corporations from themselves--with Congress' congenital and exquisite obliviousness to the law of unintended consequences--but removing the stranglehold of 51 state bar associations, bar examining authorities, and the ABA itself. Can anyone still say with a straight face that there is any remotely beneficial purpose to such requirements as ABA accreditation for law schools, transparent restraints on trade masquerading as "ethical" proscriptions (no sharing of profits with non-lawyers), and the medieval practice of determining which regulatory authority has jurisdiction over lawyers and firms based on brute force physical presence? Why can't law firms choose, as corporations can, to submit to Delaware or New York or California law and be done with it? What is the economic justification for the need to engage "local counsel?" Why aren't the ABA's Model Rules a per se antitrust violation? I could go on...

But I actually have a more subversive suggestion, which falls under "E. Other" in Paul's schema: I don't believe GC's really want things to change, for all their trashmouth game talk. GC's want their backsides protected by the imprimatur of the Magic Circle, the New York Elite, or the Skadden/Latham brand name. GC's don't want "good enough" quality; they want top-drawer quality.

And I submit this is not irrational. Legal fees as a percent of deal value (unless you're smaller than the attendees at the Portugal event) are typically not material compared to the i-bankers' fees or the opportunity and other costs of corporate personnel assigned to the deal. Do I think Gillian is wrong that 100 pages of appellate opinion interpreting a garden variety contract clause is idiotic? No, of course it is. But the answer is to eliminate regulation of the bar by the bar and watch a thousand flowers bloom.

Paul rejoins the conversation and introduces the new, and entirely pertinent and fitting, concepts of "quality" and "value:"

My learned friend Bruce makes some very compelling points about the consequences of lawyer self-regulation.

His argument about why GCs don't insist on change, while in many respects descriptively accurate, is rooted in a common fallacy: that spending more on legal services is the same as getting better quality.

Dollars spent on legal work is to quality as LSATs are to intelligence - a somewhat self-referential indicator, but largely of a limited type of the feature measured, and problematic in that it crowds out other definitions and metrics. So for sure if the primary good purchased from a law firm if the firm's reputation to shift accountability, then Bruce's argument is correct. But I'd be curious if anyone can come forth with any data to show that in fact (as opposed to in repute) more expensive law firms produce better results, e.g. can it be shown that the investment banks who had the largest losses on their mortgage portfolios were served by lower reputation law firms?

Once this conversation settles down, I will start a separate string (and perhaps a wiki to really pull something together)on what I consider the core issue: how can we develop a definition of VALUE in legal services that is meaningful and useful, and not simply measuring inputs like hours spent, diligence of lawyers, law school attended or reputation of the firm. With such a definition of value, I think we could expect that some lawyers' reputation and income would go up, but some would not.

b/t/w, I think Bruce's point about regulation is 100% correct, but his point about marginal pricing theory is not - no one pays the price for electricity or medical care or food or seatbelts or anything else equal to what the detriment would be if they didn't have it.

Barend Blonde, a legal consultant from Belgium, introduces the European perspective and casts a vote for "B" in Paul's schema::

From my purely European perspective, I find that you a are a bit quick in abandoning option B from Paul's list: Yes, things take a while.

The arguments I read are valid and exciting, but I think we shouldn't be blinded by the seminars we attend and the forums we visit. The GCs that visit the Lisbon Technology Forum are not your average GCs or and the GCs 'cruising the Ramp' are not 'standard'.

I admire GC of companies like Tyco and Cisco for what they are doing and their value can hardly be underestimated. But the truth is they are the scouts of a Mexican army that is still figuring out what to do. The average GC is still a conservative guardian of the hourly rate. The average GC is not thinking about how to use technology to put pressure on law firm services. The average GC is struggling with the implementation of a decent matter management system.

We just finished a poll among European inhouse counsel. We asked them to rank 10 priorities. 'Improving efficiency in outsourcing work to law firms' came out 7th, 'reducing costs' came out 8th. What keeps them awake? The professionalisation of their departments (internal brand, role, skills, IT) and compliance.

The legal market is a free market. Markets change when there is an urge to change. If the legal market doesn't change rapidly, it just means the sense of urgency is not there yet. Tyco, Cisco and you guys are slowly building it up. Keep up the good work!

Finally, I elaborate a bit on the thinking behind my suspicion that "GC's don't really want to change," by analogy to shopping at Tiffany's:

Paul's thoughts about quality and value are, as usual with Paul, intriguing, as well as a bit of a departure from where I was headed, so a small dose of clarification may be in order.

I violently agree that we lack sensible or compelling measures of the "quality" and the "value" of high-end legal services today. If the shocking durability of the billable hour teaches nothing else, it teaches that we are by and large at a loss to determine value (a/k/a price), since we are throwing up our hands at valuing the output and resorting to the blunt instrument of summing the costs of the inputs (with a profit margin built in, to be sure).

My point about the imprimatur of a brand name, or "quality," as Paul nicely puts it, may be a bit more subtle or at least a bit different than the implication that GC's will pay a price equal to the "detriment...if they didn't have it." My point was that having a Magic Circle or a New York Elite firm's name on your acquisition agreement or your IPO registration or your massive IP licensing deal has an in terrorem effect against challengers. It's like buying your diamond engagement ring at Tiffany's instead of on 47th Street. It may not actually be better quality, but it's perceived that way, and at some (I would suggest fairly self-aware) level that's precisely the bargain the buyer is striking.

That's what I meant by "GC's don't really want things to change." They want Tiffany to stay in business, and more importantly, to stay in business on the Tiffany business model--not the 47th Street business model.

Finally, although no one asked me, as an erstwhile student of industry structure and antitrust law, the high-end legal industry doesn't remotely resemble an industry susceptible to oligopolistic or cartel-like behavior. Even the Chambers league tables show pretty consistent turnover in who's up and who's down in M&A, debt and equity offerings, etc. Sure, many or all of the players are the usual suspects, but their individual market shares change rapidly and continually.

The floor is now yours:  Email me (bruce at adamsmithesq.com) with your observations.  And, if there are any GC's in the audience, it's high time to stop lurking and start speaking up. 

• law firm competency
• client satisfaction, and
• alignment of the firm's performance with the client's culture.