Why Law Firms Are Rigged to Fail

The legal industry is in crisis. But its archaic partnership models are built for inertia. 


The legal world is paying its final respects this week to Dewey & LeBoeuf, which on Monday became the largest American law firm to ever file for bankruptcy. Dewey was by all accounts spectacularly mismanaged -- up to its partners' collar-stays in debt and weighed down by bloated, guaranteed contracts it couldn't afford to pay, it quickly collapsed as its top talent bolted for the door after signs of financial trouble. But while its failures were specific, they are representative of a broader truth that many in the industry are only now beginning to acknowledge.

Most big corporate law firms aren't built to run like modern businesses.*

Over the last few decades, being a big flush law firm was easier than selling umbrellas during a rainstorm. Before the financial crash, U.S. demand for highly-skilled legal work grew unabated for decades, which allowed firms to increase their billing rates (and their profits) year after year without clients asking questions. Top corporate lawyers raked in millions of dollars a year. A few firms began earning more than $1 billion in revenue.

Today, the business climate couldn't be more different. Cost-conscious corporations are cutting back on their legal budgets. Upstart tech companies are automating tasks like document review that firms used farm out to young associates, generating huge profits along the way. It's a lean new world, and they're simply not equipped to adjust.

Large law firms are hampered by two things. Their structure and their culture.

These are partnerships, run for lawyers by lawyers. In the industry's clubby old days, when attorneys would stay with a single smallish firm for their career, this worked fine. In the age of the international mega-firm, it's cumbersome (you try making big, bold decisions when you need 100 or more attorneys to agree with you).

It also keeps leadership monomaniacally focused on yearly profits, even at the expense of long-term investment or strategy. If earnings fall at a public company, the stock price may dip and investors might grumble. But neither the employees running the show, nor the company's customers, will disappear. Not so with a law firm partnership, where "profits" are essentially salary for the top talent, including the rain makers who bring in business. If earnings drop, so do their paychecks. And that's where culture becomes an issue. These days, it's extremely easy for a partner who is displeased with their pay to pick up and move elsewhere. Many firms have turned to poaching talent from their competitors in the hopes of also nabbing their books of business. When profits drop, partners almost inevitably split, or at least start shopping for better prospects.

Thus, law firms have to operate with a short-term outlook. But the problems they're facing are long-term in scope. As Indiana University Law Professor William Henderson wrote yesterday for The AmLaw Daily, fundamental aspects of their business models are under attack from entrepreneurs who are finding ways to do tasks cheaper and more efficiently. There are companies like Axiom, a combination legal temp agency and consulting firm, which offers clients low-cost, high-skill attorneys. In 2007, it had 150 lawyers. Now it employs around 1000, renting their services to companies like Cisco and American Express. Then there are "e-discovery" firms like Novus Law, which are automating the pre-trial phase in litigation where each side digs through documents. Both of these companies strike at the core of the big firm business model, by offering a cheaper, quality alternative solutions for tasks which once provided large law firms with high margin work.

I don't have the silver bullet for fixing the partnership model (if I did, I'd be publishing my ideas in a McKinsey brief). But it's clear that, to compete with these young companies, law firms will have to imitate multinational corporations. They'll have to replace some workers with software. They'll have to pay some mid-level attorneys less. They'll have to find new ways to make money to pay for the work they're comfortable doing. And they'll have to move quickly. The next Dewey isn't so far away.


*As always, my disclosure: I previously worked on the business side of a corporate law firm.