#45 - BigLaw in the 21st century

Disrupting the billable hour

I.

“Even those [law firm associates] who seem to succeed often confess they have been lured into a Faustian bargain and that for all their material success, they have lost their souls.”

Towards the end of an interview I had with a corporate law firm, when it was my turn to ask the questions, I popped the following: “What does it take to be successful as an associate at your firm?” The answer was a classic: “Well, you need to be humble. You need to understand that the work you’re doing will very often be unglamorous, and you’ll be doing a lot of it, so if you think the work is beneath you, then you won’t last long.”

It’s not a secret that many corporate lawyers are profoundly unhappy. The reason stems from a key aspect of the law firm business model: The billable hour. For example, let’s take a hypothetical and ambitious first-year associate at a top corporate law firm. Like most other first-year associates, our associate makes roughly $200,000 per year all-in. She also needs to keep track of her hours assiduously in order for her firm to correspondingly bill the client for her work. Junior associates are expected to bill around 2,000 hours per year, but let’s say our hypothetical associate is so ambitious that she wants to bill 2,200 hours for the year. The amount of time she spends on the job also doesn’t map 1:1 onto the amount of time she can bill. According to Yale Law School, our associate will probably need to be at work for over 3,000 hours (about 60 hours per week with no weeks off) in order to bill 2,200 hours. If the law firm bills the client for those 2,200 hours at $500 / hour, the law firm generates $1,100,000 in revenue. The more our associate bills, the better for the firm, and the more she can climb the ranks. However, our associate captures very little of the economic value she creates ($200k vs. $1.1m), and while the firm is billing the client $500 / hour for our associate’s time, our associate herself makes a comparatively measly ~$65 / hour.

II.

I have not met a single law student who praises the billable hour. Everyone knows that it sucks, yet it still exists. Why?

My theory is that the billable hour model is just one piece of a huge, ossified flywheel that continues not only to generate outsized revenues for law firms, but also to attract young prestige-hungry lawyers and to produce high-quality work for clients:

While each piece of this flywheel are important, I think a couple are particularly interesting:

• Prestige: One might think that at some point, young lawyers have had enough. “I’m stick of this billable hour BS, and I’m putting my foot down! Pay me more or work me less, or I’m out.” But no. Many fresh law school graduates continue flocking to top law firms that work them to the bone, and my theory is that it’s in no small part because of prestige. I’ve written previously that the legal profession is highly stratified. You’d hope that the rankings end at law school, but in fact, even corporate law firms are ranked, and many law students choose to work at firms based on those rankings. Law firms desperately cling onto their ranks and try their hardest to crawl their way up into the “V50” or “V20” or “V10” or whatever rung of the ladder is up next for them because they know that the ranking boost will increase their talent flow. Prestige is a form of lock-in.

• Top clients: One might also think that at some point, clients have had enough. “I’m sick of these law firms milking my cash. Charge me less, or I’m taking my business to another firm!” But again, no. The legal world is so complex nowadays, the potential penalties are so large, and the costs of losing a corporate lawsuit are so tremendous, that the bigwig business executives will sleep easier at night knowing that their legal work is in the hands of a V5 law firm with the best talent. So the clients grumble all the way to the bank as they cut their multi-million-dollar checks to the suit-people at Skadden, Arps, Slate, Meagher & Flom (the name of a firm!).

III.

Of course, I write this all tongue-in-cheek. I like corporate lawyers, they’re very smart people. But I do wonder where the tech ~disruption~ is. Will it ever come?

I’ve seen two startups make ambitious attempts to disrupt the BigLaw billable model (both attempts ultimately failed): Clearspire and Atrium. Each is instructive in thinking about the future of BigLaw in the 21st century.

Clearspire, founded in 2009, built a “two-company” model: (1) A law firm staffed with professional lawyers who actually completed all the legal work for clients, and (2) a services company that provided software and other support for the law firm. With Clearspire’s integrated technology platform, Clearspire’s lawyers could work together from anywhere around the world, enabling Clearspire to reduce office requirements, increase efficiency, and reduce costs. Clearspire also billed clients using a “statement-of-work” (SOW) process whereby each client matter had a fixed cost rather than a billable hour variable cost, enabling greater price predictability, accountability, and transparency. Unfortunately, Clearspire ultimately failed because clients were unfamiliar with the Clearspire SOW model. Clients wanted to stick with the billable hour. Clearspire apparently hypothesized that large corporate clients would be attracted to its model because of the clients’ significant volume of work and the substantial savings, but this was also wrong. The more established the corporate client, the more it preferred an established, traditional law firm.

Atrium, founded in 2017, also built a two-company model. Its law-firm arm offered a suite of legal services specifically for startup companies and charged clients on a subscription, rather than hourly, basis. Atrium’s software arm developed legal software in-house to accelerate its lawyers’ work. Near its height, Atrium grew to about 150 employees and was even apparently able to poach a bunch of top-notch lawyers from renowned Bay Area law firm Wilson Sonsini. However, in January 2020, Atrium decided to lay off all of its lawyers, focusing instead the legal software portion of its business. A couple months later, Atrium shut down entirely, citing an inability to figure out how to make a dent in operational efficiency. In other words, they were burning far more money than they could make. According to Atrium’s founder Justin Kan in a tweet storm explaining Atrium’s shutdown:

Justin Kan @justinkan

We should have moved more quickly to a flat rate hourly model and iterated the business model. We didn't do enough turns of business model iteration quickly enough.

I encourage you to read the entire thread (it’s very insightful!), but the Tweet above stood out to me in particular. Is Justin saying that … he should have built something more similar to the billable? 😳

Okay, to be fair, a “flat rate hourly model” isn’t necessarily the same as the BigLaw “billable model” as it currently stands. But what I think Justin was getting at (again, read the entire Tweet thread) was that the subscription revenue model was not operationally efficient. With so many Atrium lawyers needing to be paid and so little revenue coming in, Atrium was drastically in the red. In an attempt to increase operational efficiency, Atrium pivoted to software-only, since software margins at scale are amazing. However, the company had so much inertia that it couldn’t really change course. Part of this inertia came from the fact that the provision of legal services is not a quick, one-time thing like checking your News Feed might be. Transactional legal services often require days, if not weeks, of negotiations and contract-drafting, and to the extent you’re involved in litigation, it can take years. It’s hard to iterate, and Justin just couldn’t see a viable path to the green.

IV.

Unlike Clearspire and Atrium, most of the legal tech startups aren’t disruptive to the BigLaw model. Instead, they are what Clay Christensen might call “sustaining” innovations because they prop up the existing BigLaw value chain. These companies sell / license legal software to BigLaw firms to help their attorneys produce higher quantities of higher quality work, feeding the aforementioned flywheel. For instance, here’s a chart from Tracxn on the top legal tech startup business models by funding:

With the exception of “Legal Forms,” which is serving a different legal market than big corporate law firms, the remainder are essentially designed to fit within the existing BigLaw value chain.

So, again, I ask: Where is the BigLaw billable going in the 21st century?

V.

A starry-eyed 20-year-old me was absolutely sure the professions would be disrupted “soon” thanks to artificial intelligence (robot lawyers, robot doctors, etc.). Now, I’m a bit more skeptical, for precisely the reason that many of the tech innovations in the professions are sustaining rather than disruptive.

However, let me end with one final idea for the future of the professions. From The Innovator’s Dilemma (emphasis mine):

The second element of the failure framework, the observation that technologies can progress faster than market demand . . . means that in their efforts to provide better products than their competitors and earn higher prices and margins, suppliers often “overshoot” their market: They give customers more than they need or ultimately are willing to pay for. And more importantly, it means that disruptive technologies that may underperform today, relative to what users in the market demand, may be fully performance-competitive in that same market tomorrow.

But is it possible for the professions to really “overshoot” in terms of performance? After years of complex corporate litigation, the winning party usually doesn’t think, “You know? My lawyers were just too damn good, I wish they were a bit worse so I could pay less!” No, the winning party is wiping the sweat of their brow as they go grab a drink and heave a sigh of relief. Similarly, if I’m going in for brain surgery next week, I’m going to try my absolute hardest to find the best possible brain surgeon out there. When the stakes are high, good simply isn’t good enough. At the high end of the professions, it’s impossible to be too good. It’s impossible to overshoot.

This doesn’t mean that the professions will never get disrupted. It just means that the high-end of the professions will be the very last to get disrupted. While new tech and business models might “underperform today, relative to what users in the market demand,” they may be “fully performance-competitive” at some point in the future. Indeed, if you graph tech performance over time, this is how disruption works:

Today, “low quality uses” in the law, where existing legal solutions “overshoot,” are in small things like parking ticket disputes. However, these uses are not in the purview of BigLaw, which is the “most demanding use.” Companies like DoNotPay are using software to disrupt the low-end of the market, so I guess only time will tell whether and when these companies move up-market to disrupt the legal monastics sitting atop the law firm rankings.

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📚 What I’m reading

1. Power to the Person. (Not Boring)

2. NFTs and CBGBs: How’s that for a clickbait title. (Alex Danco)

3. The hidden reality of U.S. foreign policy. (Glenn Greenwald)

4. A better way to think about conspiracies. (New York Times)

5. To take or not to take (COVID stimulus checks). (New Ideal)

6. When SPAC-Man Chamath Palihapitiya speaks, Reddit and Wall Street listen. (Wall Street Journal)

7. The short-term, middle-term, and long-term future of the coronavirus. (STAT)

8. As the insurrection narrative crumbles, Democrats cling to it more desperately than ever. (Glenn Greenwald)