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February 06, 2007

WHAT’S ALL THIS GARBAGE ABOUT BUSINESS MODELS?

In his recent speech at Northwestern School of Law’s 34th Annual Securities Regulation Institute (a link is in the margin under the heading “Articles of Interest”), Cisco General Counsel Mark Chandler made a couple of points about business models.   In discussing what he considers to be the legal industry’s “business model under distress” (emphasis added), Chandler said:

The systems exist today to change the delivery of legal information to clients. But that change would challenge a model that today delivers high profits. Every big company, including Cisco, is using those systems to make our support services more effective, and to drive down the costs of providing service. Law firms are not . . . Today, there is little incentive for law firms to apply risk-reward logic to the amount of legal services provided. And General Counsel know that.

The growing scope of knowledge availability will endanger this system.

. . . [T]he greatest vulnerability of the legal industry today is a failure to make information more accessible to clients, to drive models based on value and efficiency. The present system is leading to unhappy lawyers and unhappy clients. The center will not hold.

I’m sure many, if not most, lawyers who read this or who have read Chandler’s speech are thinking, “What does all that talk about business models have to do with the practice of law as a business?  And, more importantly, what does that garbage have to do with me and why should I care?”

An easy way to put this into perspective is to think of law firms as service sector businesses whose single largest asset is intellectual capital.  Some of that intellectual capital is structural capital (e.g., technology, systems, data, documents, processes, methodologies, and processes); some of it is customer capital (e.g., strategic relationships, client relationships, and client contacts); and, some of it is human capital (e.g., the knowledge, experience, and skills of the organization’s people).  Like, say, a financial institution that makes loans with its assets, law firms charge others for temporary access to and the right to use their assets.   The scarcer, or more difficult it is to gain access to, such assets, the more such access costs.  The more plentiful, or easier it is to gain access to, such assets, the less such access costs.  (Think about the effect of the advent of real estate mortgage securities on the home loan industry.)

I’m going to go out on a limb and say that most law firms probably have some form of a business model, whether tacit or explicit, and it is captured for the most part by what Chandler calls the “one to one client relationship with a lawyer who bills by the hour.”  Gary Hamel, a leading strategic and management “thinker,” says, “[A] business model is simply a business concept that has been put into practice.”  However, in his book Leading the Revolution, Hamel goes on to note that the business concept embodied by the business model includes 4 major components:  Core Strategy (business mission, product/market scope, basis for differentiation); Strategic Resources (core competencies, strategic assets, core processes); Customer Interface (fulfillment & support, information & insight, relationship dynamics, pricing structure); and, Value Network (suppliers, partners, coalitions).  These 4 components are linked together by 3 “bridge” components, defined by Hamel as being:

“Configuration” - the unique way in which competencies, assets, and processes are combined and interrelated in support of a particular strategy”; the link between Core Strategy and Strategic Resources; great strategies and their business models are the product of a unique blending of competencies, assets, and processes.

“Customer benefits” - the particular bundle of benefits actually offered to the customer; the link between Core Strategy and Customer Interface; refer to a “customer-derived definition of the basic needs and wants that are being satisfied.”  (Emphasis added).

“Company boundaries” – the decisions the business has made about what it does itself and what it contracts out; the link between Strategic Resources and Value Network.

Think about each of the bridges - configuration, customer benefits, and company boundaries - as they typically exist in law firms today.  And then contemplate that, as Hamel warns:

In a discontinuous world, business models don’t last forever.  And when they begin to decay, the temptation is to pour human energy and capital into improving the efficiency of the operating model [what people actually do on a day-to-day basis].  But better execution won’t fix a broken business concept.  Ultimately, you need to invent new business concepts or dramatically reinvent those you already have.

In an interesting 2004 case study of eLawForum (a link to the study is in the margin under “Articles of Interest”), Harvard Law School Professor Clay Christensen and Scott Anthony summarized:

Law firms are among the most profitable and least risky businesses in the world.

. . . By granting law firms what amount to exclusive relationships, corporations have created a sole-source market that sacrifices their ability both to shift risk to their law firms and to reduce legal fees significantly. Insulated from price competition in this closed environment, law firms have kept profitability high by raising their hourly rates while simultaneously dramatically improving productivity through specialization.

. . . But because corporations accept the sole-source market, law firms play a cat-and-mouse game with the billable hour and cost-plus pricing, hoarding productivity gains and saddling clients with both cost and outcome risks.

The authors go on to say, in more detail, in talking specifically about specialization and the accelerating impact that information technology through proprietary retrieval systems such as those developed by CCH, Lexis-Nexis, and Westlaw has had on such specialization and the business of practicing law:

. . . The growth of specialization means that most corporate legal work does not involve complex problem-solving. With the right experience, specialists can easily recognize patterns and apply familiar tools so that they do not need to “reinvent the wheel.” Pattern recognition dramatically increases efficiency. Hourly rates assume everything requires complex problem-solving.  While few industries have experienced greater productivity gains from specialization, the absence of a competitive market enables law firms to hoard cost savings instead of passing them along to corporations.

. . . It is extremely difficult to avoid wasting corporate assets (emphasis added) within the confines of the sole-source/billable hour/cost-plus market. With one hand, law firms give discounts on hourly rates to their largest clients. With the other hand, they take back what they have given by raising the base hourly rates to which the discounts are applied and increase the number of hours they bill to do the same work. Law firms are masters of the cat-and-mouse game of the billable hour. As long as they respect the procedures mandated by the law department, law firms can circumvent any attempts at cost reduction by controlling the two key variables—the base rate and the number of hours spent.

Chandler’s point, which builds upon the legal market excesses identified by Christensen and Anthony that long have been manipulated by law firms, is that technology is transforming the nature of knowledge accumulation and distribution and that the growing scope of knowledge availability will force law firms to change the way they do business.  Faced with the prospect of innovations that likely will be disruptive to their business system that “looks like the last vestige of the medieval guild system to survive into the 21st century,” access to what law firms know, how they get it, how they use it, how they deliver it, and what they get paid for it, is under attack.  That’s why all this garbage about business models.

Chandler also mentioned “metrics” in his speech.  I’ll get into metrics in my next posting.

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