There has been a shift of legal practice among many larger law firms over the past two decades.  The change does not involve client assertiveness, pricing or any of the usual topics the media typically cites as representing sea changes in the legal profession.  Instead, it is centered on the role of litigation in driving law firm revenues and firms’ ability to compete for the most attractive litigation matters.

Litigation Dependence

Twenty years ago, in the middle of the 1990s, general practice large law firms were heavily dependent on transactional practices, which made up 60 to 70 percent of their total revenues.  Litigation (inclusive of practices like employment and bankruptcy) made up the remaining 30 to 40 percent.  Today, that balance between transactional and litigation has flip-flopped and litigation makes up 60 to 70 percent of most firms’ practices.

The driving influence of this change was unquestionably the two “white collar” recessions that have occurred over the past dozen years.  During the run up of the technology industry from 1997 to 2002, the total U.S. spend on legal services increased 39% to $173 billion – more than double the growth of the previous 20 years.   But in 2002-2003 the technology “bubble” burst driving the first recession that significantly affected law firms.  Revenue and profits plunged and many large law firms responded by laying off associates, primarily in transactional practices.  When the transactional market began to recover with the growth of hedge funds and other funding vehicles, law firms found that rebuilding a transactional practice was difficult and it was easier and more profitable to continue their dependence on the flow of litigation work. But no one complained; in only five years from 2002 through 2007, the total value of legal services in the U.S. rose 50% to over $250 billion.

Then, with the recession of 2008, more transactional associates were laid off and firms were pressed to deal with underperforming partners, many of whom where transactional lawyers whose practices had never recovered.  The balance between transactional and litigation practices was permanently skewed.

Law Firm Bifurcation

The recessions of the 2000s had another significant impact on large law firms. The available transactional work was increasingly funneled to capital market cities – primarily New York, Chicago and San Francisco.  During the technology boom and the years that followed the tech bust, large investment banks, venture capitalists and investment funds grew in size and influence.  “Too big to fail,” also brought about, “Too big not to use,” for most corporate borrowers.  So for securities transactions, even mid-sized companies in the heartland of America found themselves dealing with financing from large capital sources in New York.

Not surprising, underwriters, bankers and lenders had influence in determining which lawyers were involved in their transactions, and their preferences tended to run to law firms with addresses on Wall Street or LaSalle Street.  As a review of the League Tables for the past dozen years shows, for non-capital market firms the amount of transactional work available and its size and sophistication declined dramatically.

Increased Competition for Litigation Work

With less transactional work available to the firms outside capital markets, more firms were chasing litigation.  At the same time, three additional factors affected the litigation marketplace.  First, tort reform grew dramatically to the point where 34 states now have a limit on punitive damages and 23 limit non-economic damages.  As a result, the dollars at risk decreased, as did clients’ vigor in defending cases.  The volume of cases didn’t go down but the value clients placed on them and correspondingly, the fees they were willing to pay did.

Second, corporate general counsels and business owners became more experienced to doing business in foreign countries.  In the process they became more accustomed to international arbitration and concepts such as “loser pays,” which helped make them less accepting of the costs of American style litigation.

The third factor was the sheer volume of lawyers.  There are 1.4 million law school graduates living in the U.S. of whom a little over 800,000 are actively practicing law. That’s one lawyer for every 222 people in the United States (amazingly, more than one out of every 4 people working in Washington, DC is a lawyer).  And we continue to pump out lawyers with the class of 2013 reaching 45,000 graduates.  As a result, NALP reports that almost half of the 2011 and 2012 law school graduates do not have a full time job that requires a law degree.  Throughout the U.S., law firms are suffering from staggering over capacity and the need to fill the plates of hungry lawyers in large law firms drives the push for lateral hiring and the aggressive growth of business development training.

Part of the difficulty is the manner in which litigation lawyers generate business.  Traditionally, large amounts of litigation work come from referrals.  It was not unusual in some firms with large transaction practices to see 80 percent of their litigation come from their own firms’ existing transactional clients.  Similarly, big chunks of litigation came as referrals from other law firms because the case was situated in the recipient’s local jurisdiction.  Now with smaller transactional practices, the opportunities for internal referrals have decreased.  At the same time, firms that historically referred cases located outside of its jurisdictions to local counsel find themselves suffering from the same over capacity as everyone else.  As a result, out-of-town have less of a tendency to refer a case and are more likely to send a lawyer to the location, get admitted and try the case themselves.

Strategic Implications

For law firms dependent on litigation for a majority of their revenue, particularly those located in second tier cities, the strategic implications are staggering.  Their strategy can no long focus on simply adding capability and spending money on marketing.  The days of the “If we build it they will come” strategies are largely over and, to remain profitable, firms will need to synchronize their resources and the flow of business.  This probably means focusing on at least four new strategies:

  1. Demonstrable competitiveness.  The traditional methods of marketing a litigation practice typically involve vague references to the law firm’s litigation capabilities, its rankings in Chambers and how many litigators were named “Super Lawyers.”  However, the inherent puffery involved in law firms’ self-promotion has lowered the credibility clients place on undocumented statements by lawyers.  Instead, clients are impressed by quantitative measurements of capability, even if competing firms are unable to produce comparable statistics.  While confidentiality limits the ability to discuss actual case outcomes, firms may consider developing statistics to demonstrate that their litigators produce highly successful outcomes at reasonable prices.  For example: number of federal and state cases handled by type, percentage settled without trial, verdicts compared to final settlement offers, average fee compared to dollars at risk, etc.
  2. Focus on referral sources. In general practice firms, the target of litigation business development needs to be on referral sources as much as potential clients.  This is especially valuable for law firms in smaller cities seeking referrals from capital market firms representing local corporations in transactional matters.  Proposals and presentations to such firms should be built on techniques for maintaining the referring firms’ profitably while lowering clients’ overall cost.
  3. Integrate litigation into transactional practices.  Even with decreased dependence on transactional practices, business and real estate lawyers within a firm represent its greatest potential source of litigation cases.  An effective business development technique is the high profile involvement of a litigator in all transactional matters to advise on issues such as contractual enforceability and the decrease of litigation risk.  Even if some of the litigator’s time is eventually written down, it provides a comparatively low cost way of building a relationship with the client.
  4. Matching growth to capacity.  Despite law firms’ claims that they only hire to fulfill need, firms constantly add lawyers to do work they hope will come in the door.  Their fear is that a client will show up and the firm will not have the capacity to take on the engagement.  The result is a chronic lack of work causing a spiral of the quality of clients and practices in order to fill plates.

To operate a profitable litigation practice, law firms are going to have to be scalable to the volume of work available.  That means that their professional and paraprofessional workforce will have to be adjustable at a moments’ notice (one firm that is pioneering scalability has an objective of cutting marginal staffing and support costs to zero within 48 hours of a case settling).  By extension, scalability requires that senior associates and non-equity partners be capable of functioning as much as supervisors and trainers as practicing lawyers.   It involves the creation of a workforce that has heavy components of staff lawyers hired on an hourly basis to provide true capability with workflow, and telecommuting and off site professionals to avoid overhead expenses of occupancy and technology.

None of these strategies represents a silver bullet for law firms’ overcapacity of lawyers for the volume of litigation work available.  But they are a start.