Middle Office Outsourcing and Large Law Firm Management

Bruce MacEwen, a highly regarded law firm consultant and legal market thinker, wrote an excellent Adam Smith, Esq. blog post, The Boundaries of the Firm, and Constraints (28 Dec 2010).  In it, he discusses Nobel Laureate Ronald Coase’s The Nature of the Firm, a seminal work that explains why firms (companies) exist and limits to their size. MacEwen also has provocative observations about large law firm management.

The blog post summarizes Coase:

“The balance between which activities should be inside, and which outside, a firm is constantly subject to refinement, adjustment… The evolving boundaries of the firm are, by their nature, growing and shrinking as technology (particularly telecommunications) advances.”

This is not just academic for the legal market. Thomas Friedman pointed out in the The World is Flat that low cost fiber optic cables allowed India to participate more fully in the global economy. That phenomenon gave rise to legal process outsourcing (LPO), which had its start in India, though today occurs from multiple countries, including low cost US and UK locations.

MacEwen focuses on another factor that can change the boundary and size of an organization: management. He writes

“One of the resources inhibiting the indefinite expansion of firms–or rather, a resource whose scarcity inhibits that expansion–is management talent.”

That observation leads him to consider law firm management. On the plus side, MacEwen notes that large law firms, unlike corporations, fully align ownership and management. And they are good at recruiting outstanding legal talent. On the minus side, however, they do poorly with professional staff. MacEwen writes:

“When it does come to ‘non-legal staff’ (an insulting and crabbed formulation in itself), we do not remotely place the value on them that we should, which means that we:

• Select from an insular and often poor talent pool (‘I see that you haven’t worked for a law firm before…..’);
• Aren’t willing to pay them what they’re worth on the free market;
• Tend to ignore or downplay or second-guess their advice once they’re on-board.”

I agree that partners often under-value those without a JD and second-guess staff advice.  I disagree that firms are insular.  Firms are more open today to hires from outside the legal market; indeed, some specifically seek talent not from a law firm.  I also disagree about compensation.  Senior law firm managers I know talk about “golden handcuffs:”  their sense that no other industry would pay nearly as well as their firm.

In my view, the biggest impediment to more effective law firm management may well be distraction.   From below, daily operational distractions are endemic: make sure secretaries are properly assigned for the day, supervise basic accounting and billings tasks, update mailing lists, organize an event, and answer questions about benefits. All necessary but for reasons I cannot explain, way too many quotidian issues regularly rise to senior levels in law firms. With all the daily distraction of operations management, senior managers lack the time to focus on strategy and planning.

From above, frequent unreasonable demands from a small minority of partners are a major distraction. Owners as managers may indeed align interests but also create problems.  In many firms, senior staff spend too much time placating a small percent of overly demanding partners.  Management is compelled to provide service above and beyond the reasonable, for example, laboriously producing reports that will not change any decisions or frantically marshaling an army to meet a demand that lacks solid business justification.

In Coase-ian terms, “drawing the organizational boundary in a different place” can mitigate distraction. Specifically, outsourcing the middle office – functions such as marketing support, business research, word processing, IT, and finance & accounting – frees senior law firm staff to serve as real managers.

By outsourcing higher volume tasks, management no longer needs to spend so much time fussing over operations. That becomes the outsourcing provider’s problem. The provider runs much of the daily operations under the guidance of senior staff. Of course the transition to this model takes time, but once it happens, senior staff are freed to focus on planning and strategy.

Working with a third-party provider can also reign-in inappropriate partner requests.  Effective outsourcing agreements establish service level agreements (SLA), metrics, and a governance procedure. This systematic approach to providing service identifies partners who, for example, always request last-minute, in-depth business research for a pitch…. but never win the business.

Firms can choose to pay for this type of over-done activity but in an outsourcing arrangement, uneconomic requests are at least documented and transparent.  By externalizing costs, firms create visibility and controls which are lacking today. I suspect that the vast majority of partners who use firm resources wisely would appreciate not only reigning in some of their partners, but also service level agreements that make clear what service and turn-around-time they can expect (and what to do if they happen not to get it).

Tying this all back to Coase requires considering transaction costs. Some firms believe that the outsourcing costs are too high.   But compared to what?  As firms have grown in size and complexity and as the loss of pricing power has forced them to exam overhead, they have learned that their internal costs are quite high.   So the case against outsourcing is not as clear as some think.  Moreover, as providers gain experience, their costs go down. So “crossing cost curves” alone may drive more outsourcing.

Firms have not, however, in my view, properly considered the real cost of insourcing.   By focusing only on the cost of full-time employees and on who “owns” and “controls” staff, they miss the hidden distraction costs.  Were they to explicitly consider this, their views about outsourcing might well change.

Perhaps in the perfect world of classical microeconomics, firm-owned and -operated services would incur no distraction cost. But in the real world, daily distractions dull management, a cost that is real but hard to capture. Outsourcing may not be the only answer to improve law firm management, but it is certainly a good one.

Fronterion Predicts Promising LPO Developments in 2011

by Ron Friedmann and Mark Ross

Fronterion, a legal process outsourcing consultancy, recently released Ten for 2011: Top 10 Trends in Legal Outsourcing in 2011, its second annual LPO market predictions.  We comment here on these; bold headings are quoted directly from Fronterion.

1. A Fundamentally Changing Legal Profession
We agree with Fronterion that the legal market structure has changed.  For example,  general counsels have gained buying power.  We do not expect dramatic change in 2011; rather, we think change will be incremental over the next decade.  One recent change has been law departments taking more work in-house.  We think this trend is self-limiting because of corporate resistance to growing headcount.  As companies continue to seek legal costs savings and realize they cannot bring more work in-house, they likely will work with LPOs, either through their outside counsel or directly.

2. Enterprise Approach
Fronterion writes that “A firm‐wide approach by law firms on the use of LPO vendors will become increasingly common as LPO initiatives are led by management who use more formalized corporate structures.”  In our discussions with law firms, we do see an increasingly institutional approach.  Enabling partners spread across multiple offices to embrace LPO requires a truly collaborative approach between the chosen LPO provider and the law firm’s management team.  Over the next five years, we expect many large law firms will have one or two preferred LPO provider relationships and better partner compliance.

3. Onshore Expansion
Fronterion observes that onshore and hybrid LPO delivery models will grow in 2011, reflecting the importance of process and technology as well as low cost labor.  This is consistent with what my colleague Mark Ross and I wrote in Outsource Magazine, A Changing Conversation (Nov 2010):  the question has moved from “should we outsource” to “how to outsource” and “what’s the best way to centralise non-core support functions in a low cost location?”

Both the US and UK have many lower cost locations with good supplies of lawyers and support professionals. For example, in the UK, Bristol, Wales, and Northern England offer significantly lower costs than London. In the US, many Midwestern and Southern smaller cities are much lower cost than coastal cities or Chicago. The choice of location depends on factors such as cost, ethical and legislative restrictions, complexity, amount of communication required, project duration, and comfort with a location.   (The weight to give each is a topic for another day.)   We think, however, that the onshore trend supports moving more work offshore longer term.   As firms realize the benefits of centralizing middle office and legal support domestically, the leap to moving work offshore is smaller.

4. Expanding Client Geographic / Jurisdictional Reach
We agree with Fronterion that LPO will spread from high cost US cities to Texas, the Midwest and the Pacific Northwest and from London to other parts of England.  Why?  Because LPO is as much about process as it is about low cost.   Many US and UK firms operate in relatively low cost areas but lack “law factory” competence: industrializing work with rigorous processes, metrics, and governance systems are not their strengths.

5. Progressive Value Proposition AND 6. Increasing Technology Applications
We take these two predictions together because both involve technology.  We agree that LPOs will create more proprietary technology.   For example, Integreon has invested heavily in proprietary platforms and third-party tools.  But we think this trend has limits.  Law departments, law firms, and LPOs alike must consider the pros and cons of proprietary versus 3rd-party software.   Software development has become easier but the cloud computing trend works against proprietary systems.  So the make versus buy decision today is no clearer today than it was 10, 20, or 30 years ago.  (For provocative views on the potential move to the cloud, see The End of Corporate IT and Moving A Law Firm To Google Apps at the popular 3 Geeks and a Law Blog.)

7. Dynamic Vendor Landscape AND 9. Divergent Vendor Approach
Fronterion expects both consolidation (7) and an LPO market with many differentiated providers (9).  We think these predictions are a bit at odds and that consolidation will be the dominant theme.  Customers often drive consolidation because they want the efficiency and confidence of buying a range of services from a single vendor.  Plus they want the benefits of bigger companies that can scale up for big projects and deliver work from multiple locations.  Maybe not in 2011, but over the next five years, we expect a few dominant LPO players to emerge but to co-exist with smaller, specialized players.

8. Public Acknowledgment
We agree with Fronterion that public acknowledgment of LPO use by law firms and law departments will likely occur in 2011.  Given buyer concerns, a law firm that makes clear it is using LPO services will gain favor with and ultimately greater market share from corporate clients eager for better value.  Of course, after a handful of announcements, many more are sure to follow – a common legal market pattern.

10. Ethical Guidance
We agree with Fronterion that 2011 will see additional ethics guidance on LPOs.    The American Bar Association (ABA) in the US and the Solicitors Regulation Authority (SRA) in the UK are now separately studying legal outsourcing intently.  Both regulatory bodies have confirmed that guidance will issue soon. The ABA has posted a Discussion Draft on its website proposing amendments to Model Rules 1.1, 5.3 and 5.5, while the SRA has confirmed that it will be looking at LPO as part of its consultation on the latest draft of its handbook, which is due to be launched in April 2011.

Now, Even Law Firms are Doing “LPO”

UK law firm Herbert Smith recently announced that it is opening a wholly-owned document review center in Belfast, Northern Ireland.  Belfast is a relatively low cost, onshore UK location.  See Legal Week, Herbert Smith to open Belfast office to handle disputes document review (24 Nov 2010), and the firm’s announcement.

This move is significant, especially coming on the heels of Thomson Reuters acquiring LPO Pangea3.  Herbert Smith is prominent for its strong and large litigation practice.  A couple of years ago, few would have predicted a top-tier British law firm would do this.  What motivated the seeming change of heart and thinking?

Sonya Leydecker, the partner responsible for the Belfast center, explains that the Belfast Center

“will enable us to offer clients a combination of quality, efficiency and value for money. Clients are increasingly looking to their lawyers for more imaginative approaches to the management of disputes. In particular, complex projects such as disclosure are important but can increasingly be systematised and managed in new ways. The Belfast office will make a new range of resourcing options available to clients.”

We have long considered document review as one of several legal functions that can be unbundled from other legal work so that it can be produced more efficiently.  I now use the short-hand term “LawFactory” to describe such work.

One interpretation of the Herbert Smith announcement is that the market now accepts a key legal process outsourcing (LPO) premise: centralize high volume legal work in a single location with lower costs than the main office and manage it with industrial techniques (e.g., clear metrics, quality control measures, and formal service level agreements).

My colleague Mark Ross points out in A Changing Conversation (Outsource Magazine, 17 Nov 2010) that  the discussion among lawyers is shifting from “should I outsource or offshore” to “what’s the best way to centralize high volume work in a low cost location and instill appropriate processes and controls”‘   That question now supersedes location and even ownership.

This development is good for the market.  Clients will benefit as more firms opt for centralized, low cost service operations, which provide better value.  Firms will benefit because they will retain the higher value work for which clients are willing to pay high rates.  And LPOs will benefit because more firms will want low cost centers and many will not want to build their own.

Building and operating a low cost center is harder than it looks.  Many firms will be happy to have their LawFactory work performed by an LPO.  Integreon, for example, has an established low-cost operation in Bristol plus offers the option to move work offshore, where costs are even lower.

What the Entry of Thomson Reuters into LPO Means

By Liam Brown, Matthew Banks, Mark Ross, and Ron Friedmann

Last week saw the most high profile acquisition to date of a legal process outsourcing (LPO) provider when Thomson Reuters, Inc. (TRI) acquired Pangea3. Only a week earlier, UnitedLex acquired LawScribe. What conclusions can we draw from this activity? We think that there are four main points:

1. LPO Market Validated. We think the Wall Street Journal Law Blog post, True Believer: Thomson Reuters Betting Big on LPO Boom, got the most important meaning just right:

“Did you politely nod along in conversations about India and ‘legal processing outsourcing,’ all the while thinking that it was just a fad? That U.S. law firms would ultimately somehow win back the work by figuring out how to do it better, faster, cheaper?

Well, the news that data and information giant Thomson Reuters is buying Pangea3 should extinguish some of that lingering skepticism.”

We agree that TRI’s move validates market acceptance of LPO. Moreover, we think the acquisition is good news for the legal market. We do not have any knowledge of TRI’s plan but we assume that the company will invest in and promote LPO. This will educate law firms and law departments and accelerate growth not only for TRI – Pangea3, but also for other reputable LPOs.

2. LPO Consolidation Confirmed. This news, while noteworthy, is not surprising. Consolidation is natural in a growing market. One year ago, LPO industry analysts ValueNotes released a report on the state of the industry, “Crisis Creates New Opportunities for LPOs”. (See our November 2009 blog post, An Overview of the Latest ValueNotes Legal Process Outsourcing Report for our assessment of the report’s findings.) It observed that more than 20% of LPOs had ceased operating or closed down their LPO operations. The report quoted one of the authors of this post, Mark Ross:

“The coming 12-24 months could prove to be tough for many of the smaller LPO providers, several of whom may simply give up the chase and withdraw from the market altogether. Others will look for an opportunity to achieve the scale increasingly viewed as a prerequisite by potential clients, by either merging with a competitor, or selling to a larger, more stable provider. This activity, together with consistent growth by the leading, large-scale providers of legal and knowledge process outsourcing services will continue to push the industry as a whole further down the path towards consolidation.”

For a long time, we have thought that players in the LPO market would consolidate. The early LPO years, characterized by numerous small or boutique players, was not sustainable.

3. Lawyers Want Integrated, Scalable, and Multi-Service Offerings. Large, diversified, and well-funded companies are likely to dominate the LPO market because buyers of legal outsourcing services will increasingly opt for providers who offer financial stability and scalability through a global, multi-shore delivery platform. They will also seek providers who offer multiple service lines, across the legal services spectrum. In our view, electronic data discovery (e-discovery or EDD) is a key service because it is so closely connected to document review, the biggest component of LPO. Another high growth area for LPO is the provision of end-to-end support for a corporation’s contract management function.

Integreon is already a Tier 1 EDD provider. We built the full spectrum of EDRM capabilities (all the components of e-discovery, which include data collection, processing, hosting, review and production) through acquisition and organically over the last few years. TRI acquired one component, document review software, in July 2010 and could presumably combine that with Pangea3, as well as other EDD businesses it might acquire or build. The technological infrastructure to offer an end-to-end solution to the electronic discovery process will soon become a prerequisite.

We also assist corporations manage their commercial contracts both through proprietary contract management system (CMS) technology and through partnerships with the leading CMS system providers. In a world where multi-national corporations are operating under increased scrutiny and regulatory compliance burdens, while their legal departments are struggling with the “more for less” conundrum, only LPO providers with the domain expertise, global platform and the technical capability to provide support across the enterprise commercial contract lifecycle, can meet the challenges corporations are facing in this arena head on.

4. Legal Domain Expertise is Critical to Serve the Legal Market. Lawyers want service providers who have a deep understanding of law practice. TRI clearly has this deep legal expertise. Its acquisition of an LPO makes us wonder about how LPO will fit in other very large global companies. For example, it is not clear to us if companies such as IBM or Accenture will enter the LPO market. Both are very capable but not known for legal expertise and they might find it difficult to build the domain expertise. (There is also a question of whether LPO is a big enough business to “move the needle” for them.)

We note that both Infosys and Wipro, two of the largest and most successful outsourcing companies in India have signaled their intent to enter the market. On April 28th 2010, the Economic Times reported in Wipro logs on to LPO services that Wipro “has started offering legal process outsourcing (LPO) services.” Earlier, on 5 Nov 2007, the Economic Times reported a similar move by Infosys in, Law & order: Infosys to foray into LPO business. Both are great brands in business process and IT outsourcing but we have not seen evidence that the brands carry much value among lawyers.

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In sum, we think that TRI has set the legal outsourcing market on a new, higher path. We expect that TRI will educate the market and grow it, which will benefit other scale LPO providers.

Learning from a General Counsel Who Has Unbundled Legal Service

The Lawyer published a great article on Monday, Colt resolver… Robin Saphra, group GC at Colt Technology Services, uses a combination of legal models to boost service levels.  It explains how Saphra has unbundled the legal services Colt buys.

Colt took a “hard look at the spectrum of legal services” and decided to use “a combination of models that takes in internal advice from a 45-stong team; panel firms; an offshore captive operation; contract attorneys; and a deal with an external firm [Berwin Leighton Paisner’s (BLP)], which is Colt’s preferred interface for a string of overseas relationships.”

BLP’s relatively new managed legal services division handles Colt’s international employment work.  Colt realized that it did not have the scale to have its own employment lawyer everywhere.  While it could have retained multiple national counsel, Colt recognized this could lead to inconsistency and inefficiency.  In the GC’s word, BLP offers a “joined up” approach.

Colt was also attracted to cost-effective offshore lawyers.  Rather than work with a legal process outsourcer (LPO), however, Colt chose to set up its own 6-lawyer captive in Bangalore.  That team will work on medium-volume, reasonably complex work.

We expect that over the next few years, dis-aggregating / unbundling legal services will be the norm rather than the exception.   Once unbundled, more work will move to offshore lawyers.  As an LPO, we think we can compete effectively with captives.

From our perspective, the moral here is “unbundle – now”.  Once a GC crosses that threshold and determines offshore lawyers should be in the mix, deciding on a captive versus a third party is relatively easy.

How LPO Fits into the Legal Landscape

The legal market landscape is changing.  In Law Firms Feel Pressure From New Breed of Competitors (The Legal Intelligencer, October 26, 2010), Gina Passarella writes that the legal market is fragmenting, making room for a “broadening array of law firms,”  legal process outsourcers [LPO] ,and other providers.  That assessment is sound but we disagree with her statement that “LPOs have been created in direct competition to law firms.”

In our July blog post, LPO as a Driver of Law Firm Innovation, we wrote that a flat legal market and general counsel demand for better value are forces that “push legal work toward standardization and systemization.”  Because LPO services are optimized for routine work, the client drive for value does favor LPOs.

That does not mean, however, that  LPOs compete with law firms.  As we wrote in July, “work once done only by associates will flow to new and more efficient operating models offered by alternative sources such as LPOs, contract attorneys, virtual law firms, online legal resource providers, and still-to-be-invented providers.”  LPOs are simply a beneficiary of underlying legal economics.  Also, though LPOs can provide important legal support, they cannot practice law and must operate under the supervision of a licensed lawyer.

Rather than view LPOs as competitors, firms can partner with them.  For example, in the US, Pillsbury partners with Integreon on e-discovery and document review services (see Pillsbury Launches Pearl to Contain Companies’ Litigation Costs and Improve Results).  In the UK, Simmons & Simmons uses Integreon for a range of LPO services (see International Law Firm Simmons & Simmons Signs Agreement with Integreon for Legal Process Outsourcing (LPO) Services).

Firms have other options as well.  For example, Passarella quotes K&L Gates chairman  Peter Kalis:  “If you, within your platform as a law firm, can localize a lot of back office services and more routine-type services for clients in low-cost venues, you can achieve the same sort of outcome” as LPOs.  Kalis contrasts his firm, with lawyers and staff in some low cost locations, with major New York and London law firms that have ‘grotesquely swollen’ overhead because of the high cost of those cities.

The UK’s  Berwin Leighton Paisner (BLP) offers another example of how a firm can adapt to the new economics: it has a “legal services division” for high volume work.  (See IT and telecoms firm Colt hands BLP outsourcing arm its second deal, Legal Week, 20 September 2010).

What BLP is doing, however, is unusual and may be hard for most firms to manage.  As I note in my personal blog post, Can Law Factory and Bet the Farm Co-Exist Under One Roof?, managing high-end (bet the farm) and low-end (law factory) work under one roof presents challenges.

Until recently, the “corporate legal ecosystem” lacked diversity.  Big companies hired big firms; medium companies hired medium or large law firms.  Diversity is a key element of a healthy ecosystem.   As a result of economic trauma, we now see a more diverse – and I would argue – healthier legal ecosystem.  Firms, even BigLaw, are differentiating;  virtual firms pop up regularly; and alternatives such as Axiom are gaining new traction.  I expect that LPOs will indeed thrive in the new legal ecosystem but despite all this, I also expect law firms will continue to dominate the market.

ABA Continues Examining Legal Outsourcing Ethics

LPO as a Driver of Law Firm Innovation

Deciding on the Right Outsourcing Destinations (Onshore and / or Offshore)

Choosing the Right Legal Process Outsourcer