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The winds of change are howling around the legal industry. The ecosystem of legal services � that marketplace in which traditional firms, boutique firms, temp agencies and outsourcers vie for the work of corporate legal departments � is in the midst of a significant evolution. As general counsel, the buyers of legal services, continue to face increasing cost pressures, they are flexing their considerable muscle to fundamentally alter their relationships with these providers to extract greater value for each dollar spent. For a handful of the most successful traditional law firms, this environment brings an opportunity to adapt, differentiate, and garner the premium price-insensitive bet-the-company work that will drive growth in profits per equity partner. For most others, it will mean a new era of competition, both with other traditional firms and with a new category of firms that enter the market in response to the needs of corporate buyers. This evolution in the ecosystem of legal providers ultimately will align the industry more efficiently and more effectively with clients’ businesses and goals. GCs face a significant challenge in today’s business environment. Their budgets are showing little or no growth as corporations manage their cost lines tightly. Meanwhile, law firm rates have been rising by an average of 5% to 6% a year. See Larry Bodine, It’s Safe to Raise Rates by 5% to 6% for Corporate Clients,” LawMarketing Portal, Nov. 18, 2007, www.lawmarketing.com/pages/articles.-asp?Action=Article&ArticleID=696. A recent study by RSG Consulting found that rising fees and the cost of buying legal advice are the key concerns among clients, with more than half believing that the current growth is not sustainable. See Eversheds press release, “Top firms and clients deliver verdict on future of legal profession,” Feb. 19, 2008 (citing “Law Firm of the 21st Century” study carried out by RSG Consulting on behalf of Eversheds). In response, relationships with outside counsel are starting to change. Corporations’ loyalty to their former “go-to” firms is waning. Today, corporate procurement departments, which typically don’t have long-term relationships with outside counsel, are increasingly involved in the selection of outside counsel. More work is being kept in-house, particularly transactions and regulatory work that require a high level of integration and alignment with the company’s business objectives, and only the most specialized or expert work is being sent to traditional firms. Clients increasingly are realizing that work previously considered to be highly complex is becoming routine and can be handled more cost-effectively through use of internal resources, smaller firms or new-model firms that have entered the market. Companies will pay premiums only for the highest-risk, bet-the-company matters and are scrutinizing exactly what qualifies as that work. This shift in turn is creating greater demand for counsel who focus on “run the company” matters such as commercial contracts, licensing, U.S. Securities and Exchange Commission compliance, employment counseling, leases and even small mergers and acquisitions (M&A). For this kind of work, which in the long run typically represents substantially more hours of legal work than the bet-the-company matters, GCs have a variety of options. The choice among hiring in-house, using smaller or regional firms, or utilizing new-model firms involves a weighing of factors beyond just cost: How important is integration with the business? How much does flexibility matter? How does the ability to add capacity quickly play a role? The firms that can’t compete for the bet-the-company work will need to understand where they deliver the greatest value and become laser-focused on exploiting those opportunities. It’s not all good news for the law firms that still get the premium work. GCs are not only redefining and reducing the big-ticket, bet-the-company work sent to such firms, but they also are applying pressure to those firms � via requests for proposals, volume discounts, blended rates, rate freezes, project pricing and the continued convergence trend � to provide the same results at a lower cost. For firms to continue to add value and deliver results for clients, they must be flexible and forward thinking in response to these trends or risk clients taking this work elsewhere. In the end, there is one common aspect that defines a positive inside-outside counsel relationship: the ability to form a real, mutually beneficial partnership. Adapting to survive Despite the overwhelming call by clients for legal service providers to keep costs in check and in line with growth in client budgets, the RSG Consulting study cited earlier notes that many top law firm partners are not in sync with their clients. Just 21% of those partners surveyed noted the need to control costs or add value as a concern. The increased focus by clients on cost-efficiencies and optimal distribution of work has led to the active re-evaluation of budgets and spending on outside counsel. A number of departments are hiring business planners, or even chief operating officers, to drive these initiatives, which, in turn, will lead to a restructuring of the relationships the client has with various outside legal providers. As clients become increasingly sophisticated at segmenting their work to identify the true bet-the-company, high-risk matters that require outside expertise, that work will flow to just a handful of firms that have the brand, experience, infrastructure and footprint to effectively handle such needs. While that work will continue to be premium-priced and clients will continue to be relatively price-insensitive, they won’t settle for anything less than the very best firms. As such, one can expect the law firm market to maintain its current segmentation whereby profit growth for the most profitable firms continues to outpace their less-profitable peers. As bet-the-company work is more tightly defined, it will continue to decline, triggering a shift throughout the rest of the legal ecosystem, resulting in greater demand for the “run the company” work. Law firms that cannot compete effectively for the most premium work will need to adapt to compete for this work. It will be a challenge because brand will not matter as much in this tier; the premium will be on value delivered. Work at this level will emphasize experience over expertise. While the work is technically complex � for instance, inbound technology licensing � it typically will not be high risk, bet-the-company work, like major patent litigation or public-public M&A. GCs will not pay crisis rates for noncrisis matters and will look to the most efficient way to meet the needs of their business for this work. Traditional law firms will be at a disadvantage for this work with their current cost structure. Their high overhead will raise their pricing ceiling to a level that will make it difficult to compete with additional in-house hires. Moreover, GCs will place particular emphasis on integrative solutions, so that legal counsel is aligned with their business objectives. Offshore entities For the lowest tier of work, which requires the least amount of technical expertise and where the emphasis is on efficiency, GCs will no longer turn to their traditional firms, in-house hires or new-model firms. Instead, for document review and contracts administration, where cost efficiency and the ability to scale is at a premium, one can expect to see some work shift from traditional temp firms to offshore entities. India, in particular, is an attractive market for this work, since its lawyers are trained in the common law system, speak English and typically are paid one-fifth the salary of their counterparts in the United States. The drive for cost effectiveness in this tier, where the work is the most commoditized, will lead to ferocious price competition and a move away from traditional services pricing on a time-spent basis, to traditional product pricing on a per-unit basis. The shift from dollars-per-hour to dollars-per-contract, or whatever deliverable is required, will effectively shift the risk of inefficiency from the client to the provider, motivating the provider to function and price at the lowest marginal cost. Not only will GCs become increasingly sophisticated at segmenting types of work and distributing it to the most effective and efficient provider, forcing providers throughout the ecosystem to respond by aligning more effectively with their clients, but we also can expect large matters themselves to be segmented, or “unbundled.” A client may want a name partner at a traditional, global firm to advise on a “poison pill” defense, and would be quite happy to pay the firm’s full rates, but does it makes sense to use first-year associates from those firms to do document review at more than $300 per hour if offshore resources are available at a fraction of the cost with the same quality? This unbundling of the typical law firm pyramid for major matters could result in GCs paying partners for expert advice on M&A deals or major litigation; paying in-house lawyers, smaller firms or new-model firms to project-manage the process and draft the key documents or briefs (instead of senior associates); and paying offshore entities to do the diligence review (instead of junior associates and paralegals). The cost efficiencies would be significant at each level and should far outweigh the increased administrative costs of working with three or more providers as opposed to just one firm. After decades of stasis, the legal industry is changing quickly. These changes are being driven by corporations running their legal departments in the same cost-conscious manner as the rest of their business, and have resulted in changes in legal strategy, execution and budgeting. As corporations continue to become more sophisticated in their approaches, law firms will be forced to respond to these changes and devise new approaches to meet their clients’ evolving needs. New entrants, both at the high-end (new-model firms) and low-end (outsourcing), will enter the market offering new solutions. Ultimately, the providers that prove the most nimble, flexible and opportunistic will position themselves to thrive. Mehul Patel is executive vice president and general manager of Axiom, a new-model firm that changes the way attorneys and clients work together. He is based in the firm’s San Francisco office.

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