Originally Published Feb. 12, 2013

Editor’s note: This is the first in a series of articles examining how law firms are thinking smaller when it comes to the space they need, the costs they pay for labor and the nonlegal services they handle.

From Wheeling to Lexington and Dayton to Tallahassee, U.S. law firms have increasingly looked to move back-office operations to less expensive geographic markets in an effort to save on rent and employee compensation.

And in an era when demand for legal services is stagnant and cost-cutting measures are increasingly difficult to find, consultants are pointing to significant operational and structural changes as the only way firms will realize any substantial cost savings and, in turn, protect profits.

While law firms can probably do more in the way of cutting attorneys or staff than they think they can, law firm consultant Paula Alvary of Newton, Mass.-based Hoffman Alvary said many firms are close to the point where big net gains will have to come through major structural changes. One such example is moving back-office operations to a lower-cost market, she said.

A recent joint report by Citi Private Bank and Hildebrandt Consulting echoed similar sentiments.

“Without more transformative changes in law firm structure, it is our view that these efforts to control expenses can only be taken so far, and in fact, after a two-year dip in the immediate aftermath of the recession, we saw a significant uptick in expenses in 2011 and 2012,” the report said.

According to a survey by Citi and Hildebrandt, 34 percent of respondents said they had moved their back-office support functions to cheaper locations. Of the 66 percent who had not, only 5 percent planned to do so in the next year.

Since Orrick Herrington & Sutcliffe famously moved its back-office operations to Wheeling, W.Va., more than a decade ago, the trend has gained some steam. Since 2011, Pillsbury Winthrop Shaw Pittman moved its back-office operations to Nashville, Tenn., Bingham McCutchen went to Lexington, Ky., U.K. firm Allen & Overy moved U.S. and U.K. staff to a new location in Belfast, Ireland, and just recently Kaye Scholer said it was moving operations to Tallahassee, Fla.

But is the concept of moving back-office operations to somewhere like West Virginia, Ohio or even India a realistic possibility for Pennsylvania firms? Most in the state say no. Cheaper space in the same city, however, is on the table.

“I do not believe that you will see most of the Philadelphia firms looking to move their back-office administration to a lower-cost city because I think Philadelphia … is close enough that it’s not worth the expense and the administrative obstacles to do that,” Cozen O’Connor Chief Executive Officer Michael Heller said.

Heller said it might make sense for some of the largest firms in the state — those with offices all over the world — to move their back-office operations, but he again noted that Pittsburgh and Philadelphia are already lower-cost markets.

When Cozen O’Connor was negotiating a lease last year for space in a new building, Heller said the firm contemplated “for a half a second” whether to have firm administration be placed in a separate, cheaper building in the city. The deal the firm got at its new location in One Liberty Place was cost-effective enough, however, that everyone could be housed in one building.

Morgan, Lewis & Bockius, one of those large firms in the market with offices all over the world, has taken the route of opening a separate location in Philadelphia for its administrative staff. While the firm’s attorneys are housed in several floors at 1701 Market St., its large e-discovery data center and some nonlegal administrative support can be found in offices at 1801 Market St.

What Heller said Cozen O’Connor and other firms might explore is the idea of moving or hiring attorneys in cheaper geographic markets. Those attorneys would handle more rate-sensitive matters in a location such as West Virginia or Buffalo, N.Y. Heller said the idea would be to go to a market where there were a number of high quality attorneys available for that type of work.

Ballard Spahr Chairman Mark Stewart said his firm also thought about moving administrative staff to a separate location in the city when his firm renegotiated its lease recently, giving up two floors of space. But instead the firm decided to create an administrative floor in its existing place. That gives Ballard Spahr the opportunity to move that one floor to another building if it needs the additional space for new attorneys, Stewart said.

Stewart said there are some efficiencies of having administration on-site. And he said the firm didn’t see a big-enough cost savings for moving administration to a different building or across the river to Camden, N.J., that the firm would want to have seen to make the change. He said moving staff can create an expense, some people might not make the switch and there would be inefficiencies of not having them in the same building.

Drinker Biddle & Reath’s executive partner, Andrew Kassner, said moving administrative functions to cheaper markets might be a pressing need for firms in California, Chicago and New York, but not for firms in Pennsylvania.

Scott Green, CEO of Pepper Hamilton, agreed. While he helped his former firm, WilmerHale, move its back-office operations to Dayton, Ohio, such a move doesn’t make as much sense for Pennsylvania firms, he said.

Green said WilmerHale’s support functions were housed in the more expensive markets of Washington and Boston. For Philadelphia firms, the “economics aren’t quite as compelling,” he said, adding, “at least not yet.”

Mary Ashenbrenner, head of Wells Fargo’s legal specialty group in Pennsylvania, said employee costs in Pennsylvania are pretty reasonable. She said she doesn’t anticipate seeing a lot of large Pennsylvania firms moving their back-office operations outside of the state.

India or Pittsburgh?

About 11 years ago, Reed Smith Chief Operating Officer Gary Sokulski looked at whether to off shore some of the Pittsburgh-based firm’s business operations, such as word processing, where there were multiple people handling similar things across multiple offices.

The firm looked at Chennai, India, a hub of outsourcing activity for U.S. corporations. But when weighing the efficiencies, quality-assurance concerns and the idea of being committed to the economies of your local communities, Sokulski said the firm decided that wasn’t the right move for it at the time. He said it has also come to bear that over the past decade the inflation rate in India has eaten away at some of the cost savings that might have been realized.

So Reed Smith scrapped the plans for India and instead created its Global Customer Centre in a separate office building in Pittsburgh.

“We had a uniqueness, us and K&L [Gates], that our marketplace had a very high blue-collar work ethic along with a very low cost of living, cost of housing, cost of people,” Sokulski said.

Reed Smith took people out of its higher cost locations across the country and moved the word processing, marketing, accounting, human resources, information technology and now e-discovery review, to the GCC. The building is five blocks from Reed Smith’s main Pittsburgh office. It’s cheaper to rent, more dense, the employees dress more casually and many of the services are available 24/7 or 24/5, he said. There are now more than 300 people working in the GCC.

Sokulski said the firm’s aggregate operating cost per attorney is about $75 million less a year than its competitor firms. A big part of that is because of the savings realized through the GCC, he said.

Sokulski said he is always evaluating whether there are better cost options for the firm and its clients and part of that evaluation is whether he should move 300 jobs somewhere across the world. But Sokulski said he is very comfortable that the firm is in world-class space where it is.

The next article in the Thinking Small series will focus on how law firms are re-examining the amount of and way they use office space.

Gina Passarella can be contacted at 215-557-2494 or at gpassarella@alm.com. Follow her on Twitter @GPassarellaTLI.