Can law firms compete effectively for ALSP services?
One of the most important and intriguing developments in the legal market over the past decade has been the evolution of alternative approaches to the delivery of legal services. This development is probably best evidenced by the impressive growth of alternative legal service providers (ALSPs) as significant players in the global legal services market.
In February, the Thomson Reuters Institute, in partnership with the Center on Ethics and the Legal Profession at Georgetown Law and the Saïd Business School at the University of Oxford, issued its third biennial survey report on the ALSP sector. The report reveals a sector that has grown rapidly over the past six years, reaching estimated global revenues of nearly $14 billion in 2020. It also shows very high market penetration, with 79% of law firms surveyed saying they are using ALSPs, along with 71% of corporate law departments.
The ALSP study identified three types of players in the ALSP sector: independent ALSPs, law firm captive ALSPs, and the Big Four auditing and accounting firms. Among these, independent ALSPs are by far the largest segment (with revenues of some $12 billion) and law firm captive ALSPs – those entities created within law firms to offer select services to clients – are the smallest (with about $480 million in revenues). Interestingly, however, law firm captives are also the fastest growing segment of the market, having grown by some 60% over the past two years. This growth rate suggests that some law firms are attempting to preempt the threat that ALSPs pose by creating competitive services of their own while using the ALSP model.
However, this rapid expansion of law firms into the ALSP sector raises the question of whether law firms are organizationally and culturally suited to manage such businesses effectively, particularly in competition with other legal market players. Stated differently: Is the business model of law firms compatible with those of ALSPs?
Most law firms use a business advisory model in which lawyers provide customized advice to their clients with the human capital of the lawyers themselves as the only valuable asset. This business model is facilitated by lawyer-only professional partnerships that enable a broad consensus-based style of decision-making. Over the years, this business mode of legal advice (not legal service) delivery has been deeply embedded in the ethos of law firms and, indeed, reflected in many ethical rules and restrictions of legal practice.
By contrast, ALSPs as new market entrants have responded to the demands of corporate clients for efficiency, predictability and cost-effectiveness in the delivery of legal services. In doing so, ALSPs enabled clients to lower their overall legal spend without challenging the law firms’ monopoly on the rendering of customized legal advice. The business models that have enabled ALSPs to achieve these results differ significantly from the business model of the traditional law firm, as John Armour and Mari Sako discussed in their article, “AI-enabled business models in legal services: from traditional law firms to next-generation law companies?” This article appeared in the Journal of Professions and Organization in 2020.
Today, ALSP services may be categorized in three broad groups: (1) legal operations to improve the efficiencies of legal service delivery; (2) legal technology to focus on the design of technical systems for both the business of law and the practice of lawyers; and (3) related consulting to address the overall needs of clients in selecting and implementing forms of legal technology and optimizing process flows in legal operations.
All three of these service lines are enabled by a number of characteristics in common, many of which are not traditionally found in law firms, such as:
- access to IP and technology solutions and platforms, as well as nonlawyer human expertise in process mapping, project management and data science
- a multidisciplinary approach to problem-solving that cuts across various professional specialties
- access to capital to provide the resources necessary for acquiring needed human and nonhuman assets
- an ability to structure compensation packages sufficient enough to attract and retain top-quality nonlawyer talent
- a centralized process for making business decisions, with hierarchical management
To achieve these results, most ALSP services are structured under a corporate organizational model that provides for centralized management, access to external capital, flexibility in structuring equity and compensation arrangements, and an ability to adjust quickly to changing market dynamics. For structural, cultural and sometimes regulatory reasons, these characteristics are difficult to achieve in the professional partnership format used by most law firms.
Notwithstanding such difficulties, the ALSP survey found that law firm captives are implementing the legal operations and legal technology business models to undertake corporate transactions, M&A due diligence, legal drafting, and contract management and abstraction on behalf of their corporate clients. At the same time, 43% of US law firms turned to independent ALSPs for consulting advice on legal operations, and 42% for advice on legal technology. This is an endorsement of the leading-edge expertise of independent ALSPs – no longer on the periphery of the market and hardly “alternative” – but also a manifestation of the difficulty law firms face in attracting and retaining nonlegal talent.
For a cautionary tale of law firms attempting to extend their businesses beyond their core expertise, one need only look to the efforts of many US law firms to create “ancillary businesses” in the mid-1980s, a detailed discussion of which can be found in the Hildebrandt Handbook of Law Firm Management. At that time, a number of firms began to experiment with ancillary businesses as a means of expanding the range of services offered to law firm clients. The practice spread quickly, and by 1991, more than 80 such ancillary businesses were being operated by law firms around the country, in such areas as government relations or lobbying enterprises; investment, tax or financial consulting operations; and international trade consulting.
Critics charged that the affiliations between lawyers and nonlawyers represented by ancillary businesses posed a threat to the “professionalism” of lawyers and raised serious ethical questions about lawyer independence, conflicts of interest and preservation of client confidences. Responding to these criticisms, the American Bar Association in 1989 initiated a well-publicized review of ancillary business practices that ultimately resulted in adoption in 1994 of the ABA’s Rule 5.7 of the Model Rules of Professional Conduct. That rule in effect set out the circumstances under which law firms could permissibly form ancillary businesses.
Today, there is no real question that US law firms can ethically operate ancillary businesses (such as captive ALSPs), but the organizational structures and procedures that are required to do so remain complicated and administratively awkward.
On the other hand, in the UK the regulatory barriers to such operations are much less onerous. But traditional UK law firms, just as those in the US, must address the question of whether their business model is fundamentally compatible with the models needed for most ALSP services.
Working through these issues in a way that enables law firms to be competitive in their expansion into the ALSP services market will remain a significant challenge.