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Is the U.S. legal profession undergoing a major structural shift?

In an July article in the ABA Journal entitled “Paradigm Shift<http://www.abajournal.com/magazine/article/paradigm_shift>,” Rachel Zahorsky and I answer “yes” to this question.  After the story went to press, the U.S. Census Bureau released some additional supporting data.  If you want the whole storyline boiled down to a picture or two, the charts below, which incoporate the new data, come pretty close.

The charts were generated from a dataset called County Business Patterns <http://www.census.gov/econ/cbp/index.html> (CBP), which covers payroll and employment data broken down by geography and industry.  One of the principal advantages of CBP is that it is not a sample; rather, it is universe data of all workers subject to FICA taxes (i.e., social security and medicare).

Chart 1 below shows total employment — i.e., W-2 employees, not  partners — in law offices from 1998 to 2009.   1998 is the baseline because that was the year that the Census Bureau switched from the SIC<http://www.census.gov/epcd/www/sic.html> to the NAICS<http://www.census.gov/eos/www/naics/> coding systems.  So from 1998 onwards, we are comparing apples to apples.

[Employment in Law Office 1998 to 2009]<http://www.elsblog.org/.a/6a00d83451b58069e201539015f985970b-popup>

The most significant feature of Chart 1 is what I call the “upside down hockey stick.”  In a nutshell, the high water mark for law offices was 2004 when the sector employed 1,122,723 workers — 4.5 years before the collapse of Lehman Brothers.  It has been trending sideways or slightly down since then. And note that the headcount is taken in March of each year.  So these data are nearly 2.5 years old.  The bleak Class of 2010 Report <http://www.nalp.org/uploads/PressReleases/11SelectedFindings.pdf> from NALP suggests that things have not gotten better since 2009.

Chart 2 below compares percentage growth from 1998 to 2009 in two subcategories of legal services:  law offices (NAICS 541110)  and all other legal services (NAICS 541199).  The latter is important because it a catch-all for everything that is not either “law offices” or “title abstract and settlement offices”, the latter being a category whipsawed by the housing market collapse.  ”All other legal services” includes legal process outsourcers, companies that supply contract attorneys, and some specialized legal service vendors.

[Law   Offices v All other Legal Services]<http://www.elsblog.org/.a/6a00d83451b58069e2014e8a097db3970d-pi>

The takeaway from Chart 2 is that since 2004, law office employment has slowly contracted (-26,106 jobs) while all other legal services, during the same period, added over 5,700 jobs– and from a much smaller base.   Granted, this data lumps together lawyers with legal secretaries and paralegals.  But the 2009 average pay in the Law Offices was $78,500 versus $46,8oo in all other legal services.  Further, when the law office sector contracted between 2008 and 2009 by roughly 13,000 jobs, the average pay of the lost worker was $166,000, which means the industry is not just shedding support staff because of better technology.  This is why I wanted to see the 2009 figures.   This shift very much affects lawyers.

Industry trends like those shown above are similar to those we would expect to see in disruptive innovation<http://en.wikipedia.org/wiki/Disruptive_technology> scenario.  See Clayton Christensen, The Innovators Dilemma<http://www.businessweek.com/chapter/christensen.htm> (1997).  When mature incumbent companies  experience maturation of their markets, at least for existing products, new entrants are often experimenting with new processes and technologies at the lower levels of the market.  The incumbents dismiss these developments as unimportant and not worth their trouble because they are higher up the value chain.  New entrants, however, get very good at learning and innovation and some eventually gain big traction on the value chain.  One day, the incumbents wake up and realize that new entrants are taking market share.  Having zero understanding of new entrants’ innovations, the incumbents get pushed aside.  At the late stages, it just looks like garden variety Schumpeter Creative Destruction<http://en.wikipedia.org/wiki/Joseph_Schumpeter>.

If you are a law firm lawyer and you think this analysis does not apply to you, well, Christiansen’s theory predicts this will happen.  This inattention to bottom of the value chain is what creates the opportunity for the new entrant and what sows the seeds of the incumbent’s vulnerability.  The only protection is to innovate, which is a complicated managerial task when your firm has a strong legacy brand and a product line it is trying to preserve and promote.  Workers were attracted to the safe brand in the first instance.  Christiansen has prescriptive advice for big companies–e.g, create an organization within the organization where the big company culture will not penalize experimentation and  trial and error– but it is not easy.

When I first saw in these patterns (through 2008 at the time), I decided to go out and meet with the owners of “all of legal services” businesses.  A few common themes jumped out:

• A large proportion of non-lawyers owners with non-legal industry experiences
• A combination of lawyer and non-lawyer angel investors and venture capital
• A shared belief that this wonderful business opportunity was created by (a) high law firm profits and (b) the persistent of the billable hour, which stifles efficiency and innovation
• Use of both process engineering and cheap overseas labor to achieve competitive advantage
• Use of technology to collect metrics and use of statistics to measure ROI

 

The bottom line:  We don’t need regulatory reform to get the revolution in legal services started — the profit-making opportunities are too large not to attract very clever, well-financed people, many of whom are non-lawyers applying basic lessons learned from other industries.

Eventually the regulations will catch-up with the innovators.  But the updated regulations won’t shut the innovators down.  Why?  Because (a) these companies are adding value for very sophisticated clients, and (b) the policy rationales behind fee-splitting and the unauthorized practice of law have no application here.   Because the UK and Australia have already embraced this future, it would be crazy double down on regulations designed for lawyers who practice 100 years ago.  This regulatory risk was understook at the outset by these innovators — they bet money their own time and money they could successfully engineer around the regulatory barriers.  This market entry/regulatory calculus is common in other industries.

Implications for Law School?

They are huge.  The decline is traditional law firm jobs is very disruptive because the supply of law school graduates continues to climb.  In ordinary industry, capacity just goes away in response to declines in demand.  But we are not an ordinary business.

The money is likely to flow to the point where we get ourselves into more trouble.

• Although entry level salaries are going down, tuition is likely to go up or sideways at best
• The supply side of legal education is comprised of young people making their first major investment decision, which is influenced disproportionately by media images and over optimism bias
• The people financing the legal educaton dream are primarily the American Taxpayers — unlike, say, home mortgages, there is no serious effort to calculate individual ability to repay.  Financing of expensive graduate education is treated like an entitlement.  This is unsustainable at best and terrible public policy.  It is creating a bubble.
• Universities often dip in the law school till, so the micro benefits often outweigh the macro effects.  The harm is externalized to an oversaturated traditional legal profession (e.g., creating excessive, harmful competition among solo practitioners).  This excerbates tension between the academy and practicing lawyers.

 

Granted, the decline in traditional law office jobs is not dramatic.  But the combination of more law schools, US News use of employment data, and greater transparency by the ABA and DOE is going to produce a long, potentially acrimonious game of hot potato.

The endgame is pretty straightforward:  some capacity is going to have to go away.  Alternatively, law school faculty will have to retool–a necessity that few legal academics will find attractive or comfortable.  If we decide to good down the retooling road  – an option I embrace because I find it both attractive and more comfortable and responsible than denial — a good place to start is learning more about the “all other legal services” category.    That is the future– legal products and services that are better, faster, cheaper.