Could New Technologies Cause Great Law Firms to Fail?

Darryl Mountain
Legal Technology Consultant
Ontago Inc.,Canada
[email protected]

Abstract

This article addresses the question why law firms ought to invest in online legal services when studies to date show that there is no correlation between law firm technology capabilities and profitability. It divides online legal services into two types: digital delivery and legal web advisors. It uses the framework set out by Clayton Christensen in The Innovator's Dilemma to explain how legal web advisors are a disruptive technology that law firm competitors (i.e. accounting firms, dot-coms, and corporate clients) are beginning to harness to erode law firm margins. Unless law firms reinvent themselves as technology organisations, they could find themselves increasingly marginalised. Large law firms need to develop legal web advisors and should consider spinning off technology subsidiaries to do so. Small law firms need to link up with online advisory services on an application service provider basis.

This is a Refereed article published on 28 February 2001.

Citation : Mountain D, 'Could New Technologies Cause Great Law Firms to fail?', 2001 (1) The Journal of Information, Law and Technology (JILT). <http://elj.warwick.ac.uk/jilt/01-1/mountain.html>. New citation as at 1/1/04: <http://www2.warwick.ac.uk/fac/soc/law/elj/jilt/2001_1/mountain/>.

1. Introduction

Fifteen years ago, artificial intelligence (AI) was set to radically change the face of the legal profession as we know it. As it turned out, neither AI nor expert systems lived up to their potential at that time. They required huge investments and provided marginal perceived payoffs.  Eventually, both fell under the weight of their own start-up requirements.

Today, AI has been reincarnated in the form of legal web advisors. Legal web advisors offer interactive legal advice delivered via Extranet without human intervention using questions to collect facts and then using decision tree analysis to produce answers.

Some of the world's largest law firms in London, England are pushing ahead with developing legal web advisors despite the absence of a link between law firm profitability and use of technology ( Voorhees, 2000 ). Why would the London firms, who bill out their services at the highest hourly rates in the world, involve themselves in such risky, low margin endeavours? The answers lie in the disruptive power of these new technologies.

2. Digital Delivery and Legal Web Advisors

Legal web advisors were pioneered in London in 1994 when Linklaters introduced a browser-based product called Blue Flag. Blue Flag is now a suite of products covering regulatory compliance, derivatives documentation, employee share plans, funds, share disclosure, and transaction management. Within months, Clifford Chance followed with NextLaw, a web-accessible online service that helps assess the legal and regulatory risks of e-commerce and reportedly required an investment of more than 1 million pounds sterling ( McKenna, 2000 , Linklaters and Blue Flag). Today, there are approximately a dozen online legal services in the UK and Australia and the pace of their introduction is accelerating. The revenue model to date has been to charge these services out by subscription and then to have lawyers leverage from these online services to attract value added legal work.

Online legal services can be placed in two different categories: digital delivery services and legal web advisors. Digital delivery services deliver human legal product by digital means: the simplest example is the use of e-mail to distribute legal documents. Both law firms and application service providers (ASPs) offer digital delivery. ASPs are companies that deliver software across the Internet by subscription instead of a packaged product. ASPs such as New-York based IntraLinks Inc. and San Francisco's Niku Corporation provide transaction hosting services. Many large London firms have opted for in-house capability instead and host their own transactions through branded extranets (websites that provide a private body of information to a limited number of external organisations). Examples are Clifford Chance's Fruit Net, Allen & Overy's newchange dealroom, and Andersen Legal's Dealsight.

Clifford Chance has led a movement to establish a set of industry-wide law firm IT standards for extranets. Like e-mail, extranets will eventually become an invisible part of the technology infrastructure and will not form a basis of competitive advantage.

Legal web advisors, on the other hand, offer interactive legal advice delivered via Extranet using artificial intelligence. Legal web advisors use AI in a more cost-effective and pragmatic fashion than did the systems of fifteen years ago. For example, they do not attempt to work independently of lawyer input. Lawyers and knowledge engineers work together to describe the order in which information is obtained and used to determine a solution.

The software leads the client from one question to another using a decision tree system. This type of system uses a sequence of decisions based on user input to classify the problem before moving through nodes and subnodes to the problem solution. Once the client has completed the path and has answered all the relevant questions, the software produces output. This output is not in the form of a legal opinion; instead, it is in the form of 'You need to do A, B, C, D, and E.' It is more similar to the advice a lawyer gives to a friend at a party than it is to traditional legal advice. It provides 90 percent of the answer in situations where the client doesn't care about the other 10 percent and is not willing to pay for it.

The distinction between digital delivery and legal web advisors may blur in the future as online legal services become increasingly sophisticated.

3. The Innovator's Dilemma

Richard Susskind, who is widely regarded as Europe's leading legal technology expert, was one of the first people to identify the disruptive potential of the Internet on legal practice. In his book entitled The Future of Law: Facing the Challenges of Information Technology , Susskind ( 1996 , p46) predicts that:

He believes that law gradually will be transformed from an advisory service to an information service as lawyers package their conventional work product in electronic form. In contrast to the reactive advice they receive today, clients will receive proactive and more generic legal advice. This advice will not be completely customised but will be 'good enough' to meet client needs and far cheaper than one-on-one legal advice.

This proactive advice will reach the 'latent legal market' of people who are unable to benefit from the legal input they require because conventional legal services are too expensive or impractical in the circumstances. Low-end legal advice will become a low-cost high-volume commodity and only specialist lawyers will continue to advise in person. Legal publishers or large accounting firms may 'muscle in' on providing legal information services, blurring the line between legal advice and legal publishing and taking over much of the market for legal services from lawyers. The movement toward client facing software (software which addresses the needs of clients as opposed to the needs of lawyers) will shift billing practices away from hourly rate billing and toward value-based and project billing. This last observation appears to make sense. New auction-model websites such as FirstLAW and eLawForum allow companies to open up projects for tendering by law firms over the Internet. Allen & Overy has claimed on its newchange website that newchange's capabilities allow it to draft a document in five percent of the time it used to take. Obviously it will be able to bid significantly lower than its competitors and recoup lost revenues through high volumes.

The message of The Future of Law is even more powerful when combined with the insights of another groundbreaking book, The Innovator's Dilemma: When New Technologies Cause Great Firms to Fail by Clayton Christensen ( 1997 ).

Clayton Christensen is an associate professor at Harvard Business School who specialises in disruptive technologies. He set out to learn why good companies fail to stay atop their industries when they confront certain types of market and technological change. He found there to be a distinction between sustaining technologies, which improve on an existing value proposition (i.e. building a more efficient gasoline engine for the automobile), and disruptive technologies, which redefine that value proposition (i.e. building an electric-powered automobile). Good companies typically excel at managing sustaining technologies but fail at managing disruptive technologies. He created the theory of the innovator's dilemma, which is that 'it is in disruptive innovations, where we know least about the market, that there are strong first-mover advantages' ( Christensen, 1997 , xxi). 

While he analysed several industries, perhaps Christensen's best example is that of the disk drive industry. In that industry, disk drives shrank very rapidly from 14 inches in diameter to 8, 5.25, 3.5, 2.5, and 1.8-inches over a 20-year period. Few of the incumbents managed to make the transition from one size to the next; it was new entrants who consistently dominated each new category. Yet each of the incumbents acted in a perfectly rational manner. The 14-inch manufacturers focused on their customers, mainframe computer manufacturers who placed little value on smallness but who demanded improvements to capacity for the current disk size. Of course, they knew of the existence of 8-inch drives but the margins were low and the market was unknown. Given the choice between attacking this risky new market and moving upmarket, they chose to retreat upmarket.

Meanwhile, new entrants in the marketplace asked a different question: 'Where is the market for a smaller, lower capacity drive?' They discovered that 8-inch drives were ideally suited to minicomputers and set out to conquer that market. Gradually, however, these new entrants were able to improve the 8-inch disk capacity until it was sufficient to meet the needs of lower-end mainframe computer manufacturers. They then took aim at the higher margins this segment provided. Once their capabilities intersected with the demand from these manufacturers, the transition from 14-inch disks to 8-inch disks was abrupt. Now the manufacturers could purchase a disk that had sufficient capacity for their needs but that also had the side benefits of a lower cost per megabyte and less variance in the absolute position of the head over the disk. What is interesting is that the 14-inch manufacturers made good profits up until almost the very end, where they dried up very rapidly. Although several tried belatedly to make the transition to 8-inch drives, every one of them was driven from the industry. The story repeated itself with 5.25, 3.5, 2.5, and finally 1.8-inch drives as the advent of desktop computers, notebooks, and portable heart monitoring devices drove demand for smaller drives.

4. Lessons for Lawyers

What are the lessons that lawyers can learn from the disk drive industry? Are lawyers in a similar position to 14-inch disk manufacturers? There are similarities. Lawyers typically introduce new technologies when driven to do so by their clients, so they are relatively good at managing sustaining technologies. One example is the use of e-mail. Sending documents by e-mail is a client expectation but it is also an easy thing for a firm to do and does not radically change the value proposition for the client. We would expect the next evolutionary step, toward extranets, to be similarly implemented by lawyers through client pressure.

Lawyer reaction to disruptive products is another story. Legal web advisors are disruptive technologies that introduce a new value proposition for the law firm client. The value proposition of a typical law firm is based on full and customised service, limited availability, reactivity, and unpredictable and high fees based on time spent. Legal web advisors offer a new value proposition based on self service that is not fully customised but 'good enough', 24 x 7 availability, proactive risk reduction, and low fixed fees earned while the lawyer sleeps.

Lawyers typically respond to disruptive products such as 'make your own will' kits by arguing that legal self-help is not cost-effective and that there is no substitute for a good lawyer. In addition, they retreat upmarket where the margins are better, abandoning their lower tier clients and leaving the commoditised work to other, less prestigious firms. In the short run, this strategy appears to be vindicated. However, some of the best law firms in the world are already using legal web advisors to commoditise what once was high value work. Christensen's research suggests that law firms can only retreat upmarket for so long before there is nowhere to retreat.

Admittedly, there are many differences between the legal services and disk drive industries. Disk drives are a commoditised, manufactured product, while law firms are in a relationship-oriented service environment with institutionalised barriers to entry. At the very least, the pace of change will be slower in the legal industry. However, accountants and management consultants face many of the same obstacles and yet have embraced technology far more than lawyers. For example, Ernst & Young's Online Tax Advisor provides written fact-specific advice on a wide variety of tax issues. Arthur Andersen's KnowledgeSpace also delivers mass-customised consulting services.

Another perceived difference between legal services and disk drives lies in the area of core competency. Many business experts argue that businesses ought to stick to their core competencies, those things that they do particularly well. Smaller disk drives are clearly within the core competency of a disk drive manufacturer. But is technology part of a law firm's core competency? Lawyers at Clifford Chance, one of the world's largest law firms, think so. According to a recent Law Practice Management Magazine article ( McKenna, 2000 , Clifford Chance and NextLaw), Clifford Chance forecasts that online services could account for 20 percent of its business within the next five years. Indeed, if Susskind's vision is correct and information technology is at the heart of the future of law, then technology is a core competency and US law firms must reinvent themselves as technology organisations.

What large law firms may not realize is that this technology has opened up the legal field to competitors that are not law firms. For example, legal web advisors are already starting to be used by consulting firms and large corporate clients. As long as these web advisors provide advice that can be relied upon to a reasonable degree, clients are not bothered by the fact that there is no law firm behind them. Clients can always hire a lawyer to clear up any uncertainties that arise out of the online advice they receive. Here is a rundown on the new types of competition that law firms will be facing over the next five years: 

4.1 Multidisciplinary Practices

It is interesting that most online legal services products to date have originated in the UK and Australia and not in the United States. Why? Perhaps it is because of the introduction of multidisciplinary practices (MDPs) in those two countries. This factor has led to greater technology-based competition and has put pressure on their firms to innovate. Meanwhile, the American Bar Association's decision to disallow MDPs has shielded US firms from competition by the Big Five accounting firms and has blunted technology-based competition among the law firms.

Accounting firms do not share the law firms' cultural resistance to new technologies. Just as they have not hesitated to commoditise their consulting practices, they will not hesitate to commoditise their legal practices if MDPs become legal in the US.

The accounting firms are beginning to offer online MDPs that offer one-stop shopping for entrepreneurial clients based on needs rather than on categories of professions. For instance, 1 ].

4.2 Large Corporate Clients

Corporate clients could pose a threat by adopting legal web advisors for their own use, training in-house lawyers to keep the systems up-to-date, and thereby minimising their need for routine legal advice. Already, General Electric has developed a Virtual Patent Advisor for its own use, working in tandem with Jnana Technologies Corporation. This tool probes an engineer with questions about an invention, searches patent databases worldwide for similar inventions, and then generates a report that allows patent counsel to assess the risks of violating an existing patent with that invention. Other blue chip companies such as Sony Electronics have purchased ORIGIN Pro NAFTA compliance software from SmartSources.com Inc. that analyzes and interprets the process of international trade and customs compliance.

4.3 Dot-coms

At the other end of the spectrum are the dot-coms, which eventually will threaten the existence of many small town practitioners with routine and repetitive practices. Once again, the UK leads the pack with desktoplawyer.com and directlaw.com . These sites, operated by Epoch Software, allow consumers to assemble their own documents over the Internet using document assembly technology and then have them reviewed by a lawyer for an additional fee. Document assembly is a branch of expert systems that involves generating a document by having the software ask questions or seek relevant input from the user. Desktoplawyer is a self-contained website, while directlaw points consumers to the documents of individual law firms. Examples in the US and Canada include USLaw.com , myLawyer.com (operated by a subsidiary of Epoch Software), and   electricLawyer.com . These sites will automate huge chunks of work that formerly were billed out by the hour. While they currently do not perform the functions of legal web advisors, their services could evolve in that direction as they become increasingly sophisticated.

These sites illustrate how online services unbundle the value added work (i.e. lawyer review) from the routine work (i.e. document assembly), package it, and commoditise it.

If we think of a lawyer's hourly rate as an average, then work that is done at $200 per hour is an average of high end work that is worth, say, $800 per hour and low end work that is worth $50 per hour. Online services unbundle this package into routine work that is completed for a nominal fee and value added work that is billed out at a higher rate than ever before. In the future, any part of a legal process that can be commoditised will be commoditised, regardless of whether it is perceived as high value and regardless of the hourly rate at which it is billed.

4.4 English law firms

The decision to disallow MDPs does not protect US law firms from foreign competition. English lawyers promote English law as a brand to be used by international corporations, no matter where located, who want to govern their contracts with a choice of law that promises certainty, stability, and unbiased dispute resolution. New York law is obviously a competing brand. If English law becomes more efficient and cheaper to use because of innovations in legal technology that are not found elsewhere, then companies will switch to English law from New York law. That has already happened once before, when the 1987-88 deregulation of the London financial markets attracted many financial players from New York, resulting in the so-called 'Big Bang'. In addition, the legal web advisors offered by English law firms have been expanded to cover many countries and could be expanded to include U.S. jurisdictions.

5. How can law firms respond to these threats?

Large firms must consider developing their own legal web advisors, making technology development a core competency. However, in most firms a cultural shift will be required: for example, more sharing of resources such as document templates. In its recent Technology & the Law Report, Australia's Victorian Law Reform Committee stated that a law firm's competitive advantage:

As development time is mainly non-billable, development proceeds most smoothly in partnerships with lockstep compensation and those where credit is given to those who participate in product development ( Cohen, 2000 , The Buy In). Firms typically call upon the technology expertise of companies such as Jnana, Documentum, Inc., and KnowHow Systems Ltd. to assist them.

In order to get the most benefits from online legal services, it may be necessary to divide your firm into what Elizabeth Broderick of Australia's Blake Dawson Waldron calls an 'internal-dot-corp-and external-dot-com-presence' ( Cohen, 1999 , Building Relationships). There are many problems with trying to stay upmarket (i.e. providing high margin, value added legal services) and pursue disruptive innovations (i.e. online legal services) at the same time. According to Christensen, a better strategy is to spin off a subsidiary and develop disruptive products such as legal web advisors through that subsidiary [ 2 ].

Only a handful of law firms have taken this step so far. Dickinson Wright (Technology Consulting Partners), Womble Carlyle (FirmLogic), and Holland & Hart (CaseShare Systems) have spun off technology entities.

There are several advantages to the spin-off approach:

One key difference between legal web advisors and our disk drive example shows, however, that the spin-off issue is more complicated for law firms than it is in a manufacturing environment. That difference is in the area of complementarity ( Dawson, 2000 ). In the disk drive example, the disruptive smaller drive replaces the larger drive and the manufacture of the larger drive ceases. However, with legal web advisors, the disruptive technology does not replace the personal delivery of legal services, at least at the current stage of technology development. Instead, it displaces personal delivery and must work in tandem with it. For example, law firms such as Linklaters leverage from their online services to attract value added legal work. Spinning off a technology subsidiary may make such collaboration more difficult because the goals of the subsidiary will inevitably shift away from the goals of the law firm. It may be wiser to give the product development effort as much autonomy as possible from the rest of the law firm without actually giving it independence as a separate entity.

Both Clifford Chance and Linklaters have been moving in this direction. Linklaters has retained BlueFlag.com as an independent e-business unit responsible for research and development and product commercialization. Clifford Chance has opted to separate the two functions, creating the CC Lab unit to undertake research and development and the CC Online services group to manage product development.

Small law firms do not have the resources to develop their own legal web advisors. Their best bet is to link up with the dot-coms to allow clients to assemble their own documents online, while at the same time strengthening their interpersonal relationships with clients and experimenting with alternative billing methods. Eventually, they may be able to refer their clients to independent online advisory services on an ASP basis. Such a development would be similar to the way in which many small law firms currently outsource their newsletters by buying pre-packaged content and tailoring it.

6. What about the long run?

Today's artificial legal intelligence is superior to yesterday's not because of any breakthroughs in the field but rather because of the disruptive potential of the Internet. The Internet allows clients to access freshly updated online legal advice from anywhere at any time. Because of this disruptive potential, to focus on the current lack of correlation between law firm technology capabilities and profitability is shortsighted. It is analogous to a 1970's observer noting a lack of correlation between a 14-inch disk drive manufacturer's profitability and its ability to produce smaller drives.

The embracing of legal web advisors by top tier law firms bodes well for their continued development. They cannot simply be ignored but will slowly but steadily make inroads over the next five years. In the long run, the level of work that they will become capable of performing will be like a slowly rising water level. While today they are still focused on relatively routine advice, their capabilities will become increasingly sophisticated. In a recent Wired Magazine article, Sun Microsystems Chief Scientist Bill Joy ( 2000 ) envisioned that 30 years from now computers will be a million times as powerful as they are at present and approaching human intelligence. If that is the direction in which the world is heading, then it is clear that technology is at the heart of the future of law. In the long run, it is only those firms that will have fully integrated technology development into their organisations who will survive.

For now, the innovator's dilemma is such that we know little in advance about the market for legal web advisors or whether a latent market for such services even exists. But it would be wise to heed Christensen's admonition that one can only determine the existence of such a market through action, not passive observation.

Footnotes

1 . See the list of firms and companies offering legal advice over the Web in Friedmann R (2000) 'Web Sites that Think like Lawyers', New York Law Journal, 25 September 2000, < http://www.nylj.com/tech/092500t1.html >.

2 . Indeed, some companies in the disk drive industry example that we discussed earlier made these types of adjustments in order to survive. In 1984, Quantum Corporation, a manufacturer of 8-inch and 5.25-inch drives, faced a situation where existing employees wanted to leave and start their own company to manufacture 3.5-inch drives. Rather than let these employees walk away, Quantum financed their venture and retained 80 percent ownership of the spin-off company. When sales of the larger drives sank to almost nothing shortly thereafter, Quantum was able to purchase the remaining 20 percent ownership of the spin-off. It had successfully made the transition to the new paradigm.

References

Christensen C (1997) The Innovator's Dilemma: When New Technologies Cause Great Firms to Fail (Boston: Harvard Business School Press).

Cohen A (1999) 'Legal Advice Without the Lawyers', New York Law Journal , 15 November 1999.< http://www.nylj.com/tech/111599t1.html >

Dawson R (2000) Developing Knowledge-Based Client Relationships: the future of professional services (Woburn: Butterworth-Heinemann), Chapter 10.

Joy B (2000) 'Why the Future Doesn't Need Us', Wired Magazine , 8.04, April 2000. < http://www.wirednews.com/wired/archive/8.04/joy.html >

McKenna PJ (2000) 'Develop a "First Mover" Advantage', ABA Law Practice Today, January/February 2000.< http://www.abanet.org/lpm/magarticle10908_front.shtml >

Susskind RE (1996) The Future of Law: Facing the Challenges of Information Technology (Oxford: Clarendon Press).

Victorian Law Reform Committee (2000) 'Technology & the Law Report' [1999] COL 2. < http://www.austlii.edu.au/au/other/col/1999/2/>

Voorhees M (2000) 'Faraway Pay Day: When will firms' investment in technology produce dividends?', The American Lawyer, 7 March 2000. < http://www.lawnewsnetwork.com/stories/A18095-2000Mar7.html >

Links

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< http://www.lawnewsnetwork.com/stories/A18095-2000Mar7.html >

< http://www.nylj.com/tech/092500t1.html >

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Organisations

< http://www.be-professional.com >

< http://www.blueflag.com >

< http://www.caseshare.com >

< http://www.dealsight.com >

< http://www.desktoplawyer.com >

< http://www.directlaw.com >

< http://www.elawforum.com >

< http://www.electriclawyer.com >

< http://www.ey.com/GLOBAL/gcr.nsf/US/Welcome_Ernst_&_Young_Online_Tax_Advisor_- _Ernst_&_Young_LLP >

< http://www.firstlaw.co.uk >

< http://www.intralinks.com >

< http://www.jnana.com >

< http://www.knowhowsystems.com >

< http://www.knowledgespace.com >

< http://www.mylawyer.com >

< http://www.newchange.com >

< http://www.niku.com >

< http://www.nextlaw.com >

< http://www.smartsources.com >

< http://www.uslaw.com >