I Have Seen the Future ...

The unifying factors for all of these outsourced services were that they were not “mission critical” to the daily operations of the law firms, and that the services provided could be quantified (counted) and therefore priced. Outsourcers were in effect paid for “piece work.” As such, it was a low-margin business, heavily dependent on the ability of the outsourcer to provide a commodity service cheaper than its competition, and law firms changed vendors frequently.

The survey also documented that outsourcing was (at that time):

• More widely accepted in larger law firms than in smaller ones;
• Engaged in by the respondent firms so as to provide additional time to law firm management to focus on core competencies (61%);
• Undertaken for expense-control reasons (36%);
• Believed to streamline the management process (28%); and
• Not suitable for IT, HR or the accounting functions. The most often cited reason for this was “risk.”

The survey did not specifically address the concept of outsourcing legal work. At the time, there were a growing number of document review and analysis vendors that provided assistance in large document discovery and litigation matters. These “load and code” companies also charged for their services by the piece, and competition was fierce among the U.S. and foreign-based suppliers.

There were a few law firms that outsourced legal work to India, mostly in the patent documentation area, although some firms also outsourced basic contract drafting and lease work as well.

But, like the LBO vendors, the LPO vendors competed on price and were far from the mission-critical functions of law firms.

I think the survey faithfully represented the thinking of most law firm management at the time it was conducted. However, what it did not adequately reflect was the path undertaken by the pioneering management of two leading law firms.

Several years before the survey, Akin Gump and Orrick Herrington evaluated their back-office administrative services and reached the conclusion that they could improve the quality of those services, reduce their costs and enable senior management to focus on building their respective firms and not delivering the mail or making photocopies.

What both firms did was outsource their High Value Add (“HVA”) accounting, financial reporting, IT and HR/payroll services. Orrick built a captive facility in Wheeling, WV, and Akin Gump outsourced to a third-party provider (Deloitte & Touche Outsourcing).

The results for both firms were dramatic: significant improvements in the level and quality of services provided, while achieving meaningful expense reductions. In Orrick's case the reported saving in 2011 exceeded $10 million, more than $50,000 in PPEP.

Where We Are

A funny thing happened on the way to continuous bill rate increases, annual associate compensation increases and annual PPEP increases in 2008. In the space of nine months, demand froze, associate layoffs became commonplace and partner de-equitization and/or dismissal became standard operating procedures.

General counsel demanded and received discounts, alternative fee arrangements and relief from disbursement billing for many law firm staples such as word processing, reprographic charges and messenger services.

In the most recent Peer Monitor survey, demand, productivity, direct and overhead expenses are all moving in the wrong direction. Rates, while moving higher, are about half of the annual increases enjoyed prior to 2008. Background interviews with law firm leaders predict that 2013 will be another flat to down year.

As the economic outlook has continued to remain uncertain and the inability of law firms to reduce or hold the line on expenses for a third year becomes more apparent, law firms are increasingly looking for a “game change.”

The cost structure of a law firm is largely fixed. Rents are long-term commitments that landlords are reluctant to re-negotiate. Associates can be cut, but you can only eat so much of the seed corn before the future viability of the law firm comes into question. Expenses can be reduced, but inevitably creep back up. Technology investments can be postponed, but equipment wears out and technology advances almost daily.

The largest single area of expense that can be controlled is that of the HVA support services. The average “all in” cost of a secretary (base compensation, overtime, bonus, benefits and occupancy) exceeds $90,000 in most metropolitan areas. In some cities, Boston, Los Angeles, New York, San Francisco and Washington, that number exceeds $100,000. Other HVA staff (accounting and finance, HR, IT and marketing) can exceed secretarial costs by 10% to 50%.

Within the last two years, WilmerHale, Pillsbury Winthrop, Bingham McCutchen and most recently McDermott Will & Emery all announced that they were moving their HVA support personnel to an outsourced model.

SB2 Consultants in conjunction with the Williams Lea company is working with a group of law firms exploring the costs of providing HVA services in a more cost-efficient and effective manner. Results from our work are, we believe, representative for Am Law firms between 400 and 1,000 attorneys.

Our average firm has 563 attorneys (71 equity partners, 176 non-equity partners and 316 associates), $325 million in annual revenue and PPEP of $700,000. Outsourcing the HVA functions will result in saving participant firms between $7 million and $10 million per year. Profits per equity partner will increase between $92,000 and $134,000 per year.

In order to achieve similar increases in profitability, participant firms would have to increase their annual revenue between $20 million and $28 million every year.

The savings are achieved through labor arbitrage by moving positions from central urban areas to less-costly areas within the United States; the re-engineering of all administrative functions to eliminate duplicative and unnecessary tasks, utilizing the full capabilities of existing accounting software and the introduction of new work flow software. Recently, this approach reduced the accounts payable function staffing and costs of an Am Law 50 firm by more than 50%.

Outsourcing provides a way for law firms to increase service levels, improving quality while maintaining partner profitability in a very challenging environment.

These conclusions are supported by the most recent ALM Research on law firm outsourcing that documents that in the last five years firms considering HVA outsourcing have increased from 3% to almost 50%.

Where We Will Be

As the dramatic shift in attitude toward outsourcing HVA functions by law firm management demonstrates, significant changes in the way law firms conduct their business are on the way. Within a short time, most HVA administrative services will be provided by a third-party vendor. This change will be driven by three factors. They are:

Law Firm Strategy ' For years, many consultants (this one included) have urged that law firms become more “business like” in the way they manage themselves. The necessities of thoughtful revenue planning, expense budgeting and practice development require significant time and effort on the part of law firm management. Too often in the past, future planning is postponed because immediate tactical problems must be dealt with. Outsourcers prescribe that you “do what you do best and outsource the rest.” I agree and would add that you invest your valuable management time in efforts with the greatest payback for the firm and let an outsourcer worry about if the vendors get paid.

Market Conditions ' The economic pressure that law firms have been under for the past several years is not going away anytime soon. Even if economic growth picks up, the demands by general counsel for the more-efficient delivery of services will not abate. Law firms are going to have to address how they can afford to hire and train new lawyers, pay top dollar for that talent and not be able to pass those costs on to clients reluctant to pay for on-the-job training. The expense squeeze that began in 2008 will continue, and outsourcing offers a way to solve the problem.

Technology ' The cost of technology infrastructure continues to increase despite Moore's Law. Perhaps, because despite declining per-unit technology costs there is just so much more of it now. The pens that attorneys used to handwrite their work and Selectric typewriters that secretaries typed on have been replaced by individual desktop or laptop computers, with drafts sent over complex network infrastructure to word processing centers that send them digitally to document processing centers. Accounting and document-management software can now cost millions of dollars to purchase, additional millions to support and will need replacement within five to seven years. These expenses can be mitigated by outsourcers through purchasing power and a larger base upon which to expense the cost of new technology.

The changes I foresee may appear to be dramatic to some, outlandish to others and even crazy to a few. But just think about where we were five years ago and where we are today. As the old saying goes, “the future belongs to those who plan.”

J. Mark Santiago is a member of this newsletter's Board of Editors and a certified management consultant. He is the managing partner of SB2 Consultants, headquartered in New York City. Santiago has consulted to the legal profession for more than 25 years in the areas of financial performance improvement, compensation systems, merger/acquisition due diligence and integration, and administrative support outsourcing. While a partner at Deloitte & Touche, he led the two largest law firm administrative outsourcing projects in the United States. He is a frequent speaker and author, and was the chairman of the Am Law CFO conferences for 11 years. He was also one of the three originators of LegalTech in 1981 and a member of its Advisory Board.

Several years ago, I worked with ALM Research to develop a survey of outsourcing trends within the legal profession. When the survey was first conducted (2006) the outsourcing of administrative functions (law business outsourcing) (“LBO”) in law firms was in its infancy. The outsourcing of legal work (law practice outsourcing) (“LPO”) was growing, and American law firms were in the midst of unprecedented prosperity. What a difference a few years make!

Where We Were

The initial outsourcing survey reported that while 62% of the survey respondents did outsource, outsourcing was restricted to “low value add” administrative activities. The most frequently outsourced function was travel services (72%), closely followed by: mailroom and messenger services (68%), reprographics (65%), off-site records storage (58%) and food services (48%).

The unifying factors for all of these outsourced services were that they were not “mission critical” to the daily operations of the law firms, and that the services provided could be quantified (counted) and therefore priced. Outsourcers were in effect paid for “piece work.” As such, it was a low-margin business, heavily dependent on the ability of the outsourcer to provide a commodity service cheaper than its competition, and law firms changed vendors frequently.

The survey also documented that outsourcing was (at that time):

• More widely accepted in larger law firms than in smaller ones;
• Engaged in by the respondent firms so as to provide additional time to law firm management to focus on core competencies (61%);
• Undertaken for expense-control reasons (36%);
• Believed to streamline the management process (28%); and
• Not suitable for IT, HR or the accounting functions. The most often cited reason for this was “risk.”

The survey did not specifically address the concept of outsourcing legal work. At the time, there were a growing number of document review and analysis vendors that provided assistance in large document discovery and litigation matters. These “load and code” companies also charged for their services by the piece, and competition was fierce among the U.S. and foreign-based suppliers.

There were a few law firms that outsourced legal work to India, mostly in the patent documentation area, although some firms also outsourced basic contract drafting and lease work as well.

But, like the LBO vendors, the LPO vendors competed on price and were far from the mission-critical functions of law firms.

I think the survey faithfully represented the thinking of most law firm management at the time it was conducted. However, what it did not adequately reflect was the path undertaken by the pioneering management of two leading law firms.

Several years before the survey, Akin Gump and Orrick Herrington evaluated their back-office administrative services and reached the conclusion that they could improve the quality of those services, reduce their costs and enable senior management to focus on building their respective firms and not delivering the mail or making photocopies.

What both firms did was outsource their High Value Add (“HVA”) accounting, financial reporting, IT and HR/payroll services. Orrick built a captive facility in Wheeling, WV, and Akin Gump outsourced to a third-party provider (Deloitte & Touche Outsourcing).

The results for both firms were dramatic: significant improvements in the level and quality of services provided, while achieving meaningful expense reductions. In Orrick's case the reported saving in 2011 exceeded $10 million, more than $50,000 in PPEP.

Where We Are

A funny thing happened on the way to continuous bill rate increases, annual associate compensation increases and annual PPEP increases in 2008. In the space of nine months, demand froze, associate layoffs became commonplace and partner de-equitization and/or dismissal became standard operating procedures.

General counsel demanded and received discounts, alternative fee arrangements and relief from disbursement billing for many law firm staples such as word processing, reprographic charges and messenger services.

In the most recent Peer Monitor survey, demand, productivity, direct and overhead expenses are all moving in the wrong direction. Rates, while moving higher, are about half of the annual increases enjoyed prior to 2008. Background interviews with law firm leaders predict that 2013 will be another flat to down year.

As the economic outlook has continued to remain uncertain and the inability of law firms to reduce or hold the line on expenses for a third year becomes more apparent, law firms are increasingly looking for a “game change.”

The cost structure of a law firm is largely fixed. Rents are long-term commitments that landlords are reluctant to re-negotiate. Associates can be cut, but you can only eat so much of the seed corn before the future viability of the law firm comes into question. Expenses can be reduced, but inevitably creep back up. Technology investments can be postponed, but equipment wears out and technology advances almost daily.

The largest single area of expense that can be controlled is that of the HVA support services. The average “all in” cost of a secretary (base compensation, overtime, bonus, benefits and occupancy) exceeds $90,000 in most metropolitan areas. In some cities, Boston, Los Angeles, New York, San Francisco and Washington, that number exceeds $100,000. Other HVA staff (accounting and finance, HR, IT and marketing) can exceed secretarial costs by 10% to 50%.

Within the last two years, WilmerHale, Pillsbury Winthrop, Bingham McCutchen and most recently McDermott Will & Emery all announced that they were moving their HVA support personnel to an outsourced model.

SB2 Consultants in conjunction with the Williams Lea company is working with a group of law firms exploring the costs of providing HVA services in a more cost-efficient and effective manner. Results from our work are, we believe, representative for Am Law firms between 400 and 1,000 attorneys.

Our average firm has 563 attorneys (71 equity partners, 176 non-equity partners and 316 associates), $325 million in annual revenue and PPEP of $700,000. Outsourcing the HVA functions will result in saving participant firms between $7 million and $10 million per year. Profits per equity partner will increase between $92,000 and $134,000 per year.

In order to achieve similar increases in profitability, participant firms would have to increase their annual revenue between $20 million and $28 million every year.

The savings are achieved through labor arbitrage by moving positions from central urban areas to less-costly areas within the United States; the re-engineering of all administrative functions to eliminate duplicative and unnecessary tasks, utilizing the full capabilities of existing accounting software and the introduction of new work flow software. Recently, this approach reduced the accounts payable function staffing and costs of an Am Law 50 firm by more than 50%.

Outsourcing provides a way for law firms to increase service levels, improving quality while maintaining partner profitability in a very challenging environment.

These conclusions are supported by the most recent ALM Research on law firm outsourcing that documents that in the last five years firms considering HVA outsourcing have increased from 3% to almost 50%.

Where We Will Be

As the dramatic shift in attitude toward outsourcing HVA functions by law firm management demonstrates, significant changes in the way law firms conduct their business are on the way. Within a short time, most HVA administrative services will be provided by a third-party vendor. This change will be driven by three factors. They are:

Law Firm Strategy ' For years, many consultants (this one included) have urged that law firms become more “business like” in the way they manage themselves. The necessities of thoughtful revenue planning, expense budgeting and practice development require significant time and effort on the part of law firm management. Too often in the past, future planning is postponed because immediate tactical problems must be dealt with. Outsourcers prescribe that you “do what you do best and outsource the rest.” I agree and would add that you invest your valuable management time in efforts with the greatest payback for the firm and let an outsourcer worry about if the vendors get paid.

Market Conditions ' The economic pressure that law firms have been under for the past several years is not going away anytime soon. Even if economic growth picks up, the demands by general counsel for the more-efficient delivery of services will not abate. Law firms are going to have to address how they can afford to hire and train new lawyers, pay top dollar for that talent and not be able to pass those costs on to clients reluctant to pay for on-the-job training. The expense squeeze that began in 2008 will continue, and outsourcing offers a way to solve the problem.

Technology ' The cost of technology infrastructure continues to increase despite Moore's Law. Perhaps, because despite declining per-unit technology costs there is just so much more of it now. The pens that attorneys used to handwrite their work and Selectric typewriters that secretaries typed on have been replaced by individual desktop or laptop computers, with drafts sent over complex network infrastructure to word processing centers that send them digitally to document processing centers. Accounting and document-management software can now cost millions of dollars to purchase, additional millions to support and will need replacement within five to seven years. These expenses can be mitigated by outsourcers through purchasing power and a larger base upon which to expense the cost of new technology.

The changes I foresee may appear to be dramatic to some, outlandish to others and even crazy to a few. But just think about where we were five years ago and where we are today. As the old saying goes, “the future belongs to those who plan.”

J. Mark Santiago is a member of this newsletter's Board of Editors and a certified management consultant. He is the managing partner of SB2 Consultants, headquartered in New York City. Santiago has consulted to the legal profession for more than 25 years in the areas of financial performance improvement, compensation systems, merger/acquisition due diligence and integration, and administrative support outsourcing. While a partner at Deloitte & Touche, he led the two largest law firm administrative outsourcing projects in the United States. He is a frequent speaker and author, and was the chairman of the Am Law CFO conferences for 11 years. He was also one of the three originators of LegalTech in 1981 and a member of its Advisory Board.