In their recent report on the state of the US legal market, Thomson Reuters draws on the analogy of Pan American Airways (Pan Am) as a caution to law firm leaders. They emphasise that those who fail to adapt and respond quickly enough to fundamental shifts in the legal sector, and prepare for the future, may see their firms decline, become irrelevant, or, just like Pan Am, cease to exist.
Without overstating the matter, we believe it is time for law firms to finally pay attention to the words of cyber punk author William Gibson – “The future is here. It is just not evenly distributed”. The future of the sector is no longer dependent on the success, or otherwise, of the traditional law firms. As Thomson Reuters correctly identifies there have been fundamental changes in the balance of power in the legal market that have increasingly challenged most of the traditional assumptions about how law firms should be run and how legal services should be delivered. The competitive environment has changed fundamentally, and relatively new entrants to the market may now have an advantage that traditional law firms find difficult to counter.
Our experience shows that despite the clear warning signs, many managing partners, management committees, and partners in law firms have adopted one of two positions. They either, deny that change is happening at the rapid pace we are currently observing, or they argue that even if such change is happening, it will not impact their business model, their client relationships, or their skillset. the basis of this confidence is increasingly difficult to understand, as it certainly is not based on a proper understanding of either technology or economics.
It is true that, as Thomson Reuters say, many of the changes have been masked by the strong economic performance of the sector, but one needs to always look through the apparent to see the obvious. That is, after all, the expectation of a leader. One should also be careful to avoid falling into the trap of short-sightedly worrying only about the performance of this year or the next, or only about one or two financial metrics. To do so is to risk missing the trends that are apparent in the available data that, if ignored or misconstrued, may lead to crisis.
Law firm leaders should also be cautious about adopting only a backward-looking retrospective analysis of the current market changes, pressures, and trends. It is certainly true that we have been talking about the disruption of the legal sector for many years. Two of the best-known authors and commentators on the sector, Professor Daniel Martin Katz, and Professor Richard Susskind OBE FRSE, have spoken of the threat of technology and new ways of working to traditional law firms for over a decade. They were and continue to be right. “But”, argue many law firm leaders and partners, “they can’t have been right, since we have continued to see strong performance and our profit per point has gone up nicely over the last decade. Clearly the threats apply to someone else, and I need not worry.”
There are two principal reasons why the sector has not transformed as quickly as was predicted back in 2010-15. The first is the masking effect of the market conditions that Thomson Reuters reference; the second is the slower than expected evolution of, and the disaggregated market approach to, displacing technologies like AI driven automation tools. Both factors have lulled many traditional law firms into a false sense of security while, around them, forward thinking competitors, new entrants (both big and small), new technologies, and new client expectations transformed the sector without them really noticing. And to be fair, if you can deliver strong revenue and profit growth year on year, then can you not accept this as job well done? Unfortunately, strategic leadership involves much more than short-term financial performance – that is, assuming you wish to leave a healthy sustainable business for those who come after you.
Traditional law firm leaders and partners cannot approach and plan for the future on the assumption that we will continue to see the economic masking effects that have defined the last decade. Even more so, they cannot see the past technology development trends as indicative of the trends we can expect to see in the next two years, never mind the next decade. Simply put, the arrival of Generative AI and Large Language Models (LLMs) specifically, as a feature of everyday life has changed the paradigm – in our view, irreversibly. Gen AI is here whether we like it or not, and it will evolve and improve not in a linear fashion, but exponentially. Finally, the rapid consolidation of the Gen AI market into a few dominant technology providers with access to vast data pools, expertise, and large balance sheets means that the pace of development and improvement is unlikely to slow anytime soon, although it may be throttled back by regulation in some jurisdictions.
So, since 2014, while many traditional law firms suggested nothing was changing, the sector saw demand levels remain static and financial performance driven largely by rate increases. In this same period, Alternative Service Providers (ALSPs) have re-shaped the sector, unfettered by traditional market constraints. By 2023 the ALSP market segment was $20bn and was growing at a compound annual growth rate (CAGR) of 20% year on year, a growth rate that the traditional legal sector could only dream of.
Approximately 80% of law firms and 70% of in-house legal departments currently are using ALSPs.
ALSPs operate a more traditional corporate commercial model that allows them to invest in short and long-term refinements, improvements, and technologies – either by using their own balance sheet or accessing external funding. Because of their governance and ownership models, ALSPs are also more adept at moving quickly and adapting to new challenges or opportunities, the most recent of which being Gen AI.
Since 2014, we also have also seen the broad legal technology sector grow to be worth more than $20bn, with predictions that it will grow to $36bn by 2027. With the arrival of Gen AI, this prediction is likely to be found to be very conservative.
In January 2023, in their annual biennial report on the ALSP market, Thomson Reuters made the observation: “Overall, it reveals an evolving legal market in which the boundaries between alternative legal services providers, law firms, corporate law departments, and even technology and software firms are rapidly blurring.” And that was prior to the rapid adoption and market penetration of Gen AI that we have seen since early 2023.
In this regard we should note that, despite a lot of noise and tweaking around the edges, the traditional legal sector has been slow to adopt Gen AI in any meaningful way. One reason for the hesitation and reservation about the technology is the sobering and valid concern regarding its impact on the traditional law firm business model, which is still underpinned by the simple rationale of ‘rate x hours’. Another reason is the already mentioned insistence by many partners that “no technology will ever be as good as me or replace my skillset.” This reaction is to rather miss the point. As we have said in other papers, denial is not an answer.
And let’s be clear, Gen AI is only the most visible part of the ongoing technological transformation of the legal and other white-collar sectors. For law firms, legal departments and lawyers to view their technology strategies through only the prism of Gen AI is like playing chess thinking that only the Queen can move, only to find that your opponent is using all the pieces.
But let us focus on Gen AI specifically for a minute:
In their recent report on the state of the US legal sector, Thomson Reuters report that just half of large law firms have an overarching digital transformation strategy at the C-Suite level, “even as Gen AI continues to evolve very fast with the pace of adoption hitting unprecedented levels”. This lack of a digital transformation strategy demonstrates both the slow pace of change adoption within the sector, and a lack of awareness of the potential impact and opportunity created by technology broadly and Gen AI specifically. AI and displacing technologies are not new. Many have been used within law firms for many years, although usually on a small scale, and often only by the internal innovation team or “innovation hub”, and some support professionals. Gen AI in the form of accessible and easy to use Large Language Models has been around since late 2022 and has evolved and improved quickly and very publicly ever since. We believe every law firm C-suite, should quickly have understood the possible implications of the technology – positive and negative and then equally quickly refined, adapted or developed an effective digital transformation strategy. Non-traditional competitors and many clients have certainly done so, further embedding their advantage in this chess game.
Thomson Reuters offers up 3 possible scenarios for the future of Gen AI:
- The rising tide – which sees the increasing application of Gen AI significantly enhances both client value and law firm profits.
- The lopsided landscape – involves clients leveraging Gen AI to assert further control over legal services, diminishing law firms’ traditional roles to an even greater extent and enabling most of the technology’s value to be claimed by clients at the expense of firms; and
- No big thing – Gen AI simply does not have a significant strategic impact on law firms, serving instead as an advanced tool for knowledge management and search functions but not substantially altering current legal practices or the overall balance between law firm and client. Gen AI finds utility in operations, marketing, IT, and HR but does not notably change client benefits or firm costs.
We are strong proponents of the second scenario, although we would add to it that the landscape will be lopsided not only in favour of the clients but, as between firms, also in favour of those firms that recognise the need for change, quickly make the required changes, and secure a competitive advantage in doing so.
Even if we were to see only marginal further improvements in the capabilities of Gen AI and LLMs, the logic is inescapable. Gen AI and LLMs will have a profound and transformative impact on the sector. We are already seeing this across the sector. Even if currently only at a small scale, the trends should be ringing bells in the boardrooms:
Initially, individuals and small businesses, who previously relied on smaller law firms, start using Gen AI tools. These tools offer a more affordable, accessible, and often sufficiently competent alternative for various their regular legal needs.
As a result, there’s a decrease in demand for traditional legal services at the lower end of the market. Firms in this tier experience a decline in revenue and client base. To adapt, they need to shift their focus, offering more specialized or complex services that AI cannot easily replicate or targeting niche markets where personal touch or deep expertise is highly valued.
Mid-tier firms will start feeling the pressure as the lower tier adapts. They might face competition from lower-tier providers moving upmarket and the democratisation of AI tools becoming more sophisticated and capable of handling more complex tasks. These mid-tier firms will need to innovate, either by integrating AI into their service delivery to reduce costs and improve efficiency or by focusing on high-value, bespoke services. Just like the smaller firms put pressure on them, so too will they start putting pressure on the top-tier, larger firms.
While specialist boutiques, and larger, top-tier firms may have a slightly longer runway, the aggressive adoption of generative AI by corporate clients will lead to a decline in traditional, routine legal work for even these firms. This necessitates a strategic shift in even these most “protected” firms, focusing on high value, specialised legal services, adapting their ownership and revenue models, reallocating resources, and investing in advanced technology and strategic partnerships to remain competitive and relevant.
In summary, the greater integration of AI across all tiers of the sector, and across the entire client ecosystem is likely to change the commercial models, nature of work and the skills required across the entire legal sector. Law firms will need to focus more on areas where human skills are paramount – like creativity, complex problem-solving, and emotional intelligence. New business models will evolve and emerge, focusing on AI-human collaboration. There should be an increased emphasis on upskilling and reskilling all staff, not just lawyers, to succeed in this new environment. Ethical considerations, data privacy, and regulation of AI in professional services will become increasingly important topics. These are topics for law firms to directly engage with, rather than adopt a “wait and see” approach. They require strategic consideration, allocation of skilled resources and investment.
The rapidly evolving legal services landscape, characterised by the rapid advancement of displacing technologies like Generative AI, the entry of new large and small, and more agile competitors, and a further shift of power to clients, calls for a critical rethinking of the traditional law firm model, a model which is geared towards maximising profits for current equity participants.
With the very real likelihood that Generative AI and broader displacement technology adoption will mean a fundamental shift to the traditional law firm commercial model, law firm owners and equity participants face a philosophical crossroads. Do they continue to focus on short-term profit maximisation, or do they adopt a more corporate, longer-term perspective, that sees them investing in the future and for the possible benefit of a future generation of owners? Such a shift may necessitate a change in the mindset of many equity participants – from expecting constant profit growth to accepting more commercially realistic profits, and even possibly accepting that other specialist, non-lawyer business professionals within their firm will earn more than even the highest earning equity partners. There will also need to be a careful review of the mandate given to Managing Partners, CEOs and management committees. A mandate to future-proof the business may not sit comfortably with a mandate to maximise profit in the short-term.
On any construction, and irrespective of the philosophical approach adopted by equity participants, the traditional law firm business model will need to change to meet the new demands and realities. Given the likely impact of Generative AI on revenue flows and the commercial value of a at least a portion of the existing billable hour capacity, firms will need to quickly consider their commercial models, including ownership structure; technology (not “IT”); funding and investment philosophies; remuneration systems; talent recruitment, training and retention; and organisational design. When doing so they will need to pay particular attention to the, very often, high fixed costs they carry, in the form of long-term rental commitments and employment costs. The costs associated with any restructuring, including potential severance or retrenchment packages, also add complexity to the transition to a new business model.