This is the first of a three-part series looking at the rise of AI-based tools and several other drivers of change in the way law firms train new lawyers and how some firms are approaching learning and development.

The legal profession finds itself in a new wave of hype about artificial intelligence (AI) due to the popularity of ChatGPT and other forms of generative AI. There’s no question that AI has now made significant inroads in legal practice, with machine learning methods currently at work in eDiscovery, contract review and analysis, document generation, and legal research.

The amazing interest in the public facing ChatGPT, and ongoing discussions about how it might be leveraged in legal work, is largely driven by the fact that anyone can test it out and use it today. Even in its current, fairly primitive form and with all its limitations, it’s easy for lawyers to see how generative AI could take on some of the tasks that are now handled by human lawyers.

The recent Thomson Reuters Institute survey report, , shows how a new generation of AI-based tools is attaining high levels of awareness and interest in a very short time — much more quickly than earlier generations of AI tools. In fact, 80% of the respondents to the survey say that generative AI can already be applied to legal work, while just more than half say it should be. Contrast that with the skepticism that earlier applications for AI had faced, in eDiscovery or contract analysis, for example.

What will AI mean for training & development?

Traditional training of new lawyers in law firms can be described as informal mentoring combined with throwing young associates into routine tasks such as document reviews. However, what happens when technology automates many of those routine tasks?

A 2022 study, the Litera Technology in M&A Report, looked at some of the impacts of AI-based tools on firms’ M&A practice. The survey’s respondents identified both positive and negative impacts of AI on the career development of young associates. On the one hand, most agreed that the use of AI in M&A deals is creating new career paths, and that freeing young associates from menial tasks gives them time to focus on their analytical and advisory skills. Almost as many respondents, however, thought that the use of AI-based tools in document review makes it harder for young lawyers to learn the craft because they don’t get the experience of identifying and extracting contract terms.

It’s an odd paradox that AI tools make legal work more efficient and accurate but might also make it harder for young lawyers to learn their craft. Josh Kubicki, Director of Legal Innovation & Entrepreneurship and Assistant Professor of Legal Practice at the University of Richmond, describes the problem as the removal of cognitive friction from the learning process. In a recent edition of his Brainyacts newsletter, which explores all things generative AI, Kubicki described cognitive friction as “the mental effort, challenges, or obstacles encountered when processing information, solving problems, or learning new tasks.” The struggles that young lawyers have when tossed into a sea of documents that need review, and the realization that they are in over their heads, is a source of that cognitive friction.

Dealing with cognitive friction in legal work provides pathways to learning. It’s a “valuable catalyst for growth, as it encourages critical thinking, creativity, and problem-solving skills by pushing individuals to engage more deeply with the task at hand,” says Kubicki.

Yet, what happens to learning when AI takes the menial, routine, ambiguous, and complex out of a new lawyer’s day-to-day? Where will the learning come from?

Drawbacks of traditional training methods

“To teach associates, we’ve thrown them into the deep end of the pool, let them struggle, and maybe or maybe not, a partner or senior associate will catch them and help them figure things out,” says Kubicki. “But that’s incredibly uneven. It’s not managed properly. And it’s a heavily biased ecosystem.” Indeed, new AI tools may be taking away lawyers’ opportunities to learn by overcoming cognitive friction, but the old way was never applied consistently or effectively either.

The answer, says Kubicki, is a more intentional approach to learning and development. “How can we manufacture cognitive friction in a controlled environment? Well, then you start looking at structured learning programs.” Such programs are more interactive, planned, and just-in-time. They move beyond the legal profession’s preferred model of sitting in a room watching someone narrate a PowerPoint deck, and instead they tie training to the work at hand and vary the pace, medium, and format.

And some firms are already putting that kind of intentionality into practice. However, it’s not just the training challenges presented by AI that are driving them there.

Other drivers of change in professional development

Interestingly, the growth of AI is not the only factor pushing law firms to take a closer look at how they train associates. The pandemic, and the technological accommodations that many law firms had to make to enable remote work, have also had a big impact. In addition, law firms are increasingly influenced by trends and research in learning and development outside of the legal industry.

When the pandemic struck, law firms that were dependent on the older model of in-person mentoring and classroom-based training were suddenly forced to leverage collaboration technology and establish new hybrid working models, in which it was no longer a given that person-to-person training or mentoring would always be possible.

Hybrid work limited spontaneous learning and created uneven experiences for live training sessions in which some lawyers attended in-person, but others only viewed remotely. This also made it more difficult for associates to build social relationships with peers and leaders who were traditional sources of training and mentorship.

Even before the pandemic forced the issue, however, many organizations outside the legal profession were already re-examining their learning and development efforts. Recognizing the importance of training in employee satisfaction and retention, a number of new techniques had become commonplace, including:

• • • Continuous learning, a focus on embedding learning throughout an employee’s experience.
    • Blended learning, where classroom-style learning gives way to training that combines some online portions, which users can access at their convenience, as well as in-person experiences.
    • Gamification has become more common, with competition and rewards built into the training.
    • Increased use of technology to create more engaging and interactive online learning tools that go beyond simply transmitting a canned curriculum of information.
    • Emphasis on soft skills training, including critical thinking, problem-solving, and creativity.

Similar to organizations outside the legal industry, law firms are starting to professionalize the management of their learning activities. Firms have created Directors of Learning & Development and similar roles to better adopt these and other techniques, and they are taking a more strategic view of lawyer training that recognizes its role in building value within the firm.

In the second part of this series, we will look at some of the specific techniques that law firms are using in response to these trends.

However, one key area remains to be explored — specifically, how are clients reacting to these large jumps in hourly rates?

It should be noted from the outset that the fact that rate growth is higher in 2023 than last year surprises basically no one. Nearly every observer of the legal industry knew that the pace of rate growth would accelerate this year, and the only question was, by how much. We now have an indication of that answer, and it’s an appreciable amount.

Gauging client pushback

Many legal market commentators have also been speculating that clients will likely start pushing back more aggressively on rates. This is a nuanced proposition as there are several different ways clients may do this. Let’s explore some of the possibilities.

First, clients may be inclined to ask for larger discounts off published standard rates. In truth, this may or may not be happening, but it’s not particularly germane. Standard rates are the advertised top rates from a law firm, similar to the rack rate on a hotel room — it’s a number they publish, but almost no one actually pays it. The point of trying to increase the discount on standard rates would be to attempt to exert some influence over the actual rates being charged by law firms. Whether clients are requesting larger discounts or not, the fact remains that worked rates still went up by quite a bit. Even if clients are pushing back on standard rates, they are not doing so to a large enough degree to place much of a damper on the growth of agreed-upon rates.

Nearly every observer of the legal industry knew that the pace of rate growth would accelerate this year, and the only question was, by how much. We now have an indication of that answer, and it’s an appreciable amount.

Second, clients may be expressing price sensitivities to their law firms throughout the course of their matters, encouraging firms to increase the amount of the potential fee the firm writes down before the client receives an invoice. There is some evidence that law firms are, in fact, increasing the amount of potential fees they proactively write-down prior to invoicing, which is contributing to the reported decline in realization. Whether this is the result of actual or simply perceived pushback from clients is an open question. It seems more likely that any increase in write-downs is due to perceptions of possible client objections by law firm lawyers rather than anything proactive on the part of clients.

Third, clients may be seeking larger discounts on their invoices, once received. If this were the case, we would see a widening gap between what we call billing realization (the percentage of the agreed rate that’s billed to the client) and collected realization (the percentage of the agreed rate that’s collected from the client). If the gap between these two figures widens, it’s an indication that clients paid a smaller percentage of their invoice. While there is some evidence that the gap between billing and collected realization widened for the quarter, it is difficult to tell at this point if this is the start of a trend or just part of the regular realization cycle.

Finding the value proposition

While there may be additional actions clients could take in reaction to rising rates, there is one that merits particular attention: Clients might just vote with their feet.

An unhappy client has a plethora of potential law firms and alternative legal services providers from which to choose, particularly if the main issue of contention is cost.

At a series of roundtable discussions in which I’ve participated with general counsel this year, I often have heard of concern over the increasing costs of outside counsel at a time when in-house law departments are facing an uptick in their overall matter volumes along with pressure to curtail their budgets — clearly, a difficult conundrum.

For many of these GCs, one option that comes immediately to mind is to shift to lower-cost law firms for some of the legal work needed. This phenomenon of demand mobility is something we explored in our Report on the State of the Legal Market earlier this year, as well as our State of the Corporate Law Department, released in March. Indeed, clients are not shy about discussing their feelings on this among their peers. They will freely discuss not only the fact that they’re doing it, but what types of matters they’re shopping around, how they’re identifying potential new law firms, and even which specific law firms to whom they are giving additional work.

At a time when half of legal service buyers report switching at least some portion of their panel of outside law firms, we are in a time of nearly unprecedented volatility in terms of legal demand shifts. That’s not to say that all work is at risk or that every higher-cost law firm should be worried, however. Another observation I have heard frequently from GCs is that for some firms, cost is no problem because of the value the firm delivers.

Of course, value is a bit of an amorphous term in that its meaning is very much in the eye of the beholder, i.e., the client. But there is some commonality of definition: quality, efficient legal advice that meets the client’s need — without exceeding a reasonable scope — and which recognizes the client’s broader business objectives.

For those law firms that deliver value well, clients will often tell me something along the lines of, “I have no problem with what they charge me, because they’re worth it.”

Such a characterization would be a worthwhile goal for every law firm. Truly understanding what the client values and delivering against that value proposition requires a lot of discussion with and understanding of the client, their goals, and their business. But for those firms that can do it well, it is, perhaps, one of the best ways to ensure the long-term strength of the relationship with the client.

But, how does a law firm go about calculating carbon emissions, also referred to as greenhouse gas (GHG) emissions, which is the first of many topics that U.S. regulators among others are starting to require? The process for quantifying this is known as carbon accounting.

Components of carbon emissions

The most common elements of the firm’s operations that are key to calculating carbon emissions are categorized in Scope 1, 2 and 3 type emissions.

Scope 1 emissions overview — Law firms are office-based and usually serve as tenants. Direct emissions (known as Scope 1) come from activities under control of the firm. Not surprisingly, law firms generally have smaller amounts of Scope 1 emissions. Typically, these emissions will come from any fuel and gas related to the operation of the building as well as from refrigerants (i.e., refrigeration, air conditioning) and fall into several areas of combustion:

• • • stationary (fuel and gas onsite);
    • mobile (firm-owned vehicles using fossil fuels); and
    • fugitive emissions (vapors directly released, like refrigerants, fire suppression).

Details of Scope 2 and 3 — Law firms will have most of their emissions come from Scope 2 and 3 categories. For Scope 2, indirect emissions come from purchased energy in the form of electricity, steam, heat, and cooling. Purchased electricity is the biggest emissions area in Scope 2.

For Scope 3 the most common indirect emissions are in the categories of measuring business travel, commuting, and purchased goods & services, including paper and waste. In the commuting category, some firms will include remote work by staff. Remote work emissions include emissions generated by equipment, such as lights, laptops, and other office equipment at home.

Key factors in carbon emissions calculations

Quantifying GHG emissions can get complicated pretty quickly, and this is why it is important to identify the subcomponents by Scope and focus on data collection first.

For Scope 1 and Scope 2, law firms will use their metered (or sub-metered) data, such as utility bills or purchase receipts and contracts. If they don’t have this, estimates based on square footage by region is the next best option.

For Scope 3, travel data can usually be found with the firm’s corporate travel agency or in the expense management system with purchase records. Commuting data and data related to remote work emissions can be obtained through surveys to employees.

In the area of purchased goods and services, it’s best to first try to obtain the data from the provider, but if the data is not available, using external databases, such as the data from the Intergovernmental Panel on Climate Change (IPCC), is the next best option. For water, the data can be obtained through sub-metered data or water bill. For waste, it is best to work with the building management.

Gather a multidisciplinary team for emissions data gathering & calculation

Compiling a cross-functional team within the support functions of the firm is necessary for the most efficient way to initiate and complete the data gathering process.

• • • Real estate, facilities & operations — Facilities and operations need to work with the building management to obtain critical data for utility data, water, waste, etc. The internal real estate department can be helpful as well.
    • Procurement & finance — Members in the procurement and finance function can help to view and track spending within the supply chain to gather Scope 3 data. Many positions within the procurement team now encompass the responsibility of emissions and decarbonization.
    • Technology — The firm’s IT group also play a role in emissions management by providing more insights on data centers, energy usage, life-cycle assessments, etc. from the procurement and e-waste perspectives.
    • Human resources — HR has a critical role to play in obtaining commuting data, sending out surveys, helping to determine remote work emissions, and other items related to the workforce.

Doing the calculation

Combining the carbon emissions is the next step once the Scope 1, 2, and 3 data sources are collected. The challenge in this step is understanding what emission factors to apply — not surprisingly, this is the point when some organizations choose to hire a consultant.

Some of the emissions factors, which is a representative value that attempts to relate the quantity of a GHG being released to the atmosphere with an activity associated with the release of the GHG, can be found on the Environmental Protection Agency (EPA) web site in the U.S., and on the U.K.’s departmental websites for the Department for Business, Energy, and Industrial Strategy; and the Department for Environment, Food & Rural Affairs. For other jurisdictions, the IPCC also has an emission factor database.

Measuring emissions will continue to evolve with the ability to gather more emission factors to create higher quality baselines. While it is important to start with the data collection, it is imperative for law firms to prioritize the biggest areas of emissions, such as travel, with low-quality data. This is where there is the opportunity for significant improvements, and law firms can refine the calculation over time.

Driving the need for continuous improvement in the calculations are the RFP requests to measure and disclose carbon emissions data from clients. Indeed, this number is likely to increase exponentially, and there will be increasing pressure for third-party verification and assurance.

An enhanced reputation is a huge benefit of carbon accounting and is a big driver to making meaningful change. Striving for this incentivizes law firms to find better ways to do things to reduce inefficiencies, waste, and consumption, which benefits everyone.

Fears of missing out on opportunities or alienating rainmaking lawyers trap some firms in the ambiguity abyss — that largely undifferentiated position of saying, We are a full-service firm that’s able to meet the complex needs of sophisticated clients.

Our analysis of the last 15 years of law firm brand positioning, recently reviewed alongside law firm financial data, has produced a compelling argument for law firms to build a differentiated approach to the legal market.

A differentiated approach

There are four ways to think about segmenting and differentiating a firm’s approach to the market:

1. 1. 1. Expertise — We are smarter than other firms in this area of law.
      2. Client type — We understand this kind of client better than other firms (e., public vs. private companies, start-up vs. mature companies, etc.)
      3. Geography — We offer strength in a defined geographic region.
      4. Sectors — We can navigate the dynamics of this sector and are well-positioned to serve all client needs in this space.

While law firms need to consider each of these factors as part of their strategic plans, competitive advantages are created when one factor is considered the key strategic priority that then informs the other three. Let’s look at this concept in action.

Case Study 1: A sector-focused approach to the market

Law firm ABC has a clear sector-focused approach to the market and is heavily entrenched in the technology sector — from traditional tech companies to fintech and e-retailers, this firm serves them all.

The good news for Law firm ABC is that their stated strategy is strongly corroborated when looking at our research of more than 2,300 General Counsel and senior corporate law department leaders. (Sadly, this isn’t always the case, which may indicate a poorly executed strategic plan.)

When looking at the types of companies that keep Law firm A top-of-mind, nearly 70% of those senior legal decision-makers are from organizations in a tech-related sector. This, unsurprisingly, also means a large proportion of these companies are based on the West Coast of the United States.

More proof of Law firm ABC’s effectiveness in executing this strategy comes when assessing the firm’s ability to gain access to new work or generate more legal demand.

Our Market Insights team undertook a conversion analysis, which involves looking at what proportion of legal buyer respondents who name a law firm top-of-mind then go on to say that firm is the one they consider hiring for different types of legal work. In other words, how well does a firm convert mindshare into market share.

Law firm ABC is twice as effective at turning awareness in new work with legal buyers in the technology sector compared to all other sectors combined — an impressive proof point that underscores how the firm’s focus in this sector is more than just lip service. And the firm’s financial performance? When looking at demand (billable hours), this firm has nearly 50% higher demand growth than the average firm over a three-year timeframe.

Why differentiation works

Of course, lots of factors go into a law firm’s ultimate success, and brand differentiation is one of the levers that law firms can control. In the case study above, Law firm ABC uses a sector-focused strategy to differentiate itself from other firms in the (extremely crowded) market.

And Law firm ABC is not a one-off example.

Our ongoing research with General Counsel shows that many outside law firms identified by clients as having deep sector knowledge earn, on average, 43% of their clients’ external legal spend — that’s nearly 2.5-times the typical firm.

With lack of time being one of the most pressing issues that General Counsel and other law department decision-makers face, a differentiated brand helps buyers quickly understand how your law firm can help them — rather than trying to figure out if yours would be the right firm to call in a specific situation.

For more on how your firm can differentiate in various ways, check out our latest video, which digs deeper into understanding the various ways firms can differentiate — and measure the success of their approach to the market.

Among the other respondents, however, the feeling was not necessarily distaste for generative AI, although some of that did exist. Instead, many are still simply unsure exactly what generative AI is or what it can do. Yet, considering the pace at which law firms have adopted technology previously, this is an understandable feeling given that the public release of OpenAI’s ChatGPT occurred only in November 2022.

Overall, the report found uncertainty across the board among law firm respondents: 25% said they did not know whether generative AI should be applied to legal work, and 21% did not know whether it should be applied to non-legal work. These feelings even extended to other forms of AI outside of generative AI/ChatGPT, as 24% did not know whether their firm uses AI outside of the generative context.

Jason Adaska, Director of the Innovation Lab at Holland & Hart, has a team of data scientists working on potential generative AI applications for the firm. Adaska says that because generative AI has appeared on the scene so quickly, there is “an increasing bifurcation in the conversations that I have” between people interested in using it and those unaware of its existence.

“Some people, they’ve seen it in the media, they’re kind of up to date with it,” he adds. “They may not come from a technology perspective, but at least they know about the conversation. Even in March I had some conversations with people who say, ‘I didn’t catch that. What is ChatGPT, what is this word you’re throwing at me?’”

Discovering how generative AI & ChatGPT can help

Similarly, Arsen Shirokov, National Director, Information Technology at McMillan, has already begun having conversations with internal stakeholders and external vendors about ways generative AI can be applied in his firm. A sticking point he’s run into, however, is that unlike previous legal technologies that have had a distinct use case, generative AI’s applications are so expansive that they can be hard to nail down.

“Almost everywhere else in technology, you say what this product is: this is an IG solution, this is a business workflow solution, this is an architecture solution, right? …With generative AI, I think we haven’t figured that out yet,” Shirokov says. “We don’t necessarily know which generative AI solutions are for research, for example. Take ChatGPT: It can also draft things for you, but for review, you cannot feed the bunch of documents to ChatGPT yet and just say, review this.”

Until those questions are answered, many lawyers also remain unsure of how their firms will handle generative AI on a wider scale. Our report found that 36% of respondents said they did not know whether their law firm had risk concerns around generative AI usage. Additionally, 19% did not know whether their firm had issued warnings against unauthorized generative AI use; and 22% did not know whether their firm had banned unauthorized generative AI use outright.

“How are we going to get people comfortable not just with the technology, but with the fact that they are interacting with a machine, and yet it doesn’t feel like you’re interacting with a machine?”

Even those respondents who reported their firm had underlying risk concerns over these advanced technologies counted a lack of technological maturity as one of those barriers. “A lack of understanding of the underlying risks,” wrote one respondent when asked why their firm had concerns around generative AI.

“Lack of insight/ability to control algorithms, data sets, and assumptions/biases of generated results. Lack of disclosure of disclaimers, boundaries, and assumptions when results return. Lack of ability to assess confidence in generated results,” wrote another.

As a result, for those law firms actively considering embracing generative AI — the report found 40% of firms were at least considering its use — encouraging adoption may be as much of a knowledge and informational issue as a technological issue. To that end, Jessica Lipson, Partner and Co-Chair of the Technology, Data & IP Department at Morrison Cohen, said her firm has been treating communication as a “high strategic issue” in potentially adopting generative AI technologies. “How are we going to get people comfortable not just with the technology, but with the fact that they are interacting with a machine, and yet it doesn’t feel like you’re interacting with a machine?” Lipson asks.

Part of the answer may take a cue from the 1989 film Field of Dreams: “If you build it, they will come.”

Holland & Hart’s Adaska says he’s gained interest in his team’s generative AI efforts by simply letting attorneys play around with the tool themselves. “I think that’s the story of the last few months in this,” Adaska adds. “A number of people who maybe would have either not paid attention or have been skeptical are being won over by actually trying things they thought weren’t possible and being pleasantly surprised.”

Environmental, social & governance (ESG) issues represent one of the key areas of complexity in global regulatory landscape. Yet, when asked specifically about ESG, it was the third-most cited risk on the horizon, with one-in-five law departments seeing ESG as a major future risk.

Even more interesting is that data privacy and cybersecurity were also in the top 5 risks on the horizon, according to the survey. Clearly, GCs and CLOs would agree that these two risk concerns are important governance issues as part of the G in ESG. Indeed, looking at top 5 risks on the horizon cited in the survey, one could easily argue that ESG, when including data privacy and cyber-risk, is actually among the most important risks on the horizon.

If we agree that ESG encompasses data privacy and cybersecurity, then ESG rises to the top as one of the most popular risk on the horizon over the next three to five years by corporate legal departments across the world. And while the regional variations are also quite interesting, they send the same message: ESG, including data privacy and cyber-risks, is a key governance issue that is top of mind for many corporate law department leaders.

Taking action on these insights

More importantly, law firms can use this market intelligence to invest in their practices. For example, law firms with ESG practices should be ramping up in the regulatory & compliance areas because this has been cited as the most pressing current priority and one of critical importance in the future. In particular, in-house legal departments are challenged to keep abreast of regulatory changes — and because ESG is a major area of fluctuations in regulatory requirements — law firms would be wise to prioritize their analysis and forecasts of ESG regulations across jurisdictions and highlight new details of reporting requirements of existing regulations and show how clients can meet compliance obligations.

In addition, spotting issues in emerging ESG areas, such as biodiversity, is another consideration. For example, the Task force for Nature Related Financial Disclosures  just released its Beta v0.4 with recommended disclosures, which clients may find confusing and complex.

Decarbonization of their supply chains is another major challenge for companies, particularly for those with complex value chains. There are many components of this issue with which clients may need assistance, such as implications for vendor contracts and outlining new requirements for data reporting in contracts, such as greenhouse gas emissions and certification in forced labor regulations. At the same time, companies need to increase their ability to conduct due diligence of prospective suppliers on human rights and other denied-party screening.

Antitrust issues also are a growing area of concern for companies, in large part because of U..S lawmakers’ recent allegations that industry collaboration on ESG violates antitrust laws, specifically, firms could focus on the “rule of reason” test through the lens of market impact or market power,  as well as delineating business justifications in the U.S.

Finally, employee well-being continues to grow in interest among shareholders and investors, and ESG and diversity, equity & inclusion (DEI) was cited as a top-5 priority for in-house legal departments. This represents a tremendous opportunity for law firms’ labor & employment practices, especially as companies continue to struggle with varied preferences in work flexibility amid remote working frameworks. In addition, companies are consistently in need of updated and expanding HR policies across pay equity, learning & development, as well as DEI, among others.

The existing regulatory landscape is a tough challenge for many in-house lawyers. Moreover, the future remains murky is in this space, according to corporate law department leaders, and in-house lawyers will need the assistance of outside counsel to meet expectations. This leaves law firms with an abundance of business opportunities across ESG practices to seize upon.

Yet the growth rate shown in the most recent report still came as a bit of a surprise: a 20% compounded annual growth rate (CAGR) for the past two years, resulting in a current market size of $20.6 billion. In interviews with leaders from more than a dozen ALSPs, respondents said they expected standout growth in the sector to continue, and survey data from the client side supports these expectations. Among respondents from the largest law firms, 26% said they plan to increase spending on ALSPs, while only 3% said they expect their spending to fall. Within corporate law departments, 21% expect to be spending more on ALSPs in the future, with just 8% expecting spending to drop.

Interview respondents consistently referred to the ALSP market as “opening up” over the past two years, citing a variety of catalysts: changes wrought by the global pandemic, the impact of the Big Four auditing and accounting firms, and the shrinking size of many corporate legal departments, among others. ALSPs are taking advantage of those changes to greatly expand their service offerings; and while the industry is young, a number of ALSP leaders said they’re beginning to see a trend more commonly associated with mature industries: consolidation.

More growth ahead?

A sales director at a U.S.-based ALSP says that ALSPs have moved through the very early stages of the growth curve associated with any new innovation and are now poised for accelerated take-up. Among customers, the innovator and early adopter segments of that base have been using ALSPs for years, and their positive experiences are clearing the way for a wider mass market. “All of a sudden, people will say, ‘Okay, it’s safe now,’” the sales director says, “which will lead to even more expansion.”

He also pointed out that the traditional legal market leaves behind a lot of unmet demand. “Clients simply cannot afford all of the legal and regulatory advice they need to buy,” he says, especially if law firms remain wedded to the billable hour. “There’s this latent demand out there, and if you change your model, you can grab more market share, because [clients] just cannot afford to buy answers by the hour.”

The Big Four have also had a positive effect, says the founder and CEO of a U.S.-based ALSP, admitting that “this is going to sound strange.” The Big Four have convinced many general counsel, CFOs, and CEOs that business and law shouldn’t be so separate, the founder explains. “We found that the Big Four moving into the space has actually just opened up the top of the funnel — it’s so much larger now.”

ALSPs also get a boost from the fact that corporate law departments are shrinking — even though their workloads are not. A founder of an independent U.K.-based ALSP echoes that sentiment. “One of the things we see is that a bigger client doesn’t mean a bigger law department,” the founder says. “Inside legal counsel and inside legal operations are shrinking.” Meanwhile, he adds, inside teams have too much work, or work that isn’t a good fit for their capabilities. Legal departments are even bringing in procurement professionals — a relatively new part of the legal landscape — to try to close that gap in a cost-effective way.

Not surprisingly, the pandemic had an impact as well. “The stigma of offshore support has worn off,” says the vice-president of a U.S.-based ALSP. “We all ended up working from home, and we learned it doesn’t matter where the person is that you’re talking with.”

New opportunities

Together, these trends mean opportunities for ALSPs. The largest seems to be in regulatory & compliance work and advisory work, as well as in technology consulting. ALSPs are also looking to expand into specific service areas, such as labor & employment law, and into new geographies.

The impact of regulations such as the General Data Protection Regulation (GDPR) in the European Union and the California Consumer Privacy Act (CCPA) have produced “a huge focus” on privacy, says a U.S.-based ALSP leader. His firm is partnering with a technology company to provide faster and more focused data breach review. They’re also spending “a significant amount of time” helping clients update their contracts to reflect the new laws.

The new regulations are especially hard to navigate for those organizations that do business across countries and regions. “It’s increasingly complex to operate businesses in multiple jurisdictions and try to manage all of them,” explains the CEO of a law firm captive ALSP in the U.S. “For a lot of our clients, some of their biggest needs are just better use of some of the tools that exist that make it easier to have a good lens on the range of matters our clients have in different jurisdictions.”

Technology consulting, as mentioned in the ALSP 2023 Report, is also a growth area — one that overlaps significantly with legal operations. A partner at a law firm ALSP says his firm is regularly asked to weigh in on matters such as how to manage work, how many lawyers to hire, and where those lawyers should be located. On the technology side, his clients want advice about which technology solution to buy, how it should be implemented, and how it can be made to work best for them. The partner described a typical request as one in which clients say: “I bought some technology, and it’s crap, and it doesn’t work. Help me, because I’ve spent half a million pounds on it, and I can’t admit it doesn’t work.”

Growth through acquisition

As ALSPs grow, it’s not surprising that they become more attractive acquisition targets, fueling consolidation. “In the early stage of this industry we were trying to say, ‘Who do we acquire?’” says the co-founder of a U.S.-based ALSP. “There was nobody of any size to acquire. They were all tiny.” Another ALSP founder expects consolidation to continue, as companies that are strong in one service area — for example, discovery — look to buy a competitor that is strong in a complementary area, such as legal operations.

A partner at a law firm ALSP is already noticing that his competitive set is smaller. “Four or five years ago, I think there were 10-plus providers in the market. There might still be, but you certainly don’t see them. You probably see three or four at the most.” Now, he’s finding his clients are using ALSPs quite heavily, and hire just a handful of providers. His diagnosis of his market segment could just as well apply to the ALSP market as a whole: “It’s grown up,” he says. “It’s matured as a service offering.”

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Following the aftermath of a second year of persistent inflation, many experts had anticipated a substantial surge in rate growth, with aggressive projections ranging between 7% and 8% for the first quarter. Although the actual results fell slightly short of these optimistic forecasts, the 5.5% rate growth achieved by the average law firm still stands out as the swiftest increase observed during a first quarter period since the end of the Great Financial Crisis (GFC).

These positive outcomes were observed throughout the market, with all segments exhibiting higher growth rates than their previously most significant post-GFC increases. Specifically, Midsize law firms saw rate growth of 4.9%, while Am Law Second Hundred firms saw their rates rise by 5.2%. Notably, Am Law 100 firms led the way in terms of rising rates, achieving a remarkable growth rate of 7.2%, surpassing the segment’s previous all-time record in the history of the Thomson Reuters Financial Insights program.

Navigating inflation & expense pressures

Last year marked the first time when the Q1 Core Personal Consumption Expenditures (PCE) inflation rate surpassed the average firm’s Q1 worked rate growth. This trend continued throughout the year, with rate growth consistently falling below core PCE.

In the current quarter, firms have returned to the status quo, in which worked rate growth once again outpaces inflation. While this development is encouraging, the difference between inflation and firms’ rates remains relatively small compared to historical norms, which is particularly pertinent for less assertive Midsize firms.

Although expenses are growing more slowly both in aggregate and on a per-lawyer basis, the aftermath of rapid compensation hikes — combined with inflation-driven overhead growth and return-to-office strategies — is exerting tremendous pressure on firm profitability. In light of these factors, substantial rate adjustments were not only expected but necessary to ensure that firms remain competitive and financially sustainable in the long run.

On a practice area basis, the most significant upward adjustments occurred in counter-cyclical practices — such as litigation, bankruptcy, and labor & employment practices — which also experienced the greatest surge in demand. Conversely, transactional practices suffered contractions in demand across the board, and their growth rates were comparatively lower suggesting some degree of price elasticity. Thus, the remarkable growth in counter-cyclical practice rates was able to offset the weaker rate growth observed in other areas and propelled this quarter’s overall improvements. Indeed, across all segments, counter-cyclical work commanded higher price increases than transactional work, and this behavior was most pronounced in the top end of the market, where Am Law 100 firms recorded counter-cyclical rate growth that was more than two percentage points higher than their transactional rates. Of course, this phenomenon mostly resulted from these firms experiencing the greatest declines in demand for transactional work.

Looking at rate growth from lawyer-title perspective, a familiar stair-step approach was observed among the segments, with Am Law 100 attorneys recording the highest rate growth, followed by Second Hundred and Midsize attorneys. However, a divergence in results emerged from the relative rate increases between partners and associates within each segment. The rates for associates at Am Law 100 firms were raised much more aggressively than their equity and non-equity partners. By contrast, associates at Am Law Second Hundred and Midsize firms did the opposite, with partners commanding higher rate increases than their associate counterparts.

Law firms’ Third Law of Motion

Sir Isaac Newton famously stated that for every action, there is an equal and opposite reaction. Fortunately for the legal industry, this law of physics does not apply here. While it is true that firms’ rate hikes caused collected realization to dip below the mark set at the end of last year (in Q4 collected realization for the average firm was 91.0%), this is a typical seasonal trend and is likely to be the worst realization rate of the year as clients adjust to new prices.

However, in contrast to Newton’s third law, the reaction was not equal. In fact, compared to other first quarters, Q1 2023 resulted in one of the best realization figures in recent years. There is, almost expectedly, one exception to this trend. Am Law 100 firms, which have a transactional-focused practice mix and often serve more cost-sensitive clients, pushed their rate growth at an all-time pace and potentially suffered the greatest amount of pushback. The results of the last quarter, however, tell us that the average firm is holding onto a higher percentage of their worked rates than typical first quarter results despite the significant price hikes.

In summary, the financial performance of law firms in the first quarter of 2023 showed significant improvement compared to the previous year, thanks to rate growth which acted as a catalyst for positive change, with all segments posting some of the highest growth rates seen in recent years.

Despite the external challenges and high expenses that many law firms continue to face, not only were firms able to navigate the situation, they were also able to retain a greater percentage of their worked rates than before. As we move forward, it will be interesting to see if firms can sustain this aggressive approach and continue to reap the rewards.

While 2023 seemed to be off to a strong start, the collapse of several regional banks, continuing war in the Ukraine, and the uncertainty wrought by rising interest rates have both clients and law firms a bit uncertain about the direction of economic trends. It’s not clear where overall demand will come in for the first quarter; and while expenses continue to increase, they are offset somewhat by rising rates that firms are able to charge. This heady mix makes continued revenue growth even more important.

On the client side, demand for legal services is projected to remain strong — 41% of clients say they plan to increase legal spending this year, and only 20% expect legal spending to decline. Clients are also looking for legal advice to be delivered in combination with significant industry and sector knowledge, noting that advice presented along with commercial context has more worth than that same advice presented in a vacuum.

Law firms’ marketing & business development teams, of course, play a significant role in turning these projections into actual revenue. But much of marketing & business development was turned upside down by the pandemic. With the temporary loss of in-person marketing channels such as events, many marketing & business development teams were forced to experiment with new types of digital outreach, and they are now in a position to better compare their effectiveness.

On average, law firms are allocating 1% to 2% of revenues to marketing & business development budgets. CMOs are right to wonder if that’s adequate. Along with those budgets come admonitions to get creative and of course, do more with less, even though live events — generally quite expensive — are coming back into the marketing mix.

Balancing the short- and long-term

To meet that mandate, CMOs need to narrow their focus to those initiatives most directly aligned with their firms’ strategic aims. Those aims, of course, need to reflect client priorities: the type of work clients need done, how they want advice delivered, and which geographies are most active, for starters.

The firm’s strategic aims also need to be informed by market insights. A data-driven approach, or even a data-informed one, helps reduce internal debate. Strong, reliable data that comes directly from clients helps teams focus and move ahead. Equally important, it prevents them from using resources on initiatives that may not have much impact.

Responding to clients’ legal needs requires a two-step approach. First are clients’ immediate needs, which our data identifies as most urgent in the regulatory, legal & employment, and litigation practice areas.

While firms are handling urgent client requests, they must also be laying the tracks to support clients’ future needs. That way, when clients are ready to address, for example, data privacy head-on, firms will already have the right legal team with the right relationship at the ready. Right now, clients’ longer-term needs appear to be in areas of regulation, data privacy, cybersecurity risk, and environmental, social, and governance (ESG) issues.

Balancing clients’ short- and long-term priorities requires a balancing act of its own on the part of CMOs, who often are all too aware that they can’t do everything at once. Yet, no matter how urgent or busy short-term needs seem, it’s imperative to carve out the time to look at longer-term client priorities.

The increasing profile of marketing & business development

Other members of firm leadership seem better positioned than ever to help CMOs perform this balancing act. Those in leadership roles in marketing & business development report that the firm leadership is working together better than ever, which makes it easier for leadership to support other functions, including marketing & business development.

In addition, CMOs say that the value of marketing & business development is now better understood by law firm leadership. CMOs are spending less time convincing lawyers of the value of brand strategy, for example, or defining the importance of marketing to law firms.

CMOs are also starting a bit of a reckoning over their data strategy — or lack thereof. They’re understanding the importance of client data, especially client feedback, client insights, and the priorities that are on their clients’ horizons. CMOs also believe there might be valuable insights within their firms’ own datasets; but they also understand that their firms might not have the skills to unlock those insights. Clearly, they see that there is a skills gap when it comes to data analysis. And without the ability to mine the most important insights, they’re concerned about getting bogged down in data without taking effective action — the dreaded analysis paralysis.

CMOs, like their clients, are being asked to do two things at once: grow the current business, and transform their efforts to better capture new business over an indefinite time period. Yet growth and transformation require different skills. Growth often requires intensifying existing efforts for bigger results — and is all about faster, bigger, more. Transformation is a different beast entirely, requiring reflection and iteration.

Law firm CMOs seem well-prepared to do both, and equally importantly, firm leadership seems to understand the urgent need to support them in this critical task.

You can learn how to build a feedback dialogue with your clients that will deliver value and growth, here.

To understand this development further, the Thomson Reuters Institute has released its 2023 State of the U.K. Legal Market report, highlighting the current condition of the legal marketplace for both buyers and providers of legal services in the U.K.

For many U.K. law firms, this potential reduction in legal demand coincided with a period of increased competition among their peers. In fact, nearly half of all legal clients added law firms to their roster of advisers during the year, according to our research. The report, based largely on interviews conducted with U.K.-based senior buyers of legal services, further found that it’s becoming harder for many law firms to differentiate themselves, with a good deal of legal work being commoditized into standard packages in which price is the main differentiator. This is a bit of a reversion to the mature market for legal services compared to what had been experienced prior to 2020.

At the same time, U.K. law firms have been feeling an additional competitive pinch as a result of aggressive investments made by law firms based in the United States that are looking to expand their operations in the U.K. in order to grow their share of the market in the U.K. and Europe. The result of these efforts remains to be seen, however, as U.S.-based law firm operating in the U.K. tend to rely heavily on transactional practices, which have struggled of late, while U.K.-based law firms tend to rely on a more complete suite of client service offerings.

Further complicating the competitive landscape, according to the report, is that U.K. clients are looking to keep more work in-house, as part of a drive for efficiency and cost savings. That is not to say that there will not be work for law firms and other external legal advisers; however, it will be crucial for legal service providers in the U.K. market to understand clearly what it is that clients want and expect and then adapt their services accordingly.

You can download a copy of the 2023 State of the U.K. Legal Market report, here.

The current reliance on competitive pricing advantage seems likely to prove insufficient for many U.K. law firms. Indeed, the efforts of these firms to ensure they have the necessary expertise in all relevant areas will likely leave clients looking for greater value. Price advantage can easily be lost as firms look to become more competitive and comprehensive expertise becomes a given for most firms.

Rather, in the U.K. (more so than in many other regions of the world), clients are focusing on the quality of the whole relationship with their advisers rather than just individual factors. In a major shift over the past 10 years, the historical reputation of a law firm is no longer enough to keep it top-of-mind in the market. That is not to say that reputation is unimportant, rather, it is simply becoming less influential as factors such as legal expertise demonstrated by specialist knowledge and the commercial viability of advice provided to the client become more critical in clients’ minds.

The message of the report is clear: Firms need to re-consider how they present and deliver value to their clients. The key lies in understanding and meeting client needs — both in the context of the general counsels’ departmental responsibilities but also in the company’s broader strategic goals. In short, law firms need to demonstrate that they can act not just as a legal adviser but also as a business partner.

Many firms will say they do this already — and of course, some do. However, the evidence suggests that clients have a narrower and more limited perception of what law firms currently are offering. For those firms that can act as both legal adviser and business partner, the potential outcome could be lucrative. Some 35% of buyers of legal services in the U.K. anticipate that their overall legal spend will increase in the coming year, compared to just 26% who anticipate a spending decrease.

Increasingly, as the report denotes, clients are looking to send more of their legal spend to those law firms where the whole of the relationship between lawyer and client is one in which value is discussed, defined, and delivered.