by George Beaton & Karl Chapman*

Over 30 years ago Harvard Business School’s Michael Porter wrote his first and most famous book on Competitive Strategy. Knowledge of what a substitute is and why the economics of its business model are so dangerous are no longer curiosities for those studying at business school. But law firms still do not realise the magnitude of the threat posed by substitutes.

Substitutes offer clients the choice of how to solve a problem. It becomes a choice between conventional service providers and new ways of sourcing a solution. Consumer examples abound. Just think of iTunes and record labels. Or Amazon and the local bookstore. Let alone digital cameras and Kodak; yet it was a Kodak engineer who created the first digital camera in 1975. The roll call of the venerable departed goes on, and on. We predict many law firms will be added to this list.

The main challenge of substitutes is the ceiling on the price a market and law firms in the market can sustain. As clients switch to the substitutes the viability of incumbents declines. And, inevitably, as the pace of switching increases the speed of incumbent failure accelerates, even before the volume of switching achieves critical mass.

Many law firms consolidate (wrongly believing bigger is better), or withdraw (effectively surrendering by merging into another firm) or collapse (30 of the 100 largest law firms in the UK are reported to be financial difficulties), unless they too can adopt the business models and technologies of the substitutes. A handful are trying, but none have yet shown they can do so successfully. This should not be a surprise. A business and cultural transformation of a monumental nature is required if law firms are to change. This requires a desire for change among partners plus a strong balance sheet to finance the people and operational re-structuring needed. Neither of these conditions is currently in place.

So the really big question is this. To what extent do substitutes threaten conventional law firms? The evidence is accumulating by the day: A great deal. Here are four reasons why.

Firstly, in the post GFC era clients of all kinds – corporates, SMEs, governments, consumers – are pushing for more value from their providers. Beaton’s research shows in law firms this means either price down or delivery of more benefits. Or both. This is fertile ground for substitutes that can operate at or below the break-even point of the law firm incumbents; which is not difficult given the high cost-bases of law firms and unsustainable lawyer remuneration levels.

Second, substitutes are usually backed by external capital in larger quantities than any conventional law firm is willing to or indeed can call from its partners or borrow. For example, Australia’s Slater & Gordon, the world’s first listed law firm, is using public capital to maximise its market share of personal injury and other consumer law work in Australia and the UK. Five years on, Shine Lawyers has followed on to the stock exchange.

Third, substitutes can take risks that the conservative culture of law firm partnership will not contemplate. In any event short-termism is in the DNA of partners driven by annual distributions of profit. This is the essence of the Innovator’s Dilemma.

Fourth, in some service lines, technology like that provided by Clearspire is seen as a substitute for labour.

Here’s a short list of just some the legal service substitutes now active:

Axiom Law, founded just over 10 years ago and growing at 30 per cent per year, would now place now in the AmLaw100 league table if only the establishment would recognise this so-called ‘non-firm law firm’.

Riverview Law is providing innovative fixed priced outsourced legal and related services to corporates and SMEs in the UK. Interestingly the start, Riverview thought SMEs would be the early adopters. In practice it is been multi-national corporations that are buying its Legal Advisory Outsourcing solutions.

• There are now dozens of online providers of legal documents from Rocket Lawyer and Legal Zoom in the US through to Epoq and Law Donut in the UK. While these firms don’t provide services as solicitors, they do meet law-related needs.

To quote another management luminary, Tom Peters once famously said “The greatest dangers are usually found in that part of the pie chart labeled Other.” So too are the dangers facing conventional law firms today.  The threat seems small and transient to many law firm partners. In their rationalisation they point to minuscule market share and client inertia as reasons the substitutes are not really a threat.

We think otherwise. And so should any serious student of Michael Porter.

* Authors
Dr George Beaton is a director of Beaton Capital and Beaton Research + Consulting and can be contacted at george.beaton@beatoncapital.com

Karl Chapman is Chief Executive of Riverview Law and can be contacted at karlchapman@riverviewlaw.com