23 Jul 2012

Wrestling with the innovator's dilemma

Law firm profitability hangs on a precipice as disruptive technologies threaten to wreak chaos on traditional models. George Beaton asks: will margins be large enough in the future for all to survive?

Advanced economy legal service sectors are in the late mature stage of life. Demand is in long-term decline, client purchasing power is in the ascendancy, many services are perceived as commoditised, labour costs still outpace annual fee increases and successful substitutes are emerging.
In the next decade, without re-invention, law firm profits will plunge. The question is: where does the global $200 billion-plus ‘big law’ sector turn?
Innovation is the obvious answer. But for the law firms, word processing, email and a few internet applications are probably the greatest advances they’ve seen in decades – and those have merely boosted productivity rather than re-invented business models.

Beaten by disruptors

Innovation is starting to come from outside law firms themselves in the form of disruptors such as legal process outsourcing businesses and alternative business structures in England and Australia – but these developments still represent less than 1 per cent of the current market.
There are two types of business innovation technologies: sustaining and disruptive. To succeed, a law firm must replace the former with the latter – or eventually be beaten by the disruptors. Sustaining technologies improve current performance and are familiar because they improve well-established ways of delivering benefits to clients.
In law, word processing and email are such sustaining technologies. But they are generic, so the industry and its clients benefit, not a single firm. Most firms have been adept at turning these sustaining technologies into productivity gains, with even the laggards having now caught up.
The 1997 book, The Innovator’s Dilemma – written by Harvard Professor Clayton Christensen, an authority on business innovation – offers insight into the tough task facing law firms. Lawyers have big problems dealing with disruptive technologies because these innovations will almost certainly ‘result in worse product performance… at least in the near term’, according to Prof Christensen.
This feature of disruptive technology means the intrinsically conservative, risk averse, partnership-based legal profession – which focuses on today’s needs of its clients and its current duties to courts – isn’t even contemplating disruptive technology. In fact it is fighting, resisting, perhaps even obstructing it – witness the New York City Bar Association’s recent reaction to the introduction of ABSs in England and Wales.

Satisfying demand

The trouble for law firms is that while disruptive technologies occur less frequently, they cause the failure of highly successful practices that are only capable of using sustaining technologies.
Disruptive technologies are not embraced because they do not initially satisfy the demands of the sophisticated end of the market, typically where others look to for leadership. Because of this, large firms seem to be choosing to ignore –even discredit – disruptive technologies until they become more attractive in terms of profit.
However, disruptive technologies eventually surpass sustaining technologies in satisfying market demand with lower costs. And when this occurs it does so quickly; it’s game over in a decade or less. Those who did not invest in the disruptive technology sufficiently early are left to wither and fail. When to move, how fast to move, and how much to invest, according to Prof Christensen, form the ‘innovator’s dilemma’.
Clients are part of this equation as well, and they are also resistant to many changes. The best example of this is the agonisingly slow take-up of fixed or other alternative fee arrangements. For more than a decade, the demise of the billable hour has been forecast, and yet it has proved remarkably resilient.

Daunting task

In light of the grim innovator’s dilemma, can any law firm hope to succeed? The answer lies in being able to identify, develop and market emerging, potentially disruptive, technologies before they overtake sustaining delivery and product technologies. Identification of these disruptive technologies is a daunting task because, as Prof Christensen observes, ‘markets that do not exist cannot be analysed’.
One cannot predict what the market or probability of success will be for these emerging technologies. Leaders need to engage in discovery-driven processes, in which they operate on the assumption that new markets cannot be analysed and instead use learning loops and an emergent approach to strategy and planning.
The key obstacles to success with this approach are the partnership structure of firms and inability to risk failure. In trying to solve the innovator’s dilemma, firms have to leave room for failure in planning and be willing to invest in what may be a potentially disruptive technology. Is any chairman or managing partner willing, able and brave enough to lead the way?

George Beaton is a partner at Australia and Hong Kong-based  corporate advisory business Beaton Capital