The Sustainable Profits Rule Page 2

Part of the lpc series The New Economic Rules

lpc believe that the fundamental difference between this downturn and previous recessions will be a combination of

• an ongoing material reduction in the size of the market
• a transformation in the cost structure of delivering legal services involving technology and systems led change to reduce the underlying cost in providing professional services generally
• a thorough overhaul of the ownership, control and remuneration of legal businesses and other similar professions

There is a meaningful likelihood that this will be an “L” shaped recession. To put the alphabetical jargon in context a pretty severe recession is normally “U” shaped while a mild recession is “V” shaped. In other words the shape defines how quickly the economy will rebound. It probably does not require Sherlock Holmes to deduce that in a “L” shaped recession economic activity only recovers over a very long period. In other words there is a pretty permanent loss of demand in the economy.

Fanciful? Ask the Japanese – their stock market remains at only a third of the levels of 1989. They have suffered deflation on and off despite dalliances with zero interest rates and now an enormous public debt from governmental efforts to pump-prime the economy. The brilliance of the Japanese manufacturing sector has not been able to stop any of this. Domestic consumption is key to the economies of advanced capitalist countries in the 21st century.

Policymakers will endeavour to avoid the worst of these outcomes but whatever the result of their efforts the market for legal services and functions will alter. The issue will only be the degree of change. A factor in this enforced change is that much of the legal sector is dependent upon the economic activity - property, lending and corporate transactions - that is the centre of the economic tumult. Rather like the high street furniture stores that are now failing, legal services providers benefited to a disproportionate degree from the financial activity over the last 15 years. Somewhat stretching the analogy, high street furniture retailers have also been affected by a structural change - the opening of IKEA stores nationwide. The combination of the downturn, the loss of credit, the loss of customer's credit and the existence of IKEA have been devastating, in some cases fatal. Before expanding this argument to highlight the structural changes facing legal practices, the next section outlines the evolution of the model of the last 25 years in the provision of legal services.

The 1985-2008 Model

Start with the basics. Lawyers are no different from anyone else - they want to make as much profit as possible. If they can legitimately charge more than the reasonable time cost of providing a service, they will! The extent to which they are able to earn a profit, that is greater than the reasonable time cost, can be called the "super-profits" (the same basics arguments apply to non-profit organisations, such as public authorities, but there the issue is to provide the best service at the lowest cost).

Of course the definition of what is a reasonable time cost and what is a super-profit will vary depending who is asking and answering the question; logically a reasonable return is one that will attract a competent legal practice with reasonable resources to tender for the work in question.

However, over time these super profits cannot remain except in very niche situations. Ultimately one or more of the following will occur; the person who is paying for the service will attempt in some manner or means to reduce the level of fees, staff providing the service will seek higher salaries effectively seeking a share of the super-profits or others will compete to provide the same service at a lower cost.

Even before the economic crisis exacerbated the situation, if a client or group of clients believed lawyers were earning super profits from a service, that client or group of clients gradually became unhappy paying for those profits; competitors (either legal businesses or not) would aim to take a share of that pie.