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Investing in Technology: A Business Framework for Thinking About Law Office Technology

By John Hokkanen, Published on February 7, 2006

John Hokkanen, Esq. is the VP of Technology for an Internet start-up and is an Internet and Knowledge Management Strategist for Baker & Botts. You may obtain his free “Law Offices and the Internet” CD-ROM by using the online form at http://www.hokkanen.com/cdorder.

John Hokkanen
The author acknowledges the suggestions and comments from Fred Parnon, Adam Bendell, Mark Pruner, Alan Rothman, Nill Toulme, Nelson Winters, and Margaret Hokkanen.

For years lawyers have asked the questions “What technologies should we use and how large should be the investment?” Some CIOs give dire predictions of the need to go high-tech while others observe that clients do not directly reward big technology investments. Meanwhile, lawyers are aware of new threats by the Big 5 and by entrants delivering legal products over the Internet. This article seeks to apply business theory to these questions, offering a framework for clear thinking as well as some observations that flow from it.

One of the leading thinkers in business management theory, Clayton Christensen, has set forth an analytic framework in “The Innovator’s Dilemma.” Christensen discusses why strong, customer-focused companies can lose out to market entrants who exploit new technologies. Most notably, he dispels the notion that such failures are due to bad management, bureaucracy, arrogance or incompetence and instead shows how ill-fated decisions to ignore new technologies were based on rational financial criteria of seeking higher-profit work and markets.

The drive for higher profits per partner is apparent among leading law firms, and the goals of higher fees and no discounting have encouraged a number of trends. Growth and achieving national and international status allows a firm to obtain large, complex corporate work, big litigation, and transactional work involving multiple jurisdictions. Professional marketing and its core concept, branding, have become central themes, while cross-marketing the multi-jurisdictional capabilities and developing profitable practice areas have become ingrained into client response teams. Partners will now readily discuss ceding work on the low end that the firm “does not really want to do.” A decline in what some might consider traditional law firm collegiality can be seen when partners in a undesired practice seeks to leave, there is almost a rush to open the door for them.

The Value Network Theory

The ability to deliver on a higher value proposition requires infrastructure, personnel, and processes. Christensen refers to this entire operational context of the business as its “value network.” In the case of a law firm, it includes the downtown office space, the specialties of the lawyers, their marketing efforts, the development of skilled fee-earners (including paralegals, case clerks, and librarians), the technology on the desktop as well as the back office, and everything else that makes the whole place run. Smaller firms cannot compete with larger firms in large part because their value networks are designed differently; they are optimized to deliver different kinds of services to different kinds of clients. Large mature firms develop huge cost structures merely to operate, resulting in a constant pressure to develop higher value work that brings higher revenues and profits, thus satisfying partners while feeding the increasing expense machine.

Innovation assumes two different forms: sustaining and disruptive. Technologies that support and extend the existing value network are sustaining, without regard to how complex, expensive or innovative they may be. Christensen found that successful companies used such technologies to leverage their present value network.

On the other hand, technologies that do not immediately add any value to existing customers (and often may not even have an immediate market) are referred to as disruptive regardless of how simple or inexpensive they may be. These innovations appeal to the downmarket because they are not yet perfected for mainstream clients. Consequently, companies that innovate with them must adopt different cost structures and market to entirely new sets of clients. The dominant companies tend to ignore these new entrants because the new entrants opt, at least initially, for undesired markets. However, as the new technology is developed and the new business concept with its lower cost structure is keyed to the new opportunities, the innovative entrants can and will attack the dominant companies’ market share.

Christensen shows how the established companies with good management failed in light of the attackers’ new value proposition. Christensen points out: Disruptive innovations are complex because their value and application are uncertain, according to the criteria used by incumbent firms (p54)….In the tug-of-war for development resources, projects targeted at the explicit needs of current customers…will always win over proposals to develop products for markets that do not exist. This is because, in fact, the best resource allocation systems are designed precisely to weed out ideas that are unlikely to find large, profitable, receptive markets. (p84)

For very rational reasons then, established companies have repeatedly chosen to invest in technologies that extend their value proposition to higher-value work and not to invest in downmarket opportunities. Often the dominant companies have even been the ones who did the early research and development on the new technologies. However their existing clients had no use for the value proposition that the new technologies brought, so the technologies were shelved “until the market grew to where it would be profitable.” When the technologies appealed to the mainstream market, the companies that heralded them had different cost structures tuned to the needs of the new technology, and the dominant firms were repeatedly unable to thwart the entrants’ intrusion.

Technologies that support and extend the existing value network are sustaining, without regard to how complex, expensive or innovative they may be….On the other hand, technologies that do not immediately add any value to existing customers (and often may not even have an immediate market) are referred to as disruptive regardless of how simple or inexpensive they may be.

Technology Strategy Alignment

For law firms the “how much and which technology” questions mean that technology investment must either be aligned with the firm’s current value network or the upmarket one into which they are trying to extend. Established law firms, because their value proposition and networks are mature, must focus those technologies that will sustain and extend that value proposition. Investment in disruptive innovations, no matter how powerful for an entrant with the business concept that can effectively use it, will likely sit on the shelf. Although this can be thought of in a sense as a prescription for a focus on return on investment, it is probably better to frame the question as one of alignment of technology strategy with the business strategy. Because law firms serve up legal advice rather than technological products, focusing on a technology’s alignment may be an easier, and also more fruitful, decision-making model.

In “Legal Practice in the Digital Age,” Charles Christian recommends that firms focus on technology investments that enhance the client interface. He argues that the search for the “killer app” that brings internal efficiency but does not improve services as perceived by the client has been wrong-headed. Technologies that enhance services will bind clients to law firms. The value network framework supports Charles Christian’s client interface thesis. By improving the client interface, a firm is improving the most important and visible part of its value network as perceived by the client.

Disruptive Technologies

Investing in disruptive technologies is both a distraction and a diversion of important resources to an initiative that has little leverage in the firm’s existing network and that entails substantial risk. The competition for firms’ current value networks is already extreme as evidenced by the “law is not as much fun as it used to be” sentiments expressed by many lawyers. Competition in the legal upmarket is fiercer than ever because the dominant firms there are highly focused on their market shares and seeking to take it away from the other upmarket firms.

By improving the client interface, a firm is improving the most important and visible part of its value network as perceived by the client. In addition, new entrants are coming on board to get a piece of the action. Large law firms have talked a great deal about the coming impact of the Big 5 consulting firms. Certainly the Big 5’s financial strength, size, and focus on sustaining technologies, processes, and systems allow them advantages that even large law firms cannot readily match. But their cost structures, fees, and value networks suggest that they will clearly attack the upmarket segment, focusing on the highest paid, large client work like large global deals and corporate work. The entrance of the Big 5 is likely to have less of an impact on lesser legal markets because their cost structures are not likely to allow them to enter this market space. The big strategic issue for law firms is that the Big 5 may create a ceiling on the upmarket work, thus creating a real problem for increasing the upmarket firms’ profitability.

Meanwhile, downmarket firms, medium sized firms with lower cost structures, are seeking to enter the large law firms’ current workspace at lower cost structures, creating continued competition from below. If this analysis is correct, then the large law firms should indeed have strategic planning on the forefront of their activities. The good news is that the fight with the Big 5 will be on familiar terrain because these new entrants have cost structures generally as high as the law firms. For the high-end clients, this is especially good news because law firms will attempt to distinguish themselves by the value they offer and seek to add more value for the same high-end money.

For years we have read about innovative projects within law firms. For example numerous articles have been written about how document assembly can automate repetitive document practices to increase market share and obtain huge returns on investment. People with interesting ideas occasionally find a niche for these technological or process innovations. But upmarket drift is a powerful force and one that aligns everything to its needs. Repeatedly, innovative, radical technologies are shelved because they do not have a place for the firm’s clients. More often the features of the technologies that would be disruptive in the hands of an entrant with a new business concept are blunted by the dominant firm. Thus, the disruptive potential is lost because it cannot be leveraged in the dominant firm’s value network.

What is Your Worst Nightmare?

The Internet is the superhighway on which the disruptive technology companies drive at increasing speeds. This is why there is a general perception that “something is happening” and why established companies are trying to develop Internet strategies to harness some of this disruptive potential. The Net allows innovators to create new business models, to deliver them at breakneck speeds, thereby dealing powerful blows to existing brick-and-mortar companies. Here the advantages of the attacker become obvious, and everyone operating in this environment is trying to figure out how to add value and lower price, and to do it faster than the next company. Entire new models like Schwab, Ebay, and Amazon emerge.

For five years the Internet has developed, and large law firms have largely begun to adopt its technologies. A few firms have hit Internet technologies hard, developing substantial expertise in their internal value networks for using, developing, and marketing their capabilities with these technologies. Firms have moved forward with developing firm web sites, intranet-based knowledge management projects and client-centered extranets. Such sustaining technology efforts have benefited those firms because these technologies strengthen the value networks and allow those networks to develop a “sticky” relationship with clients. However, most firms have not yet studied how these technologies may have disruptive effects on their own practice.

Know Your Terms

Client Interfacing Technologies - Technologies like the telephone, voicemail, email, and extranets provide clients with additional interfaces to their counsel.

Cost Structures - The infrastructural and personnel expenses required by a particular business model for delivering its products and services.

Disruptive Innovations - New technologies and systems, built upon different business models, that eventually mature and provide comparable capabilities to previous approaches at lower costs.

Knowledge Management (“KM”) - The use of technology for collaboration, information publication and reuse. KM systems are classic examples of sustaining technologies.

Latent Legal Market - The theory that many more people would take advantage of legal advice if it were more economically packaged.

Sustaining Innovations - Innovations in technologies, processes, and infrastructures that allow firms to enhance the services delivered to existing clients or to deliver services to upscale clients.

Up-market Drift - Mature firms have established cost structures which compel them to seek work that has higher profit margins, thus causing an inevitable drift towards upscale clients.

Value Network - The sum total of the people, processes, infrastructure, good will, and market base that defines a company’s ability to deliver its products and services to clients.

Value Proposition - The value associated with a need that a particular product or service fulfills.

Latent Legal Markets

The disruptive potential of the Internet on legal practice was identified in Richard Susskind’s “The Future of Law” in which he articulates the concept of the latent legal market. Using the value network analysis, the latent legal market is a classic downmarket opportunity. A firm or company that could market legal products to this downmarket can gain a foothold by appealing to lower end customers that are currently not being served. Lawyers that create value networks, cost structures, and technologies that can grab these footholds are highly unlikely to meet any resistance from existing firms because dominant firms will not redefine themselves downmarket. Having obtained a foothold, these new entities can attack relentlessly at the upmarket margins, forcing the dominant firms to cede further market share or to redefine their value proposition and compete with companies who have developed downmarket strength.

With his focus on sustaining technologies, it comes as no surprise that Charles Christian criticizes Susskind’s concept. In particular, he notes “the one consolation for lawyers is that most of the people who make up the latent legal market--if it actually exists--world never normally use conventional legal services in the first place and so remain largely commercially irrelevant to the majority of the legal profession.”(p. 29) Christian argues that if the latent legal market exists, it is a downmarket, and, of course, upmarket firms will not lose anything by ignoring such a downmarket. This argument is exactly the argument made by the dominant firms studied by Christensen in “The Innovator’s Dilemma.” For the short-term, he is--and they are--absolutely correct. However, what this position ignores is that the business concepts used to operate in this market may be able to deliver knockout blows to other portions of the legal services market once they advance to the point where they can compete in the mainstream market. To illustrate the possibilities, firms now have the capability to create virtual law advisors using modern inference engines and to deliver that legal advice over the Internet directly to clients. Alternatively, multimedia training applications, database-driven advisories and frequently asked questions can allow self-help by clients. Mechanisms for case screening, case evaluation, and dispute resolution have already been prototyped.

As Clayton Christensen points out, the “the popular slogan ‘stay close to your customers’ appears not always to be robust advice”(p48), because it blinds one to the existence of and need to consider the disruptive technologies that are on the horizon. Recall Andy Groves’ statement that companies that are not “Internet companies” in five years are not likely to be companies at all. Groves means a lot more than having an electronic brochure on the Net; he means that a company must have a strategy with which the company is reinventing itself through this new delivery vehicle. Law firms of the 21st century face the same dilemma that mainstream corporations face with respect to their Internet strategies.

Creating Disruptive Spin-Offs

Of course the real buzz in the use of the Internet is its value as a disruptive technology, and this is an unlikely tool for most firms. Taking a disruptive technology concept and converting it into a sustaining system is not likely to hurt the firm, and it has the benefit of appearing to be radical innovation. It will not really help the firm either, however, and it is likely to be some pretty expensive research and development. As the examples in Christensen’s book demonstrate, the fact that a company develops a technology does not mean the firm will understand how to exploit its value or that a new entrant with the same concept will be held at bay. The illusion that the company is prepared in the event “that the market for the technology grows” is an unfortunate self deception.

Most firms are simply not going to obtain the internal consensus or have the internal fortitude to initiate projects that will cannibalize existing practices. Most firms are simply not going to obtain the internal consensus or have the internal fortitude to initiate projects that will cannibalize existing practices. If the firm thinks otherwise, then it may want to rethink its approach, because the historical examples run to the contrary. Such efforts diverge from the firms’ existing value network and create inconsistencies in the firm’s client base and marketing. In short, trying to do this inside a firm is probably a bad idea.

Such advice should not be misinterpreted to mean that a law firm should ignore the change potential that disruptive business concepts may bring to mainstream legal services. However, if the firm concludes (and understandably so) that it needs to do some research and development in this area, then it should create an independent business entity with separate funding. Doing so will allow the new company to focus on the hard decisions relating to what it is offering, who its target market is, and how it will deliver its service. Such a new entity will adopt a value network optimized for the problem at hand.

A clear implication that flows from the value network analysis is that law firms should understand both their market focus and the value network that they bring to it. Some law firms are not very clear about who they want their clients to be, what work they want to do for them, and the value that such work is worth. Although individual lawyers in particular practice areas may have clarity about these goals, those views may differ radically across the firm. This may mean that law firms have multiple value networks within their broad umbrellas, yielding the observation that law firms are the aggregation of individual practices.

Having groups appeal to different markets means that different value networks and resulting operational structures are put into place, and it is no surprise that real disagreement can exist, and even power struggles can follow, as different visions are pursued. Not only can a firm’s cross-marketing efforts stumble, they can have inconsistent messages. For better or worse, the very nature of the partnership structure fosters a consensus model which accommodates all views. It becomes difficult, if not impossible, to create value networks that are aligned with and reinforce one another. It should come as no surprise when one of these independent value networks breaks off from the larger enterprise.

Applying Business Theory

Law firms, particularly large dominant firms, need to consider how the value network applies to the business of law. To the extent a firm thinks that high end professional services are immune from disruptive technologies, the recent turn-around in Merrill Lynch’s Internet strategy should be a cause for reflection. In short, what is happening in Silicon Valley is likely to affect law firms just like other businesses. The strong suggestions that flow from the value network analysis are based upon the idea that law firms are subject to the same business laws that govern their clients. This means that law firms should align their technology development with their value networks, seeking to identify and pursue those technologies that support and extend those value networks. As such, it will require clear strategic thinking about which part of the legal services pie the firm is targeting.

Companies that use the Internet to create disruptive business concepts and systems will likely eat away from below at mainstream law firms’ market shares. This does not suggest the current firms’ demise, any more than it suggests that Merrill Lynch, Sotheby’s, or Barnes and Noble will be closing up shop. Though law firms need to stop obsessing about how their organizations can implement disruptive systems, they probably should think about creating other disruptive spin-offs that would ultimately prey upon their and other law firms’ legal practices.

The value network analysis admittedly offers up a scary scenario for large law firms with the Big 5 above and the new entrants below. This should be scary because it is not clear how large law firms will effectively compete with either class of competitor. The Big 5 have value networks that may be better suited for the high-end work, and the new entrants will have value networks with cost structures that will certainly encroach on traditional law firm turf. Some law firms will likely succeed at going upmarket in their niche practices, while others may create separate downmarket entities. The value network analysis provides a framework for thinking about these management issues as they confront law firms over the next decade.

The value network analysis admittedly offers up a scary scenario for large law firms with the Big 5 above and the new entrants below.

First published in the Fall 1999 issue of the Managing Partner magazine.