Geoffrey A. Moore is a business adviser, speaker and author of “Crossing the Chasm,” “Dealing with Darwin” and “Escape Velocity.”
Mark Harris is chief executive officer of Axiom, a new model legal services firm that serves nearly half of America’s 100 biggest corporations.
Ineffectual grumbling about legal costs has been a fixture of the corporate landscape for decades. But now those costs – legal fees, settlements and related investments in the hiring of additional lawyers – are gutting the profits of the world’s largest companies, especially the big banks.
This summer, Citigroup became one of the latest financial institution to connect impaired earnings with its legal problems. The Royal Bank of Scotland was in a similar predicament late last year, earmarking nearly $5 billion in litigation reserves and signaling future losses. Bank of America has just agreed to the largest single federal settlement in the history of corporate America.
Before them, Barclays more than doubled its legal provisions, and JPMorgan Chase, Lloyds and HSBC all reported hefty increases in legal costs. In fact, according to Thomson Reuters, the big banks’ legal costs have increased 44 percent this year compared with last year. Indeed, the big banks, and many other large companies outside of the financial sector, face ever-increasing costs as the volume of legal and compliance activity grows.
You might expect to see unit costs fall with volume and scale, but the opposite has happened. Over the course of the last decade, the amount corporations spent on law firms and related legal investments grew 75 percent; nonlegal business costs, by contrast, have risen 20 percent over the same period.
The banks recent compliance issues in no way reflect a lack of effort to address the problem. In fact, quite the opposite: JPMorgan has assigned $4 billion and 5,000 new hires in risk and compliance operations alone. But the “more money, more bodies” playbook that legal advisers typically espouse seems to have failed the banks on this issue.
In other words, the price and volume of legal and compliance services are skyrocketing just as the reliability of those services is deteriorating. The banks are investing extraordinary sums and hiring armies to protect against legal harm only to suffer unprecedented, profit-wrecking judgments and fines. How can this be?
Because the solution to skyrocketing legal costs and increasing risks is not to simply hire more lawyers or compliance professionals. Rather, it’s to thoroughly redesign the existing solution to more efficiently tackle the legal and compliance problems at hand.
The two of us have spent the last 18 months looking at these developments and believe the legal profession must answer the bell on the issue of scalability – a critical piece of scripture in the religion of business. That is, how do you build your business so the bigger it gets, the more efficient and effective it becomes?
Today, the legal sector sneers at scalability. Most legal work is delivered by artisans: highly credentialed (read “expensive”) lawyers or compliance experts solving each problem anew, using original interpretation and judgment, even when such attention is neither warranted nor particularly effective.
The essential character of both corporate legal departments and law firms is that they do not scale, they just get bigger. And their underlying architecture is such that bigger is not better; it’s usually far worse.
Business architectures tend to be divided into two camps: a “blue” Complex Systems model (reliant on talent, judgment and relationships) and a “red” Volume Operations model (that relies on repeatable process and technology).
Our work and research suggests that both in-house and law firm cultures reflect a blue architecture, but many of the challenges they face are increasingly red in character, creating what we call a “purple problem,” one that solves neither.
Take the example of how a big company or bank handles tens of thousands of revenue-generating contracts. Law departments and law firms start with the premise that contracts are negotiated by experienced lawyers, and the better the lawyer, the better the outcome. Fair enough.
When the volume of contracts grows, more lawyers are hired or engaged. Years, or even decades pass, and we find hundreds of expensive lawyers, all over the world, at in-house legal departments and outside law firms, negotiating a multitude of transactions using disparate technology platforms, with varying policies and effectiveness.
The result is a predictable mess. Most big companies would be hard-pressed to tell you how many contracts they sign in a year, let alone how the aggregate commitments affect their risk profile.
These contractual blind spots are a corporate problem if the contracts are, for example, software licenses, and a global economic problem when they are complex derivatives.
This is not to say that none of the work that law departments do fits a “blue” category – some of it demands precisely that approach. Rather, one cannot presume that spending more or staffing up on all work creates better results.
What you would predict in this situation is exactly what we’re seeing with the large banks. Both cost and risk are substantially higher than they should be, hard to control and highly unpredictable.
Other ramifications are equally problematic. Extended contract turnaround times can lead to broken deals, customer attrition or reduced revenue. Taken together, the company is losing ground on all dimensions – risk, cost and revenue.
At banks, the appropriate architecture for a challenge like handling and executing large volumes of contracts is a small team of “blue” — policy setters and advisers – presiding over a “red” contracting machine created by engineers and executed by a smaller number of competent but far less expensive people. Such a machine runs on process, tools and technology, not artisanal judgment.
There’s another less obvious but critical benefit of running a volume operation on technology, and that is the accumulation of a store of powerful information, or, as it’s called today, Big Data.
To continue with our example, legal contracts contain a treasure trove of information that is squandered in nearly all corporations. Data contained in the clauses of a company’s contracts can be harnessed to generate renewals or new business opportunities, gather intelligence, respond to regulators and inform capital planning, for instance. That information is buried in mounds of paperwork that is hard to access and never really examined closely. If corporations did “mine” that data on a regular basis, they would not only find solutions to legal headaches without having to reinvent the wheel, but opportunities to increase commercial value as well.
We don’t underestimate the scale or complexity of the legal problems that the big banks face. Their operations are complicated, and their leaders face ever-changing and sometimes overlapping regulatory and compliance requirements.
Our point is that the solution to the knot has been to add more string. Simply adding more lawyers and compliance professionals will only create far worse, more complicated and more costly problems.
By contrast, reducing operating overhead for legal services, if done correctly, can improve the effectiveness of repeatable work while freeing up time and talent for irreducibly complex workloads, which would profit from additional attention.