The future of legal offshoring

The recession has led to significant disruption in the legal industry and has raised serious questions as to the sustainability of pre-credit crunch operating models. While many firms hope that they are at the low point of a cycle that will see a return to former levels of profitability, there is evidence from corporate legal purchasing habits that some changes are here to stay.

Growing numbers of large multinationals are expanding the scale and scope of legal work that is delivered from low-cost jurisdictions. As a result, the recession has helped place greater emphasis on differentiating between truly value-add legal advice and commoditised legal support.

As the world economy recovers, it will be those firms that adapt their business models that will continue to be able to compete most effectively. Offshoring and outsourcing is one option firms have to address these changes.

Legal outsourcing

The outsourcing and offshoring of services has been an option for any major business in recent years, and a reality in a large proportion of them. The legal industry has by no means been immune to this trend, with the larger firms in particular having taken a number of outsourcing routes in an effort to reduce costs and build greater flexibility into their business models.

In large part, these efforts have primarily focused on back office, practice support functions, especially in the areas of: finance, secretarial and IT. However, driven by a range of influences, firms are increasingly looking at re-engineering and outsourcing some of the core legal processes that define their businesses.

It’s the economy, stupid!

While it’s true that the economy now seems to be stabilising, the outlook for most firms remains tough for at least the next 12 months. Revenues and margins have been hit by, inter alia, a drop in M&A activity, a collapse in real estate transactions, an increased use of arbitration rather than litigation and, especially, by increasing pressure from clients to reduce fees.

In response, most firms have cut staff to remove excess capacity, both fee-earners and in practice support. The question is – where to go next? At some point, having right-sized the organisation, redundancies start damaging the core human capital of your business, something that will also threaten the ability of a firm to take full advantage of the forthcoming upturn. As a result, firms are increasingly being driven to find more inventive ways to maintain their service levels, while maintaining margins.

The obvious solution for many firms has been the outsourcing/offshoring route. Several firms, including Allen and Overy, have recently announced reviews of their sourcing arrangements, while others are already in the process of lowering their cost base through offshoring.

Both Clifford Chance and Baker & McKenzie, for example, have been running programmes for several years aimed at developing offshore support functions to give them a more robust long-term platform for their businesses.

Practice support offshoring

The traditional route for offshoring in the legal industry has been to focus on the back office aspects of the business. By moving these support-services offshore, and leaving more value-add services onshore, it is argued that you can maintain service levels to both fee-earners and clients, while reducing your costs and thus improving your margins.

Offshore centres are increasingly specialist in driving out process efficiencies in transactional areas, such as general ledger tasks or word-processing support. More nuanced, non-standardised support can then be kept onshore in close proximity to fee-earners.

For example, Baker & McKenzie in London has recently moved transactional finance processes, such as accounts payable and first drafting of bills, to its global services centre in the Philippines. This has enabled London teams, which were previously focused primarily on routine bill production, to concentrate on revenue control, adding greater value to the business.

Alan Kendall, finance operations manager at Baker & McKenzie, thinks this solution offers the best of both worlds: “This process isn’t about reducing headcount, it’s about making the most of human capital we have in place,” he says. “By moving standardised, process-driven tasks to our Manila centre, we’ve been able to re-focus our onshore team on getting closer and adding greater value to the business, while delivering the overall service more cost effectively.”

Finance isn’t the only area in which this approach is applicable. Firms of all sizes have outsourced and offshored elements of marketing, HR, IT, secretarial, KM and finance functions. By analysing individual processes, it is possible to assess what is core and non-core to service delivery, and where a firm needs to truly concentrate its onshore-based support.

For example, in KM, business research has become a standardised process, with many investment banks carrying out company and sector analysis in a standardised, consistent way. Does it really make sense for firms to do this themselves when there are so many specialist providers delivering high-quality products from low-cost jurisdictions?

Legal process outsourcing

Outsourcing back office functions that are, after all, pretty much invisible to clients is one thing. However, the logic of outsourcing is increasingly being applied to legal processes. That raises a whole new set of questions, not least what this means for the future of the law firm in terms of structure and location.

While legal process outsourcing (LPO) is still in its relative infancy, there are signs that uptake is on the increase. The recent news that Rio Tinto is aiming to reduce its legal costs by 20 per cent through legal process offshoring has received much publicity. It is the latest high-profile firm to do so, following Eversheds’ groundbreaking deal to represent Tyco with commoditised legal-support work being delivered from South Africa.

Similarly, Baker & McKenzie has offshored the management of Unilever’s IP portfolio from its captive centre in Manila. Meanwhile, Clifford Chance, always an innovator in this area, has reported increasing numbers in its India-based knowledge centre, implying a growth in the volume of legal work that is being managed offshore.

While simple cost savings are one driver for the development of LPO among firms, the real impetus for this move has come from in-house counsel. Faced with internal pressure to cut costs, clients are increasingly beginning to segment their legal work according to complexity of process. As a result of this more nuanced approach to legal work, they are either turning to offshore providers to deliver work more effectively or else they are putting pressure on their external counsel to price work according to whether it is advisory or more commoditised.

For example, processes that require large scale review work (such as litigation or M&A due diligence) or standardised document assembly work (such as leasing agreements or ISDA forms) are now regularly being prepared offshore by clients or firms responding to client demands.

What these developments mean for firms is clear. In the short-term, while LPO is still in its infancy, it is possible to use the cost savings generated as a competitive advantage in winning new work – as seems to have been the case for Eversheds in its Tyco deal and subsequent global engagements. If you can offer a similar service-level promise at a better price then, in this market, the work is more often than not yours.

However, if we look at trends in other sectors where outsourcing is more developed, one must expect LPO to become the norm, rather than the exception. If this does indeed become the case, then the offshored provision of legal services will become more of a pre-requisite to compete effectively rather than a simple cost advantage.

Further pressure for the acceleration of LPO is expected in 2011, with the opening up of the legal sector to alternative business structures by the Legal Services Board. Private equity firms are already very publicly looking at the opportunities inherent in the standardisation and re-packaging of more commoditised legal activities. This can only add to the incentive for established firms to look deeply at LPO opportunities as a pre-emptive defence against the threat posed by these imminent industry changes.

The future

In the current economic environment, the opportunity presented by outsourcing is coming into clearer focus than it was when the market was more amenable to higher costs. Furthermore, many firms are at the stage where they see themselves as lean enough and simply do not have the appetite for further redundancy rounds.

Today presents a good opportunity to pilot offshoring initiatives, both in practice support and with more advanced LPO initiatives. Over the next 12 months, as the market remains sedentary, there is the opportunity to refine these approaches and then, as we emerge from recession, to take advantage of the long-term benefits they offer.

This approach will enable firms to grow without adding expensive onshore staff for more administrative practice support or legal process tasks. More importantly, perhaps, this is a unique opportunity to create business structures where your onshore staff can be allowed to focus on the high-value, more engaging aspects of their work without the excess work load imposed by commoditised activities.

Jack Diggle is a partner at OMC Partners. He can be contacted at jack.diggle@omc-partners.com