Disrupting the Dinosaur: The Challenges Facing Legal Tech Startups and How to Punch Back
This is an updated and expanded version of an article that was published by the Harvard Law School Center on the Legal Profession’s digital publication, The Practice in January 2015.
Consider this hypothetical scenario — it’s Sunday night and as usual, junior associates are spending another weekend in the office. The litigation associates are tasked with helping a major client understand a quandary they have fallen into; this client has found itself in a compromising situation and wants to understand their exposure and potential liability. Tracking down every individual court case across the country, understanding all the relevant statues, and making sense of them in a short period of time is a tall order for even the smartest attorney. However with the firm’s new data analytics software, litigation associates can research in ways that static research engines would never be able to. The software enables associates to see cases in context with data linking legal precedents and providing key comparisons across circuits. Without this software, a thorough search through thousands of pages of documents would have taken weeks, if not months.
This scenario and others like it are not improbable; in fact, the benefits of the world of technology solutions targeted towards law firms, are seemingly endless. At the ground level, work product can be more efficiently produced enabling law firms to turn their attention to higher value added services. The length of individual tasks and engagements can be reduced; a significant amount of turnaround time can be eliminated. From a quality perspective, depth and accuracy of tasks can dramatically improve. After all, software doesn’t get tired at 3 AM.
At the systematic level, technology has the potential to help law firms manage their human capital better. By minimizing time spent on ministerial tasks and improving training processes, technology products can improve both attorney satisfaction and retention; vital for Big Law in combating the current shortage of mid-level associates.
These benefits all sound like no brainers right? So why aren’t startups banging on the walls of law firms and disrupting the industry? Why has investment in legal tech startups declined 74% in the first half of 2016 compared to the same period in 2015 (source: CB Insights)? After all, the consensus amongst academics, experts and practitioners is there is a need for innovation in the space. Managing Partners and Chairs of major US law firms overwhelmingly acknowledged current law firm business models are unsustainable in the 2016 Altman Weil Flash Survey, Law Firms in Transition, a survey which polled Managing Partners and Chairs at 356 US law firms with over 50 lawyers; technology is democratizing access to knowledge and destroying information asymmetry directly impacting law firm profit margins.
Intuitively, this would seem to be the exact type of environment that is fertile for startups; customer acknowledgement of a problem in which they are willing to engage in conversation and spend real dollars towards a solution is a validation ideal that kills many startups before they get out of the gate. The reality today is though law firms want innovation, there are key institutional barriers that make it challenging for startups to sell innovation to law firms. The five main barriers include: (1) feasibility of the minimum viable product, (2) user adoption, (3) the billable hour, (4) security concerns and (5) navigating the law firm purchasing process. In this piece, I will discuss each of these barriers and offer potential mitigation strategies to each.
(1) Chicken or Egg? Feasibility of the Minimum Viable Product (MVP)
The Lean Startup Co. movement has taken the startup world by storm over the past five years. Pioneered by IMVU Co-Founder Eric Ries, the lean startup methodology is a hypothesis driven approach tightening the learning cycle when building a product to more quickly achieve product-market fit. Ries advocates startups should first build a minimum viable product — a product with core features that can be deployed to early adopters. This product serves as the foundation for measuring, learning, and iterating subsequent versions of the product. With a scientifically concrete product development process, Ries’ method prevents elaborate product build out without key assumptions being tested and accounted for.
For the lean startup methodology to be successful, prospective customers must be amenable to testing and interacting with a minimum viable product; without a willingness to engage with a product that is far from its final stage of completion, a startup’s ability to measure, learn, and iterate is severely hampered. Herein lies an inherent difficulty with law firms; that is, many law firms are systematically unwilling to engage with a product that is not complete (there are literal firm policies that prevent anyone in the firm from using products that have not been pre-approved by the firm without permission). Two factors primarily attribute to this unwillingness on the behalf of fims: (1) law firms are disincentivized from devoting energy towards educating attorneys about a product unless it has immediate benefits that make it worthwhile to expend such effort, and (2) the gatekeepers of technology purchases at firms need to ensure they prevent “product-fatigue”; it’s nearly impossible to get time stretched attorneys to participate in trials of products and so those responsible for technology purchases want to ensure they are using their limited bites at the apple on products they have pre-screened. Accordingly, law firms would rather evaluate a full product before making a decision on whether or not they would use it, let alone whether or not the they will purchase.
This preference for a full product to evaluate potential usage is an impediment for startups. Raising venture capital typically requires a cultivated user base and sales pipeline; one of the key strengths of the Lean Startup Co. process is “by the time the [final] product is ready to be distributed widely, it will already have established customers.” Startups that have proven product-market fit and are looking to scale are way more attractive to VCs as opposed to startups looking to build out an initial product and test basic hypotheses. Law firms’ preference for a full product is an implicit ask of startups to raise funding to build a product with no commitment of purchase or understanding of whether or not the product is the right product to build. This is risky for investors and therefore makes fundraising and building innovative products for law firms more challenging.
(2) User Adoption
For startups selling enterprise software, the sales process has undergone a dramatic change in the last twenty years. Twenty years ago, software was heavily integrated into the law firm’s IT infrastructure. Accordingly, despite product shortcomings, the integration process created an inherent stickiness making the initial sale to the customer a “win” (this is largely why legacy technology platforms — like age-old document management systems — are still used in enterprises today). Today, however, software is managed by third party vendors mainly outside the firm’s IT infrastructure. Seat license models allow enterprise software consumers to further tailor their software needs by adjusting in real time, paying on a per-user basis.[See below in Footnote 1 for deeper explanation]
This shift in technology has fundamentally changed enterprise software startup’s business models. Instead of operating a traditional software business model — where the startup would sell a license to their software — startups now most commonly operate SaaS (software-as-a-service) business models; SaaS companies charge customers using a subscription fee with payments most commonly collected on a monthly basis. The reduction of the relative importance of the initial sale in the SaaS business model has introduced a new layer of complexity for startups. Adoption and usage rates, metrics that were previously irrelevant, now impact whether or not law firms will continue employing a SaaS provider’s services. The byproduct of this development is that startups must do more than sell, they must create a product worthwhile enough that a profession strapped for time and resistant to change actually adopts and uses on a routine basis. If not, usage of the startup’s product will be discontinued.
(3) The Billable Hour
The primary critique of the billable hour as a foundation of law firms’ business models is it incentivizes inefficiency. We can think about law firms as being in the business of building drills and clients being in the market for holes; that is, law firm business models are focused on “inputs” rather than “outputs”. Though an increasing number of Managing Partners and Chairs of global law firms believe alternative fee arrangements are the way of the future (78% believe more non-hourly billing will be a permanent trend going forward according to the Altman Weil 2016 Survey), the billable hour is alive and well today. Technology products that improve efficiency and reduce hours spent on work, even with quality improvement, directly butts heads with revenue generation for many law firms today.
(4) Security Concerns
The overwhelming response from law firm CTO and technology directors in the 2013 Am Law Tech Survey — a survey of senior technology professionals from the AmLaw 200 — when asked about cloud based solutions was law firms are not quite ready to fully embrace cloud computing, the most economical and advanced technology available today. Though 69 percent of responding firms are using hosted solutions, few are placing sensitive information on these platforms. Only 12 percent said they use the cloud for storage and 5 percent use it for document management. Fast forward into 2016 and this resistance has not changed much.
The hesitancy for cloud based solutions stems from security concerns. Though the cloud promises efficiencies, with data breaches at major institutions such as Target, Home Depot and J.P. Morgan, this tentativeness is unlikely to disappear soon. For startups, this presents a challenge because most technology innovations today are being built either as applications in the cloud or link to existing information systems through the cloud.
(5) Navigating the Law Firm Purchasing Process
The final challenge for startups in selling innovation to law firms is navigating law firms’ purchasing processes. B2B startups focusing on software for traditional business departments (sales, marketing, finance, etc.) certainly have a long sales cycle, however generally speaking it is a more unified experience when approaching prospective customers; the role of the party responsible for purchasing decisions in the department is consistent across organizations. Internal law firm purchasing processes however are comparatively convoluted. Examples of the players that are involved in the purchasing process include, but are not limited to: (1) IT directors/managers, (2) managing partner, (3) executive/management committees, (4) firm administrators, (5) c-level executives, (6) technology committees, and (7) associate committees. On top of the number of different parties, law firms have different protocols with respect to whom they involve in the purchasing decision. The sheer permutation of purchasing processes dramatically lengthens the sales cycle in law firms; startups are forced to understand the internal dynamic of each prospective customer they are selling to.
The lengthened sales cycle is challenging for startups from an operational perspective, but it is especially challenging with respect to raising venture capital. VCs typically exit investments in a 5–7 year timeframe; accordingly investors expect fast traction in their investments. The slow sales cycle dampens investor excitement for legal startups and results in capital deployment focused towards other industries.
Each of the challenges facing startups in selling innovation to law firms are serious hurdles, but not insurmountable obstacles. The following are initial strategies and areas of focus to consider when encountering these challenges:
(1) Make the Clear Case for How the Product Impacts Margins
To combat law firms’ lack of willingness to engage with MVPs, startups must be well equipped with a clear case for how their product affects law firm profit margins. DLA Piper Co-Chairman and Global Chair Roger Meltzer noted in his presentation at Harvard Law School in 2015, that in his firm’s estimation, the growth trajectory for legal services will flat line over the next two decades. Accordingly, firm growth and profit margins will largely be affected by a law firm’s internal ability to adapt technology and lean practices to optimize their organizations. Startups need to clearly articulate a business case for how their product will affect the firm’s bottom line and give law firms a reason to devote energy to educate and encourage their attorneys to engage with a MVP. In my experience, this clarity has increased the willingness of firms to engage and try new products.
(2) Focus on User Experience and User Interface
Lawyers and technology haven’t always been the closest of compatriots; like oil and water they have never mixed well. One school of thought advocates lawyers fundamentally do not understand technology, ergo the cause of reluctance in using technology. I think this assessment misses the boat. Historically enterprise software providers haven’t paid much attention to user experience; enterprise software isn’t intuitive and requires arduous training sessions to understand the basics. Accordingly it is not that lawyers are not inherently good with technology. Rather, the technology that is supplied to law firms is not good for lawyers. My generation never required user manuals to learn how to use Snapchat, Twitter, Facebook or Google. Why should it be any different for document management, knowledge management, due diligence, or case research software? Startups have a much better chance of lawyers, especially young lawyers, adopting and using their product if they create software that has great user interface, user design, and is easy to use.
(3) Aim for the Low-Hanging Fruit
Startups need to embrace that the billable hour is not going away overnight. Instead of fighting the existing mentality in law firms, startups would do well to create software solutions for the low-hanging fruit in law firms. For example, firms with Emerging Company/Venture Capital practices spend lots of time doing non-billable work; incorporating companies and packaging startup documents require time and does not generate revenue for firms. Startups would do well to create software that optimizes these types of activities. Solving a direct and concrete problem with little inertia can serve as a foothold to expanding the product to solve additional problems.
(4) Educate law firms and attorneys on the strength of the cloud
Many law firms take issue with the security capabilities of cloud-based technology. Law firms’ concerns root from uncertainty on how cloud technology actually works. Box addressed this concern by building security directly into the value proposition of the product. Insurance companies, the government and hospitals, have adopted Box primarily because it is the most secure way for these organizations to store documents.
Startups should integrate the security cloud based solutions offer into the value proposition of their products (easy) and focus on educating attorneys of the relative safety of their products versus existing practices (hard, but not impossible).
(5) Don’t spread yourself too thin and focus, focus, focus
Startups cannot change the internal structure of law firms. However startups do have an advantage over large incumbents. They can be laser focused on solving a very particular problem that would not move the needle for existing corporations. Clayton Christen, Professor at Harvard Business School and the Father of Disruption Theory, astutely points out in Innovator’s Dilemma that startups are adept to solving problems often not palatable to large companies — startups can work on a product which is a complete gamble and may only generate $10M in revenue in the first few years, whereas a company already generating $1bn+ in revenue must look for larger opportunities to show material growth.
With a sharp focus in hand, startups would do well to identify the key characteristics of each of the consumer cohorts in the market. Moving from cohort to cohort requires a different value proposition — the innovators, early adopters, early majority, late majority, and laggards (5 sub-groups famously laid out in Crossing the Chasm) have different criteria by which they make a purchasing decision.
Early on, a legal tech startup would do well to invest in a comprehensive strategy to attack the complex purchasing process of the industry. Legal tech startups should: (1) Identify which Crossing the Chasm customer cohort law firms fall into (so as to develop a “fast lane” and a “slow lane”), (2) identify who the primary decision maker(s) is/are at the law firm, and (3) understand the law firm’s decision making process. Having a strong understanding of [1–3] equips startups with a compass to systematically navigate the sales process.
The good news is, law firms, lawyers and clients want change. The technology is here and stakeholders are cognizant of its potential benefits; the industry is ripe for innovation. To affect scalable impact however, startups must formulate strategies to mitigate the key institutional barriers to innovation in the legal industry. If legal startups can overcome these challenges, there is an incredible opportunity to disrupt the dinosaur.
 In today’s technology environment the “sale is the win” concept has not been entirely eliminated; once data is onboarded into a product and customers are comfortable with a product, time and resources are undoubtedly required to switch to another product. However because most products allow information to be seamlessly downloaded and are built with user-friendly onboarding processes, customers are no longer locked into enterprise software as they once were.