Law Firms’ AI Nightmare Is Fewer Billed Hours and Lower Profits

Welcome back to the Big Law Business column. I’m Roy Strom, and today we look at a theory about the economics of investing in AI before learning about a real-life example. Sign up to receive this column in your Inbox on Thursday mornings.

Here is a tough sell for a Big Law managing partner: Invest millions to build a generative artificial intelligence product that will shrink billable hour revenue and crimp profit margins.

That’s what can happen when the technology makes lawyers more efficient, AI consultant Toby Brown found. Brown, a former chief practice management officer at Perkins Coie, learned this by modeling the potential economic impact from AI’s efficiency gains.

His work was an attempt to answer the question law firms face when they integrate new, efficiency-focused tools into the billable hour model: How much time could AI cannibalize from a law firm?

Reviewing anonymized time sheets from real law firms, Brown hypothesized AI would have its biggest impact on time entries for “drafting and reviewing.” Those entries accounted for 47% of the revenue in his sample of timesheets, which came from a broad range of work performed by 10 large firms, totaling around $500,000 in revenue.

Brown estimated a conservative 5% reduction in partner hours and a 20% reduction in non-partner hours. That led to a 13% revenue decline and a 7% cut in profit margins.

That’s certainly not the AI future law firm leaders are dreaming of.

Despite what seems like a horrible business outcome, Brown and his co-authors at law firm consultancy Adam Smith Esq. in a recent paper urge law firms to pursue this new business model in their most successful practices.

That’s because the AI investment is worthwhile only if the firm can use new efficiencies to win work from its competitors—whether through a better service or lower price. And a firm will most likely be able to do that in practices where it is already well known.

“It is counterintuitive, and that’s why I say law firms need to think hard about where to make these big investments,” said Brown, who now leads consulting businesses for law firms. “Because whoever is the first firm to say we’re going to do it in any specific practice, once the ball starts rolling, they’ll have a defensible competitive advantage.”

At Wilson Sonsini, chief innovation officer David Wang is putting that theory to the test.

The Silicon Valley-founded firm this week began selling to clients its first fixed-fee product that relies on an AI model. Wang said a team of more than a dozen people built it over nine months, in partnership with legal tech startup Dioptra.

The product does one thing. It applies Wilson Sonsini’s human-created, 100-rule playbook to mark up sales contracts for cloud services companies. A Wilson Sonsini lawyer reviews the work before sending it back to the client.

Wilson Sonsini says the AI model is 92% accurate, measured by correctly matching applicable playbook rules and properly applying the designated remedies.

The semi-automated red-line process takes far less time than a human, maintains high quality, and it is priced lower than the cost of a review done by an in-house counsel or a smaller firm, Wang said.

The goal for the product, Wang said, is to take work from other law firms.

“If it is cannibalizing our own work—if that statement is true—then that is because it is better than the work we provide now,” he said. “It can then be predatory about other lawyers’ work. So, I’m planning to cannibalize our competitors’ work, because there is plenty there to eat. This scarcity mindset people have, I think, is totally wrong.”

The product is aimed at startup companies—a core group of Wilson Sonsini clients. It’s delivered through a digital platform the firm rolled out a few years ago called Neuron.

The firm chose the product because startup clients see tremendous value in faster, cheaper contract negotiations, Wang said. As they scramble to bring in revenue quickly, they often don’t pay for a full negotiation, he said.

The firm is working on a product related to another startup imperative: fundraising. The product represents the ability to automate a “core competence” for law firms—digesting complex information and applying a set of interlocking rules consistently and accurately, he said.

From a strategic standpoint, Wang said his technology investments are guided by asking what kind of product could grow the top line by 10% for a $1.3 billion law firm. He’s looking for investments that make a $130 million impact.

“If you’re not aiming at that kind of thing with your technology efforts, I do think it’s a missed opportunity,” he said. “There is a lot of incremental innovation that is great and should happen. But I’m excited about this because it’s of a strategic variety.”

I presented Wang’s description of the Wilson Sonsini product to Bruce MacEwen and Janet Stanton, the Adam Smith Esq. coauthors of the paper suggesting AI investments for core practices.

The product represents a “textbook example” of how to approach AI investments, Stanton said. Introducing automated tools that provide high-quality service faster and more cheaply will provide firms with an enduring competitive advantage, she said.

“Even if somebody comes up with something that matches it, that’s not an advantage,” she said. “They’re late.”

Worth Your Time

On New York Firms: Last week, we focused on New York’s elite firms leaning into the lateral partner market. This week, Sullivan & Cromwell hired two top-tier Silicon Valley M&A partners from Skadden. And Cahill Gordon & Reindel opened a Delaware office with a cryptocurrency focus.

On Eugene Scalia: The son of the late Supreme Court Justice Antonin Scalia has become the face of big business’ fight to rein in what it sees as government overreach under President Joe Biden, Justin Wise and Rebecca Rainey report.

On Law Firms and AI: Paul Weiss is testing AI products and Reed Smith hired its first director of applied artificial intelligence.

That’s it for this week! Thanks for reading and please send me your thoughts, critiques, and tips.