Margin, Volume, and the Long Tail

Private law firms naturally focus on high margin services—bet the business work—where cost is less of a concern and fees are high. However, such work is small in volume. While mostly shunned, there is significant opportunity in more routine factory work. While it carries a low margin, the smaller profits per transaction are more than made up in volume.

The topic was addressed in one the best presentations at ILTA. Gerard Neiditsch, Jeffrey Rovner, Mary Abraham, and Ron Friedmann took A New View of the Automated Law Firm and contrasted the nature of bet the business and factory work from a wide range of perspectives, including: (a) how work is produced, (b) how it is managed, (c) who does the work, (d) how business is developed, (e) how it is priced, and (f) how the work is packaged.

Margin, volume …

With an hourly rate, profit margins tend to be similar for bet the farm and factory work, because profit margin today is based more on the staffing ratios and hourly rates than the nature of the service.

While more hours and higher priced attorneys will likely be applied to a merger transaction compared to drafting an employment agreement, meaning that the gross receipts will be higher for the merger, the profit margin for each hour worked will be equivalent where staffing ratios of partners, to associates, to paralegals is about the same. In the absence of a successful document automation or legal process management solution designed to delegate work to less costly resources, the employment agreement will still be handled by a partner and an associate working in about the same ratio of hours compared to the merger.

As a sidebar note: an employment agreement is less standardized compared to a merger agreement, so on a page-by-page basis, it will likely take longer to review and negotiate.

The price for legal services is unresponsive to market forces due lack of automation and process management. As a result, the supply curve is inelastic because of inability to scale or realize any economies of scale.

Economics would argue that since there is a much greater demand for employment agreements, there should be more service providers competing to meet market demand: and, all things being equal, more demand and increased supply will lower the price. Law, however, is high price piecemeal work that requires more workers and hours to produce more services. Lacking innovation, it cannot serve commoditized markets.

Big law serves the narrow market of high-margin, low-volume legal work—good work if you can get it.

Plotting margin and volume on a grid shows that big law operates in the lower-right sector. Few businesses will have any interest in occupying the lower-left sector, and economics will rarely allow the upper-right sector to exist for long periods. In its heyday, credit swaps and derivatives may have been an example of this segment, but most firms continued to price their services by the hour and therefore did not realize higher profits.

The remaining sector is the upper left—low-margin, high volume legal services: a virtually untapped market for private law firms.

... and the long tail

Due to inability to realize economies of scale, big law services fewer and fewer of the transactions executed by their clients because they have priced themselves out of the market. This work has moved in-house.

High margin legal services represent the rarified end of the long tail. For every merger agreement executed by a large corporation, it will negotiate a handful of procurement and license agreements, hundreds of employment agreements, and perhaps thousands of confidentiality agreements. As GCs seek to reduce their outside counsel expense by as much as 25%, this trend will likely accelerate.

The opportunities for law firms (big or otherwise) able to introduce efficiencies are significant. Moreover, this untapped market is likely far larger than the market currently served.

There are many good reasons why firms may not choose this path. It will require change and investment. It may also be perceived as less challenging commodity work. Having spent years drafting and reviewing legal documents, I would argue that is just as challenging to identify contract standards and negotiation ranges for employment agreements based on thousands of documents, compared to drafting one merger agreement.

Contract Analysis -- Commonality and Consistency

In response to my last Post, Ken Adams returns to a familiar theme to question the contract analysis approach. His post, http://www.adamsdrafting.com/2010/09/30/for-optimal-contract-language-dont-follow-the-herd/ suggests the purpose of contract analysis is to find the most popular clauses.

This is an opportunity to clarify how kiiac works. In creating a reference set, kiiac creates an aggregated outline (similar to a table of contents for the collection) and a clause library for each outline branch. The outline captures the standard transaction elements and all deal-specific variations. It does, indeed, measure clause commonality, showing how frequently particular terms appear in the collection. The clause library, however, is organized not by commonality, but by language consistency. Our goal is to find the core, non-negotiated language for each provision. We then group the library by conformity to the standard, highlighting deal-specific or divergent terms in each clause. Typically all the clauses are slightly different, so it is difficult to determine which would be the most common.

kiiac proposes the core language as a starting point. You can select a different clause if it contains language you prefer, or you can quickly review the full range of alternatives and supply your own language for the provision.

Ultimately, the difference in approach between Koncision and kiiac may not be that different. kiiac’s approach is to start with a document structure and set of clauses that are familiar to the attorneys, identify the best precedent in the collection and enable a process of continuous improvement. As I understand it, Koncision will use existing precedent as a guide and may re-write terms where existing language is not optimally suited for its purpose. I think it is fair to say: we are both trying to get to the same point.

Figure 1 shows the outline created for a merger agreement, showing the organization of the agreement of the agreement and how frequently each provision occurs (the more common the clause, the more filled-in the icon).

Figure 2 shows the clause library for the governing law provision, identifying the core clause with the least or no deal-specific or negotiated language, and grouping the clauses by divergence to such standard.

The Power of Statistics

We all know the catch phrase “lies, damned lies, and statistics.” It is typically used to mean that statistics can be manipulated to support any proposition and should therefore be viewed--presumably--with some degree of skepticism.

And that’s a concern for those of us seeking to harness the power of statistics to analyze contracts and other documents.

So I was intrigued when I came across Michael Lewis’s book Moneyball-The Art of Winning an Unfair Game (2003). I enjoyed Liar’s Poker (1989) and look forward to reading The Big Short: Inside the Doomsday Machine (2010). I confess to reading a synopsis of Moneyball on Wikipeadia. It summarizes the book:

“The central premise of Moneyball is that the collected wisdom of baseball insiders (including players, managers, coaches, scouts, and the front office) over the past century is subjective and often flawed. Statistics such as stolen bases, runs batted in, and batting average, typically used to gauge players, are relics of a 19th century view of the game and the statistics that were available at the time. The book argues that the Oakland A's' front office took advantage of more empirical gauges of player performance to field a team that could compete successfully against richer competitors in Major League Baseball.”

The application of math and statistics to literature, art, and even sports is often greeted with skepticism, doubt and sometimes nostalgia. For example, Bill Simmons of ESPN writes in Finally joining the revolution: “I longed for the old days when you could say things like, ‘I hate watching J.D. Drew -- when is that contract going to end?’ and there wasn't some dude lurking behind me with Drew's stellar OPS, VORP and WAR numbers saying, "Well, actually ... "

Simmons is now a convert and is convinced by the insights offered by sabermetrics.

Reading these articles also made me think of a piece in the Wall Street Journal titled, Contract Doesn't Let Board Fire Mann CEO for Jail Term, in which the authors appear outraged that “[u]nder the terms of the employment agreement for Louis Lower, the jailed chief executive of Horace Mann Educators Corp., serving a 60-day sentence on a drunken-driving charge isn't grounds for firing—or for losing any pay.”

If the authors harnessed the power of empirical evidence, they would discover that termination for substance abuse is rare, appearing in less than 5% of CEO contracts. Stewart J. Schwab and Randall S. Thomas report on their analysis in An Empirical Analysis of CEO Contracts: What Do Top Executives Bargain For?

Some contracts may include commission of a felony as cause for dismissal and termination of pay; but typically a DUI is a misdemeanor and in some states it carries a mandatory jail sentence.

While contract analysis is a very new field, it will likely offer new insights on precedent that we thought we understood thoroughly and it may question our long-held beliefs.

Creating Forms by Committee and Consensus

An earlier post—The Fastest Way to Create a Form—describes a process to identify standards using technology to find the most conforming document and the most conforming clauses to quickly establish a baseline and then bring it up to practice standards by supplementing the baseline with missing and divergent clauses.

In other cases, a consensus building approach might be preferred. Working with ABA Model Intellectual Property Task Force, we have proposed an efficient, technology-enabled approach to develop model forms based on a potentially diverse set of documents and a wide range of individual interests.

1. Create the reference set from a source set of documents. In this case kiiac examined 105 Intellectual Property Security Agreements. (If you are interested in viewing the set, please send me an email and I will provide you with access credentials).

2. Provide an overview of the process. John Murdock, partner at Bradley Arant, created a YouTube video explaining the goals of the project and how the group can achieve consensus and develop the model form. John created the video in PowerPoint and rendered it with Moyea PPT to Video Converter. (FYI: A good resource for ideas about putting PPT content on the web is: http://www.dvd-ppt-slideshow.com/ppt-to-dvd-tips/put-powerpoint-on-web.html.)

3. Gather feedback on drafting options. The consensus building approach needs to work both during in-person meetings (that may take occur twice a year) and between such dates. In order to move the process along more efficiently, the key drafting choices are identified and the group’s opinions gathered through a Survey Monkey.

The approach to identifying the drafting questions used the technology to examine where consensus exists and where there is a range of opinions. One of the goals of the MIPSA project is brevity. While it would be easy to use the technology to identify all possible variants and string together a comprehensive lists, the group determined to use the process to streamline and clarify contract language.

Where kiiac finds that all documents contain a particular provision, it is considered required. But where a particular provision is found in the some, but not all agreements, it is considered optional or deal specific. The group is then asked whether it should be included in the model. For example, 100% of the grant clauses contain a grant of a security interest, while a smaller percentage include language to “assign,” “pledge,” or “hypothecate” the collateral. Here is a screen shot of the Survey Monkey.

The first step to create a model for the grant clause will run through December. I’ll report back on the results and level of participation.

Contract Readability -- Part 1

What makes a document easier to read and understand by both humans and machines? Does readability—or lack thereof—affect document quality?

The next few blog posts will focus on drafting practices to assure quality and avoid mistakes. The purpose is to try and identify best—and worse practices—and discuss whether they have any significant impact on quality.

The golden rules of human readability are generally well understood. JoAnn Hackos and Dawn Stephens in Standards for Online Communication (1997) summarizes the rules:

• “Use short, simple, familiar words.
• Avoid jargon.
• Use culture-and-gender-neutral language.
• Use correct grammar, punctuation, and spelling.
• Use simple sentences, active voice, and present tense.
• Begin instructions in the imperative mode by starting sentences with an action verb.
• Use simple graphic elements such as bulleted lists and numbered steps to make information visually accessible.”

But, lawyers, as typified by a well-known Dilbert cartoon, are well known to violate each rule with reckless abandon.

There’s a fabulous site you can use to test the readability of your contracts.

Online Readability Test

It estimates the number of years of formal education required to understand text on first reading using the Gunning Fog index. The software reported that for one merger agreement I processed, you will need nearly 23 years of schooling. It will be interesting to discover the most incomprehensible document.

Contractual clarity has long been the goal of the Plain English movement. But, it has made only limited progress. In the next post, I’ll address whether readability matters.

The Fastest Way to Create a Model Form

We all know the most inefficient method: ask attorneys for their best samples and form a committee to review the documents. Virtually all firms have tried this approach: all with same result.

Now, with aid of technology, there are much more efficient methods that can produce a model document in days; sometimes hours.

1. Search the document management or file system for the desired document type. Vetting or editorial review is not required. The software should identify the required documents and parse the clauses to identify the core, non-negotiated language.

2. Analyze the set of documents and

· capture the document outline, indentifying the frequency of each provision;

· capture a library of clauses for each provision, identifying language consistency

3. Find the most conforming document. This is the document that contains all common terms and the most standard clause language. Most importantly, it will have been drafted so that all its clauses and defined terms work together. It is also useful to confirm that this model is also widely used at the firm (i.e. are there a number of similar documents). If so, it is not only the most conforming document, but also the de facto standard.

4. Find the clauses in the most conforming document that might be missing. These are the clauses that occur frequently in the document set, but are absent from the most conforming document. Determine whether to add the most conforming clause from the clause library or another clause example, if desired.

5. Find the clauses in the most conforming document that diverge from the standard core language. These are the clauses that may be missing some standard language or may contain deal-specific language. Determine whether to replace these clauses with the most conforming clauses or another clause example, if desired.

In a recent application of this approach, one top-level clause was indentified as missing and four clauses were identified as divergent. The lawyer review process to create the model form took 45 minutes.

A concise history of the use of forms in the legal profession

The earliest use of model forms can be traced back to 1392, when the Worshipful Company of Scriveners first employed scribes to beautifully copy one document to the next. WHEREAS, the aforementioned forms were penned in Ye 'Olde English, the innovation is remembered mainly for its use of hand-scrolled, script font.
	In these early years, the pace of innovation is swift. The next major milestone came in 1450, when Gutenberg invents the printing press, enabling the mass production of form books. In terms of drafting practice, the distinguishing feature of the innovation is the use of the blackletter font.
However, for nearly 400 years innovation is shunned as drafting enters the dark ages. It is not until 1829 that the next major innovation arrives with the invention of the typewriter, enabling lawyers to mass produce their own forms. The innovation is distinguished mainly by the eventual adoption of the courier font.
	Finally, in 1976, Jobs and Wosniak invent the personal computer, facilitating the automated mass production--and personalization--of legal forms. However, most contracts are still drafted by copying the last document and laboriously making the necessary changes for the next client. The key innovation is the wholesale transition from a fixed width to a proportional font with the introduction of Times New Roman.
One can only imagine what new discoveries will be made in the centuries to come.