Three reactions to an Economist article about offshoring legal services

The Economist, Dec. 18, 2010 at 132, predicts increasing use of legal offshore providers. Three points deserve mention.

“Of the $180 billion that Americans spend on lawyers each year, only about $1 billion goes to outsourcers. If the $180 billion is total fees paid to law firms in the United States annually, might we assume two-thirds of those fees come from corporate clients? If so, of $118 billion or so, almost one percent goes to outsourcers? That seems high as other estimates have put the industry at $500 million or so (See my post of June, 30, 2010: estimate of India at about $440 million in 2010.).

As to the fees paid “this is growing at perhaps 20-30% a year, for the simple reason that legal costs are out of control.” Not too sure of that. If legal spending as a percentage of revenue has remained fairly stable for the past decade or more, where is the touted and uncontrolled spiral? The Economist, inexplicably, pins its explanation on the claim that “Between 1998 and 2009, big law firms’ hourly rates shot up by more than 65%, according to the Corporate Executive Board.” An online calculator for cost-of-living increases tells us $400 an hour in 1998 would have risen to $526. That is a 32% increase simply from inflation. If the “big firms” – the ones with national reputations, expensive locations, and impressive specialization – rose twice as fast, it does not shock me. I would not be surprised if the average hourly rate paid by firms increased less, since smaller firms probably raised their rates less. Moreover, average chargeable rates do not equal average realized rates. In fact, perhaps the percentage of fees paid to “big firms” dropped for many US companies during that decade. Basic economics would affirm that increased costs reduce demand.

Third, the article also states that “American Express, GE, Sony, Yahoo! And Netflix have all started using [an offshore legal provider, Pangea3] for basic legal tasks.” It mentions that the firm “drafts contracts.” Sounds like practicing law to me. Continuing, the article adds that corporate clients “often then approach their expensive American law firm and demand that it starting working with the outsourcer.” The belligerent tone has little basis from my consulting experience.

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