BLOGS

March 28, 2023

How to assess the attractiveness of innovations to legal companies

To stay competitive in the modern legal landscape, law firms must recognize the importance of adopting new technologies and practices. This means not only investing in the latest tools and software but also fostering a culture that values innovation and encourages experimentation. By doing so, firms can improve their efficiency, increase their profitability, and better serve their clients in an increasingly digital world.

Many law firms don’t implement innovative products at all or do it slowly. Partners continue to pay maximum attention to clients that bring the most profit, practices, and staff, being captured to the outdated paradigm: “invest in lawyers, office, and marketing”. When considering the investment attractiveness of innovations, lawyers often act according to the well-known proverb about a crane in the sky and a tit in your hands. That means it’s better to have something now, even when it’s too little, than to expect something more significant in the future.

False interpretations of financial analysis

In addition to the common doubts among lawyers about the value of innovative solutions, the false interpretation of discounted cash flow and net present income could also be added. The latter method of financial analysis often slows down or even destroys all attempts to implement innovative solutions in law firms. Even adopting relatively easy systems like Jusnote requires managers to re-evaluate their views on the significance of such solutions. Discounted cash flow and net present income calculations are often used to estimate ROI. Yet, these indicators can underestimate the actual profit and positive effect of innovations.

By relating future ROI to the current capital value to calculate net present income, we assume that a rational investor doesn’t care whether he receives a dollar today or with interest in the future. If this is so, when assessing the attractiveness of investments in innovative products, it’s reasonable to divide the amount of money that the investor expects to earn in the future by (1 + r) to the n-th degree, where r is the discount factor, that is, the annual rate of return on investment on the financial market, and n is the number of years during which the investor will receive this profit. 

The calculation of discounting from a mathematical point of view looks perfect. At the same time, false assumptions behind this mainly prevent legal firms from investing in legal innovations and new technology solutions. Managers mistakenly assume that the current financial well-being of their companies, against which the profitability of a particular innovation is compared, will continue permanently, even if the company doesn’t invest in any innovation at all.

At the same time, we can compare two possible scenarios:

“We leave everything as it is and do nothing”, and “We implement innovative products”. Partners often consider an investment to be a separate project: from the expected project’s income subtract its implementation costs and compare the resulting value with the current cash inflows that are taken as a constant value. In other words, the partners compare the income that can be obtained by implementing innovative solutions with the income from denying such solutions.

However, life is changing. Non-legal companies are already developing products that can satisfy a huge part of clients’ legal needs; new technologies and services appear, influencing prices, sales of legal services decrease, and legal firms lose profits. If no one in the company is focused on the future, it’s unlikely to succeed in the long run. Managing partners of law firms who try to lower the value of innovation to a simple mathematical number in the form of income make the “Parmenides’ error” (in honor of the ancient Greek philosopher who proved the immutability and permanence of the world).

Predicting future returns from investment in innovative projects or products is difficult. It is even more challenging to anticipate how much the legal company’s financial situation may deteriorate tomorrow without such investments. Finding the proper benchmark for comparing forecasts forces managers to analyze the value of one or another innovation compared to other future scenarios. The worst outcome of “doing nothing today” will most likely be a reduction in profit and competitiveness of the law firm’s “tomorrow”.

In addition, when evaluating the prospects of innovations using the discounted cash flow method, it can be challenging to correctly calculate future cash flows from similar investments. For the distant future, this indicator generally comes from the ceiling and beyond the planning perspective. 

To understand the value of an innovation, one should compare the discounted cash flow that the innovation would provide the company with the (probably smaller) cash flow that the company would receive by refusing the innovation.

Justification of investment in innovation according to the principle of disclosure

In most legal companies, deciding on introducing an innovation consists of three stages: economic justification, detailed study, and introduction of an innovative product. Partners want to foresee future profits, income, and risks associated with new technologies and products in numbers. Innovative products are mainly at a disadvantageous position compared to traditional processes, products, services, and business models. As a rule, innovations are unlikely to undergo such a selection. 

When determining the prospects of introducing an innovative product or technology, it is better to use the “planning according to the principle of disclosure” method. This method of assessment means moving in the reverse direction:

• Determining the acceptable profit, profitability, and cash flow values when introducing an innovative product.

• Defining the conditions under which these indicators can be reached. In particular, compile a list of conditions that are critical for the success of innovation and that are easy to check.

• Reviewing the list and checking the previously defined conditions. Promptly adjust the planned indicators and check the assumptions regarding the innovation. The latter occurs as innovations and technologies are used in the activities of a legal company.

Innovations benefit clients

In a similar fashion, innovative technologies and new business models help create more value for clients, gain client trust, and achieve a higher satisfaction rate. Think of the delivery of legal services from your client’s perspective. With little doubt, their expectations certainly include:

• payment automation (making billing faster and easier)

• reducing manual processes and paperwork

• having their information secure 

• consistent and convenient communication with a lawyer

• having their matters solved quickly and flawlessly

• etc.

Technology is a must to effectively manage those and many other clients’ demands without having lawyers pushing to the limit and experiencing stress, overload, and burnout.

How to keep up with the speed of innovation

To be ready to introduce innovations in the standard way of doing business, lawyers must first shift their way of thinking towards a more creative, innovative-like approach. It’s revealed that an innovative climate is one of the most critical factors for the firm’s competitiveness and business performance. That might be easier for startups since they are more enthusiastic to try new approaches and business models and are motivated to embrace new technology to surpass competitors. 

However, what is the solution for older and bigger firms? A great option is to hire tech-savvy personnel who are innovators themselves and can share their experiences with your employees on how to embrace and implement innovations and demonstrate the possibilities of legal technologies. 

Also, you may consider hiring a corporate coach who can teach lawyers how to work on and challenge their mindset, show perspectives, and improve their creative and critical thinking in order to look at innovations from various angles (which is what today’s competitive world demands). 

The key is to create a culture of innovation and make it part of your business, implement tech solutions that will appeal to clients and make them want to come back to your firm, and enhance lawyers’ self-confidence in using innovations.  

Oleg Smotrov

CEO at Jusnote