AI, Lawyers, and Jevon's Paradox
Why AI is going to increase demand for legal services, not decrease it
The rise of AI is predicated on increased efficiency, but some lawyers fear what this means for their bottom line in the world of billable hours. Some are even predicting the death of the billable hour, and even saying that it might be a good thing. The fear is a decrease in overall profitability due to a decrease in revenue because AI promises efficiency, and in a charge-per-hour industry, time is cost but also revenue. In fact, one partner at Perkins Coie predicted a decrease in profitability of 13% across the industry.
The legal industry is a trillion-dollar, competitive industry, so if AI can introduce real efficiencies it is coming, like it or not. However, there is an interesting economics principle that suggests that it might not be all doom and gloom if AI can bring efficiency to the legal profession. In fact, according to this principle, lower billable hours per matter may mean more billable hours overall. How? The answer has to do with highways and traffic. Enter Jevon’s Paradox.
Billable Hours, Price Elasticity, and Traffic
Have you ever wondered why the traffic gets worse whenever they expand a freeway? It turns out there is a reason, and it comes down to economics.
The idea comes from English economist William Stanley Jevons. In 1865, he noticed that increased efficiency in the coal industry lead to an increase in aggregate coal consumption. Standard convention at the time was that technological progress would reduce overall consumption of all resources; he argued the opposite. It turns out that he was right. This has been observed in a number of different areas of the economy over time. In the 1980s, for example, Daniel Khazzoom and Leonard Brookes predicted that increased energy efficiency would mean that overall energy consumption would increase; this turned out to be true. This has also been observed with crops. And famously, it has been observed in traffic patterns.1
The reason is what is called the “rebound effect.” Essentially, when you become more efficient in using a resource, the amount of resource used per task decreases, reducing the demand for that resource overall. But sometimes this unlocks “hidden” demand—people who wanted to use the resources but couldn’t justify the cost2 at the previous levels of efficiency. When the “price elasticity” is high—meaning that if you cut the cost of something by $1, you get more than $1 of demand—you end up unlocking more hidden demand than you eliminated through efficiency. That is the beating heart of Jevon’s paradox. You can see the connection to legal work. While the cost of a service may go down, if there is enough “hidden demand” for legal work, the overall spending will go up because there will be more matters to handle, even if the cost per matter decreases due to efficiency.
We have seen examples of this in the legal world in the past decade. Two from corporate work are Stripe Atlas and Clerky. Stripe Atlas handles incorporation matters for startups in a cookie-cutter manner for a flat fee. Previously, startups would be charged $10,000-20,000 for formation matters. Now, they can use Atlas and get access to Goodwin-drafted documents alongside process automation and deals on startup services, like bank accounts from Mercury and credit cards from Brex. Similarly, Clerky generates certain types of standard form contract drafted by Orrick, like NDAs and SAFEs. For a one-time flat fee, startups can get access to these documents and use them as many times as they like. These standard documents would often cost thousands of dollars from a good firm. And they weren’t even that profitable; they were tedious jobs that lawyers disliked doing and distracted from higher-order matters.
Stripe Atlas and Clerky have had an effect on the legal profession’s pricing power for these services. White shoe firms will now offer a $5,000 package to get startups on board that is similar to Stripe Atlas. Similarly, prices for standard agreements have gone down. Edge is represented by well-heeled counsel and was advised to not bother using a form offer letter from them. But business overall is up. Startup formation is at a record high, which means that although the fees are lower, the quantity makes up for it. Similarly, while companies are less likely to get bled dry for simple contracts, they are more likely to find value from their lawyers and feel more comfortable asking for complex work because the legal budget has not been consumed by pedestrian work. Certainly, that has been our experience. And in patent law, an initial draft is often a flat fee, but that has not meant less profitability overall for the field. Patents are higher-quality and more complex than ever.
Knowing that AI is coming, lawyers can respond by understanding how to procure well, whether outside counsel or in-house. They can be ahead of the competitive curve by being early adopters of tools that work for them and treating obstacles, like privacy and security, as hurdles to overcome instead of blockers. They can also think about how to use AI to generate efficiencies in their practice that are cost centers today, like in training and staffing for operations. And lawyers can retool their offerings for clients. With the efficiencies of AI, how can you improve the quality of what you are offering to create a higher-quality product and, therefore, a higher billable hour? Are there things that are expensive today that you can offer for cheap to bring clients in and upsell? Or what matters that take time away from more profitable matters can be done quickly to reduce drag on the practice overall? And most importantly, thanks to increased efficiency, what can you offer today that before was impossible, thus creating new legal products altogether?
Lawyers have a choice in how they react to this shift, but it is inevitable. AI introduces efficiencies that will allow law firms to compete over business. Thanks to competition, AI adoption is coming anyways. The question to ask is not whether AI will be bad but how to make it good. And it should be noted that the law is a competitive space and it always has been. Increased competition and efficiency has not stopped the profitability of the legal industry so far. In fact, AmLaw 100 revenue grew this year to a record high.
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Some economists have proven that this occurs in network models where agents can individually optimize under certain conditions.
In economics, a “cost” can be any negative impact from doing something. For example, if you have to wait, that is a “time cost.”