To innovate for the future, develop your ambidextrous capabilities

Avoiding the Red Queen

For an industry “on the verge of disruption”[1] there is good deal of incremental innovation going on. Or perhaps, as in Lewis Carroll’s Alice, Through the Looking-Glass, “it takes all the running you can do to keep in the same place”. [2] However, the appropriate strategic response to the Red Queen Effect,[3] is not (as the Red Queen suggests) that law firms need to run (or innovate) harder to get somewhere, rather they must innovate smarter. They must constantly adapt and evolve: The fundamental adaptive challenge facing firms is the need to both exploit existing assets and capabilities to ensure current viability, and at the same time, devote enough energy to exploration to ensure future viability and avoid being rendered irrelevant by changes in markets and technologies. [4] Conceptually, the need for law firms to both explore and exploit is appealing, but what does this mean in practice? At the 11^th Autumn Conference of the Bucerius Center on the Legal Profession, we invited innovation and organizational behaviour expert, Professor Charles A. O’Reilly III (Stanford Graduate School of Business) to share his insights from his extensive research into how organisations can simultaneously explore and exploit. This is what we learnt.

The Challenge

According to James March, [5] as cited by O’Reilly, “There is a bias in favour of exploitation, with its greater certainty of short-term success. Exploration, by its nature, is inefficient and is associated with an unavoidable increase in the number of bad ideas. Yet without some effort towards exploration firms, in the face of change, are likely to fail.”[6] It is a well-known business phenomenon that successful organisations are very adept at refining and improving existing products and services but fail when it comes to developing new and radically different products and services. Kodak is often cited as an example of this phenomenon. Whilst a firm might dedicate some of its resources to generating new ideas for exploration (for example, through research and development), they often decline to convert these ideas into meaningful products and services, often on perfectly rational grounds: the new ideas compete for scarce resources from the existing profitable business, or might result in a change to the current successful business model; the margins for the new business are slimmer; the client is content with what they already have, there is a risk that they might not buy the new service/product etc. As O’Reilly explains: “unless there is a clear strategy justifying the entrance into the new business, and unless senior management is prepared to protect these embryonic efforts, the tendency is for the mature business to either starve the new business or to impose on it the performance standards of the mature business, an easy way to kill a new venture”. [7] So how can law firms avoid this pitfall?

The Idea

O’Reilly calls an organisation that can simultaneously explore and exploit, the ambidextrous organisation. The secret to managing the tension between past and present, between explore and exploit, lies in a strategic leadership approach, aligning the organizational elements of two essentially different business models.

Furthermore, the ambidextrous organisation requires mastery of three distinct innovation disciplines: idea generation, the discovery and development of ideas for potential new businesses, incubation, where the new ideas are validated in the market, and scaling, where existing assets and capabilities are reallocated to help the new venture grow. [8] The last of these three disciplines being historically the most difficult to master. [9]

As the result of his research into how managers explore and exploit, O’Reilly was able to characterize specific elements of successful ambidexterity. At the conference, he outlined five ideas to help law firms prepare for the future: [10]
 

The Ambidextrous Law Firm

The Reality

Through the insights offered by O’Reilly, conversations with innovation advocates across law firms in Germany and the UK, and through the panel discussion at our Autumn Conference, with Valesca Molinari (Co-Head Innovation & Legal Tech Team, Baker McKenzie, now General Counsel Sunfire GmbH), Nina Stoeckel (Senior Director Group Legal & Compliance Operations, Merck), Sebastian Hartmann (Chief Technology Strategist & Global Lead Portfolio & Investment Steering, KPMG) and Carsten Linz (Author of Radical Business Model Transformation), as well as short presentations by innovation champions in Germany, including Oliver Schwarz (Partner, ADVANT Beiten) we identified a number of potential stumbling blocks for law firms intent exploring, as well as exploiting. This is how to overcome them:

1. Move from a short-term to a long-term perspective

Law firms focus on short-term revenue (annual profit-per-equity partner) to the detriment of establishing long-term value through investment. [11] The recent headline in The Lawyer, “Innovation is a slow-burn return for Clifford Chance”, [12] highlights how this works against the ambidextrous model: metrics for the existing business, where profits are paid out yearly and serve as an indicator of financial performance (PEP), contrast with metrics for the explorative business, where a more long-term perspective is needed. [13] For example, Clifford Chance’s Applied Solutions Ltd, launched in 2018, ran a £1.6m operating loss in 2021, compared to profit per equity partner PEP of £1.8 in the same year. To avoid killing the new venture, a strong leadership team is needed to clearly articulate the ambidextrous strategy, as well as ensuring that the new business is not assessed with the same metrics as the existing business, as this leads to the assumption that the new business is “under-performing” – and can kill the new venture. For example, according to The Lawyer, [14] having failed to deliver returns on investment as a separate entity, BCLP’s managed services subsidiary, Cubed, was quick to transfer roles back into the firm to better serve the existing business.

Could an alternative legal structure for law firms be the solution? As discussed on our panel, some law firms in the UK have established themselves as public limited companies and floated on the stock exchange to raise finance for investment. Considered by The Lawyer as a “social experiment by the legal industry”, [15] the six listed firms (Gateley, Keystone, Ince Group, RBG, Knights and DWF) have not yet stimulated market disruption in the way lawmakers envisaged when the Legal Services Act allowed non-lawyers to own and manage law firms – but we are watching this space closely. 

2. The importance of structure when generating and testing innovative ideas

As discussed on our panel, law firms are good at generating ideas. Often this is somewhat haphazard, starting with the individual lawyer, investing time “on top of” their day job, later perhaps as part of a team or task force, and eventually as part of an “innovation lab”. Tools such as design thinking (used by ADVANT Beiten), open innovation techniques and firm-wide innovation challenges (used by Baker McKenzie) are becoming more common, however, innovation is part creativity and part discipline, [16] and often a more rigorous approach to idea generation is required. For example, Linklaters employed an innovation network tool to bring structure and discipline to the ideation phase of their innovation projects. [17] In the same way, validating the new ideas, whether through lean start-ups techniques [18] (used by Norton Rose), or the well-known business canvas, [19] requires clear criteria for moving forward, modifying, or killing the experiment. As Valesca Molinari explained, generating the ideas is not the problem - we might produce 400 ideas – but deciding which to test and how to test them requires business acumen and entrepreneurial mindset, something which may not be prominent in the lawyer skill set. As our guest, Nina Stoeckel, reminded us, lawyers tend to want to “read the handbook first” before embarking on new ventures.

3. Increase collaboration – think outside of the box!

Sebastian Hartmann explained how KPMG’s appropriately named exploratory venture, “Not-Kodak”, became “Engine B” (https://www.engineb.com). During the ideation stage, it was important to gain insights from both audit and non-audit experts to investigate what changes in the business environment would entirely disrupt the audit business model. To test and scale up the idea of a fully digitalised audit process, KPMG asked potential future customers and collaborated with other audit firms and players in the industry, including the regulator in England and Wales. KPMG’s mindset was that, if KPMG could generate the idea of a fully digitalised audit process, then its competitors were likely to be able do the same – it is best to disrupt your own business model yourself than to have someone else destroy it!

Amazon Go!, mentioned by Carsten Linz, serves as an example of the importance of asking the customer. The idea of an automated shop evolved after customers said the most frustrating part of shopping was waiting in line. Many law firms show their clients prototype tools, and even work with them to develop the tool, but as both Carsten Linz and Nina Stoeckel highlighted, law firms need to take collaboration a step further. Nina Stoeckel noted that, as a buyer of law firms’ innovative offerings, given that each law firm creates and sells its own “tool”, there are too many tools available for the buyer. Legal departments don’t want 40 different products, but one universal product for the job.  Furthermore, according to Linz, it is not enough to involve the immediate customer in the chain. Discontinuous innovation can occur when we consider the value chain as a whole: what if the tool could not only identify the legal issue but also solve it, involving not just the Business-to-Customer element, but the entire Business-to-Customer-to-Business chain. Furthermore, as highlighted by Oliver Schwarz, when incubating innovative ideas, lawyers must be proficient at working in multi-disciplinary teams and play to their own strengths: few lawyers have the skills necessary to quickly bring a product to market using a lean-start-up model, this should be left to the experts.

4. Focus on structural ambidexterity when scaling up

Linklaters recently announced their intention to scale up their CreateiQ product as both a product and a brand. [20] To scale successfully, according to O’Reilly, the new venture needs to add customers, capacity, and capability fast enough to maximise the market opportunity. [21] Firms good at scaling use a combination of techniques to do this: acquire (M&A), build (investment commitment), partner, and leverage assets and capabilities from the mature business. [22]  Law firms, and other organisations, tend to be great at ideating and good at incubating. The real issue lies in scaling, especially as this is when a truly ambidextrous organisation is essential. In the legal market, one might be forgiven for assuming that most international law firms already have an ambidextrous organisation, as separate innovation units are advertised on their websites (Fuse from Allen & Overy, Reinvent Law from Baker McKenzie, Wavelength from Simmons & Simmons, Nakhoda from Linklaters, Cubed from BCLP, or the Freshfields Lab). Although some of these units have their own brand name and website, most are still fully integrated in the existing business, often led by practice group partners (“on top” of their day-job) and often relying on resources (marketing, technology, lawyers) from the firm. This may be acceptable during the ideation and incubation phase, but not in the scaling phase. As discussed by Sebastian Hartmann, a key success factor in the “not Kodak” project was separating it from the main business during the testing and scaling stages. Furthermore, according to O’Reilly, incubation and scaling cannot be carried out “on-top” of a lawyer’s day job – even more so for discontinuous innovation – a view confirmed by Hartmann, who explained that it was essential to do the type of thinking required for testing and scaling outside of one’s day-to-day work. Giving brand primacy to the products created by the exploratory unit may be an important first step, [23] whereas ultimately, the mission of the new venture should be to “kill the core business”. 

4. Alignment of Goals, Rewards and Career Steps

According to O’Reilly, one of the key success factors for an ambidextrous organisation is a clear, well communicated strategy and common reward system.[24] During the panel discussion, Oliver Schwarz highlighted the importance of incentivizing lawyers working in the exploratory unit, for example, by offering lawyers working a fixed number of “innovation hours” an “innovation bonus”. Other firms, such as Mishcon de Reya, have introduced similar schemes. [25] However, many lawyers have dual roles, being responsible for both innovation and their practice area. This can result in conflict between explore and exploit functions, with the result that the exploit function is prioritised in favour of utilization and profit targets. To combat this, not only does exploration need to be rewarded, but clear strategic communication is needed to highlight that exploratory work is equal to client work – in terms of pay, appraisals, and career progression.

Conclusion

O’Reilly reminds us [26] that although the ambidextrous organisation focuses on structural design and leadership to allow companies to lead disruptive innovation in their markets, the three stages (ideate, incubate and scale) are highly relevant to incremental innovation. Whilst the ability of leadership to adapt, integrate and reconfigure organizational capabilities are more valuable in a disruptive environment, adaptability remains crucial for law firms, especially given the number of structural, cultural, and leadership mechanisms which hinder innovation (for example, no established research and development activities, short-term outlook, focus on individual partner performance, no alignment of reward system for non-lawyers). The purpose of this article is to give forward-thinking law firm leaders ideas and concepts with which to prepare themselves for the future, so that they too can arrive “somewhere” by running smarter.

Autorinnen

Emma Ziercke und Madeleine Bernhardt

This article was originally published on 23^rd March in Legal Business World No. 2/2022

[1] https://thepractice.law.harvard.edu/article/disruptive-innovation/

[2] Lewis Carroll (1960) p. 345

[3] In Lewis Carroll's “Alice, Through the Looking-glass”, Alice realises that although she is running as fast as she can, she is not getting anywhere, relative to her surroundings. The Red Queen responds, “Now here, you see, it takes all the running you can do to keep in the same place. If you want to get somewhere else, you must run at least twice as fast as that!” This analogy is often used to describe continuous and escalating activity of firms trying to maintain relative performance in a competitive market. The only way rival firms can escape the “Red Queen Effect” is not by running harder but running smarter than their competitors. See for example, Sven Voelpel, Marius Leibold, Eden Tekie, and Georgvon Krogh, Escaping the Red Queen Effect in Competitive Strategy: Sense-Testing Business Models in the European Management Journal Volume 23, Issue 1, February 2005 https://doi.org/10.1016/j.emj.2004.12.008

[4] James G. March (1991). Exploration and exploitation in organizational learning. Organization Science,2: 71-87.

[5] Ibid

[6] Charles A. O’Reilly and Michael L. Tushman, Organizational Ambidexterity: Past, Present, Future at the 2013 Academy of Management Perspectives (in press) at page 4

[7] Charles A. O’Reilly and Andrew J.M. Binns, The Three Stages of Disruptive Innovation: Idea Generation, Incubation and Scaling, California Management Review (2019), Vol. 61(3) 49-71 at page 50

[8] Ibid at page 51

[9] Ibid

[10] From Charles A. O’Reilly’s Keynote speech “Lead and Disrupt – The Ambidextrous Organisation” and Charles A. O’Reilly and Michael L. Tushman Organisational Ambidexterity in Action: How Managers Explore and Exploit 2011 California Management Review Vo. 53(4) 5-22 at page 9

[11] See for example, Jonathan T. Molot What’s wrong with Law Firms? A Corporate Finance Solution to Law Firm Short-Termism, 2014 Southern California Law Review Vol. 88(1) 1-43

[12]  Innovation is a slow-burn return for Clifford Chance, HORIZON by The Lawyer 19^th January 2022

[13] See for example, Ocado Group in the UK. The start-up, founded in 2000, disrupted the online-grocery market in the UK with automated warehouses, but it was over 10 years before it became profitable.

[14]  Innovation is a slow-burn return for Clifford Chance, HORIZON by The Lawyer 19^th January 2022

[15]  Law Firm IPOs are a social experiment, HORIZON by The Lawyer 24^th January 2022

[16] Gary P. Pisano, The Hard Truth About Innovative Cultures 2019, Harvard Business Review January-February pages 62-71

[17]  https://www.hypeinnovation.com/hubfs/Linklaters-Case-Study-EN.pdf

[18] For useful validation methodologies see pages 55-57 of Charles A. O’Reilly and Andrew J.M. Binns, The Three Stages of Disruptive Innovation: Idea Generation, Incubation and Scaling California Management Review (2019), Vol. 61(3) 49-71

[19] See David J. Bland and Alex Osterwalder, Testing Business Ideas, Wiley, 2020

[20] https://www.globallegalpost.com/news/linklaters-assigns-brand-primacy-to-tech-platform-createiq-ahead-of-internal-startup-nakhoda-31752835

[21] Charles A. O’Reilly and Andrew J.M. Binns, The Three Stages of Disruptive Innovation: Idea Generation, Incubation and Scaling, California Management Review (2019), Vol. 61(3) 49-71 at page 58

[22] Ibid, pages 58-62

[23] See for example Clifford Chance’s Applied Solutions Ltd (https://legaltechnology.com/2021/05/17/clifford-chance-launches-centralised-rd-hub-as-applied-solutions-becomes-sales-arm/) Linklaters’ CreateiQ (https://www.globallegalpost.com/news/linklaters-assigns-brand-primacy-to-tech-platform-createiq-ahead-of-internal-startup-nakhoda-31752835) and ADVANT Beiten’s BB-Go (https://www.bb-go.de)

[24] Charles A. O’Reilly and Michael L. Tushman Organisational Ambidexterity in Action: How Managers Explore and Exploit 2011 California Management Review Vol. 53(4) 5-22 at page 10

[25]  https://www.mishcon.com/news/mishcon-to-tech-enthusiasts-spend-20-of-your-billable-hours-on-innovation

[26] Charles A. O’Reilly and Andrew J.M. Binns, The Three Stages of Disruptive Innovation: Idea Generation, Incubation and Scaling California Management Review (2019), Vol. 61(3) 49-71 at page 69