What Would an Efficient Market for Law Schools Look Like?

[by Rick Bales] As the U.S.’s 200-odd ABA-accredited law schools endure a sixth year of admissions and enrollment pain, their response to the market downturn has not been what one would expect in an efficient market. In an efficient market, one would expect to see some combination of the following from oversupply, weak demand, and a plethora of suppliers:

• Innovation and Differentiation. Considerable market differentiation should result as schools try to find a niche in which they can command a premium price, because chasing a declining demand is, in the long term, a losing proposition. However, except for some tinkering at the LL.M. and Master’s-level margins, law schools still look remarkably the same.
• Budget Cuts. Most affected law schools have cut their budgets, but not necessarily in ways that efficient markets would predict. Companies experiencing a sustained downturn in demand tend to make the first cuts to high-cost areas that are unlikely to affect future survival. In higher education, personnel costs are the biggest expense, but instead of focusing on efficiency or cutting across the board, most law schools have cut staff first, then non-tenure-track faculty, then tenure-track-but-not-yet-tenured faculty. Staff cuts (especially to admissions, placement, and academic support) and the elimination of junior faculty through hiring freezes and layoffs may have been politically palatable, but amount to eating the seed corn.
• Closures and Consolidation. An industry with 200+ market participants experiencing a 50% sustained decline in demand should expect some – probably many – of the weakest firms to close, but that hasn’t happened with law schools. Likewise, one would expect industry consolidation, as the strongest schools jostle for market share and the middling schools seek efficiency through growth. Again, that hasn’t happened.
• Realignment of Supply with Demand. In a world where Blackberry has gone from market leader to obsolescence in a few years, six years is more than enough time for law schools to have adjusted to the new normal. Instead, many if not most schools are still operating at half capacity and a significant financial loss, and are nominally charging (but also discounting) twice the tuition that the market is willing to pay.

What gives?

• ABA accreditation requirements and faculty tenure impede internal restructuring. ABA accreditation requirements and the importance of reputation in a conservative industry make law schools loath to be the first mover on any sort of innovation outside the norm, such as online education. At many schools, tenured faculty cannot be laid off for economic reasons without declaring a university-wide fiscal emergency; making such a declaration would be a self-fulfilling prophecy. Firing underperforming faculty is culturally taboo and internally painful. 
• Financial insulation from market discipline. Existing student loan programs help ensure that there is always some prospective student – even if an unqualified one – available to fill a law school seat. Endowments and university subsidies allow financially bleeding schools to stay on life support much longer than they would if they had to be consistently self-supporting.
• University leadership is overcautious and rewarded for programmatic growth rather than sound business decisions. A faculty member once remarked to me that he belonged to the only institution in the world more resistant to change than North Korea – American higher education. University leadership is exceptionally risk-averse. Unlike the private sector, no university leader every got fired for being too cautious, and it is exceptionally rare for a university to close for being too slow to adapt to market changes. Moreover, university presidents are reputationally rewarded for growth (in enrollment, programs, budget), not for strategic realignment. Most presidents are accustomed to having some programs subsidize others, and would consider it a huge black eye for a law school to close on their watch. Finally, the prestige of having a law school may prevent some closures, but presumably at some point the price tag becomes too high.

So what is the take-away? In part, this helps explain why law schools have not closed/merged/differentiated as one might expect given the sustained down-market for legal education. More importantly, it indicates that there are significant rewards yet to be distributed to the market players who recognize and are able to capitalize on existing market inefficiencies.

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