INNOVATION IN THE PROFESSIONAL SERVICES SECTOR€¦ · Innovation in the Professional Services...

Authors: Chay Brooks, Tim Vorley, Cristian Gherhes and Joel Capener

INNOVATION IN THE PROFESSIONAL SERVICES SECTORAn ESRC/NPIF funded study undertaken by Sheffield University Management School in conjunction with BPS Birmingham

FUNDED BY:

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ABOUT USThe Centre for Regional Economic and Enterprise Development (CREED) at Sheffield University Management School has a long-standing reputation for high quality, high impact research in the fields of innovation, entrepreneurship enterprise economic development. CREED is actively involved in a number of national and international research projects developing new insights that seek to advance research, policy and practice.

[email protected] TWITTER @CREED_Research

BPS Birmingham is the membership organisation that connects, promotes and represents the BPS sectors in the Greater Birmingham region. As the voice for the sector, BPS Birmingham addresses issues that affect the growth and economic success of the BPS sector in Greater Birmingham as well as the supporting the development of the city’s business professionals.

[email protected] TWITTER @BHAM_LEADERS

ACKNOWLEDGEMENTSWe are grateful to all of the professional services firms who generously granted us access and provided their time to contribute to the scoping study. This work was jointly supported by the Economic and Social Research Council funding through the National Productivity Infrastructure Fund and the Productivity Insights Network.

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Innovation in the Professional Services Sector

Foreword p3

Executive summary p5

PART I p7Context of the Industrial Strategy p8

Professional Services in Focus p9

PART II p11External Influences and Innovation p12

Data and Innovation p14

Firm Structure, Organisational Culture and Innovation p16

The Nature and Impact of Innovation p18

The Adoption and Diffusion of Innovation p20

PART III p23Conclusion p24

Recommendations & reflections p27

CONTENTS

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As we move towards a post-Brexit Britain it is imperative that the business and professional services sector continues to drive growth, providing high quality services regionally, nationally and internationally. Given that services account for 80% of the economy, it is right that they increasingly form the focus of research and policy, particularly in the context of both national and local industrial strategy. More than ever, the sector needs to think beyond business as usual and challenge the status quo if its leading position is to be maintained.

BPS Birmingham is a not for profit membership organisation supporting the interests of business and professional services firms based in Birmingham. Our motivation in partnering with Sheffield University Management School in undertaking this research funded by the Economic and Social Research Council is driven by the opportunities and challenges we recognise to be facing the sector both in Birmingham and across the UK. Increasing productivity is a key question facing leaders in the sector and innovation – particularly the role of technology – is only part of the answer.

The term ‘innovation’ does not figure highly in the vocabulary of many business and professional services firms unless linked directly to client need, but equally we recognise that it should not be missing. If the UK is to remain a leading international hub for the sector – and with regional cities a key part of that offering - we need our businesses to be forward thinking and open to the opportunities that innovation presents.

This is not a sector which has traditionally benefitted from government support. In recognising the strategic importance of the sector and its future growth, the Industrial Strategy provides an opportunity for firms to get ahead. Through the Industrial Strategy Challenge Fund our members, and the sector more widely, will benefit from additional support to explore and develop innovative business models to deliver future growth in a transformed UK economy.

Hilary Smyth-Allen

Executive Director

BPS Birmingham

FOREWORD

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In the UK, services represent almost 80% of the economy, of which financial and professional services account for £190bn of UK GVA and provide c.2.2 million jobs with a GVA per worker £25k above that of the average worker. Despite this apparent strength, the sector is not renowned as being highly innovative, or technologically leading. A central challenge set out in the Industrial Strategy is to ensure that the next generation of professional services firms in the UK remains a world leader in the delivery of high-value data-driven services.

In order to sustain its position, there is a need for the professional services sector to embrace innovation as a means to create value, increase competitiveness, and improve productivity. The scoping study focuses on the accountancy and legal sectors as a subset of the business and professional services sector, reporting the findings based on 34 interviews conducted with senior partners and/or innovation officers from a range of mid-market and large firms in the UK. The report highlights 5 key areas across the interviews that are shaping the adoption of innovative technologies and work practices in the accountancy and legal firms, they are:

1. That external factors were found to have a significant influence on the attitudes of firms towards innovation, and in many instances the incentives to innovate were client-led or to ensure regulatory compliance.

2. The power of data should not be overlooked, and this is likely to become more significant as a source of future competitive advantage and as a driver for innovation.

3. The dominant firm structures and organisational cultures of accountancy and legal firms were found to represent barriers to the adoption and diffusion of innovation.

4. The nature of innovation will have different impacts on the sector with some innovations enhancing the offer while other innovations threaten to cannibalise the core business.

5. Cost, capacity and risk were consistently identified as barriers to the adoption and diffusion of technological and organisational innovation.

If the UK is to sustain its position as a global leader in the professional services sector, firms need to become more open and receptive to the adoption and diffusion of innovation. Many legal and accounting firms have established business models, with innovations typically incremental and slow to be adopted. Whilst artificial intelligence and machine learning are only in their infancy, their potentially transformative power can be seen already such as in the rise of blockchain, augmented data discovery and quantum computing which are all firmly on the horizon.

EXECUTIVE SUMMARYThe Industrial Strategy published in November 2017 set out the framework for how the Government planned to shape future growth and deliver a stronger economy. However, more than an Industrial Strategy, the white paper was as much an innovation strategy and productivity strategy. In presenting a more proactive approach to government that seeks to actively back business, the Industrial Strategy emphasises the need to build on the UK’s strengths in key sectors.

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Part I

INTRODUCTION & APPROACH

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CONTEXT OF THE INDUSTRIAL STRATEGYThe Industrial Strategy White paper, published by the UK Government in November 2017, identifies the key challenges facing the UK’s economy but also the strengths on which a ‘future proof’ Britain can be built. The Industrial Strategy is underpinned by five pillars or foundations of productivity, namely; Ideas, People, Infrastructure, Business environment and Places. Each pillar is associated with a set of ambitions, targets and investment commitments to support their achievement. The document highlights productivity as a cross-cutting issue across all the dimensions of the Industrial Strategy. Productivity is one of the key challenges that the UK’s economy is currently facing, as productivity growth has been largely stagnant since the 2008 financial crisis.

In addition to the five pillars, the Industrial Strategy sets out four Grand Challenges that the UK’s economy will need to address over the coming years. These are a series of thematic areas to be delivered through the Industrial Strategy Challenge Fund (ISCF) as shown in Box 1. The aim of the ISCF is to enable researchers and businesses to work together to develop and implement new products, processes and services thereby creating value with a view to grow the UK economy. In this sense, the Industrial Strategy aims to stimulate productivity and growth.

ARTIFICIAL INTELLIGENCE AND DATA ECONOMYAudience of the future / Next generation services (pioneer) / Quantum technology

AGEING SOCIETYMedicines

manufacturing

Data to early diagnosis and precision medicine

Healthy ageing

FUTURE OF MOBILITYFaraday battery challenge

Extreme roboticsNational satellite test

facilityDriverless cars

Next Gen (aero) materials mfg

CLEAN GROWTHEnergy revolution

Transforming construction

Transforming food production

BOX 1: GRAND CHALLENGES AND INDUSTRIAL STRATEGY CHALLENGE FUND PRIORITIES (ADAPTED FROM INDUSTRIAL STRATEGY)

Innovation, and specifically technological change, is regarded as one of the key challenges facing the future competitiveness of the UK. While the UK has pioneered ground breaking research and innovation, it has been less effective in the commercial exploitation of these technologies as they have matured. The ISCF aims to accelerate the translation of research and innovation to close the gap between concept and commercialisation, with a view to overcome major industrial and societal challenges. Of the four Grand Challenges, the Industrial Strategy identifies artificial intelligence (AI) and the data economy as key areas for future growth, with innovations reaching across different industries, technologies and places.

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PROFESSIONAL SERVICES IN FOCUSBusiness and professional services have been identified as a priority sector under the ISCF. It is estimated that services account for almost 80% of the GDP, yet the advent of new technologies enabled by AI and machine learning are regarded to represent significant disruption. With firms in the services sector facing increased international competition and pressure to innovate, it is critical that the UK pioneers technological change in the form of AI to create new value and drive the data economy. As a part of the ISCF theme on next generation services the focus is on legal, accounting, and insurance firms where there are identifiable and significant opportunities to leverage new technologies with a view to raising productivity and stimulating growth.

This report is the output of a scoping study which has focused on the current state of innovation in legal, and accounting firms, and was undertaken to understand the potential of AI and technological change as well as the challenges they pose. In keeping with the emphasis of the ISCF, this report focuses on scoping the ‘business-led challenges’ that the sector faces. The remainder of the report begins by outlining the approach of the study and then situates this in the literature before presenting the findings of the consultations with legal and accountancy firms. The report seeks to highlight the key areas of opportunity and risk for the services sector and the challenges surrounding technology adoption and technological change.

There is recognition across the sectors about the need to engage with the questions of technological innovation, particularly in terms of document assembly, automation, AI and machine learning. All of these areas are expected to have a disruptive effect on the prevailing business models of legal and accountancy firms, but equally can be seen to offer new opportunities for productivity and growth. Technologies have tended to be under-utilised in both sectors, and so there is considerable scope for transformational change. Inevitably, in many mid to large size firms, the introduction of technology is likely to reduce the need for human labour in certain areas, especially volume and transactional work, and change the shape and organisation of firms – a point that we return to in the conclusion.

In order to gain a detailed perspective on innovation in-depth semi-structured interviews were conducted with senior partners and/or innovation officers from 34 legal and accountancy firms of different sizes – as shown in Table 1. The interviews focused on the opportunities and challenges of innovation development, adoption and diffusion, and covered both internal firm-based issues as well as the external market and policy environments. The firms interviewed as part of this research were selected from legal and accountancy firms in London, Birmingham, Sheffield, Leeds and Manchester. The firms were all mid-tier and large businesses operating nationally, with the majority also having international clients. The remainder of the report sets out the key findings from the interviews, as well as reflections for the sector moving forward.

TABLE 1: FIRMS INTERVIEWED BY SIZE AND SECTOR

FIRM SIZESECTOR

Accounting Legal Services

50 - 249 employees 4 4250-999 employees 5 41000 + employees 5 12

The Industrial Strategy Challenge Fund aims to consolidate the position of the UK as a leader by developing and adopting innovation in next generation professional services sector.

Legal and accountancy firms are not renowned as particularly innovative, so there is considerable scope for transformational change.

Part 2

FINDINGS & DISCUSSION

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There are five key areas that emerge from the findings of the study. First, how external factors have a significant influence on the attitudes of firms towards innovation. Second, the power of data as a source of competitive advantage and a driver of innovation. Third, how firm structures and organisational culture affect the adoption and diffusion of innovation. Fourth, how the nature of innovation has differential impacts on the sector. Fifth, and finally, how cost, capacity and risk were consistently identified as barriers to the adoption and diffusion of technological and organisational innovation.

EXTERNAL INFLUENCES & INNOVATIONInnovation is typically associated by firms with research and development (R&D), and this is inherently centred on the market-facing offering as the focus through the creation of new or better products or services.1 However, while innovating the offering is essential for remaining competitive, this represents just one of the several dimensions that comprise the business model of a firm.

The business model identifies sources of revenue, the intended customer base, products, and details of financing, which companies employ to create, deliver and capture value.2 These different dimensions can be grouped into front-end components (i.e. key resources, activities, partners, and cost structure) and back-end components (i.e. value proposition, customer segments, channels, customer relationship, and revenue structure).3 By integrating these into a unique configuration, the business model represents a key source of value creation and can help create a unique competitive advantage. Therefore, operating under a viable and competitive business model is essential to organisational success.4

For BPS firms, technology in general, and new technologies such as AI and machine learning in particular, provide major opportunities for innovation in terms of their offering and beyond. However, the majority of interviewees agreed that, while technology has become more prevalent as part of their operations, it is still not leveraged to its full extent to create greater efficiency and enhance service delivery. As such, services continue to be delivered in a largely traditional manner rather than the use and adoption of new technology being intrinsic to the activities of BPS firms. This means that there are still significant efficiencies to be created by adopting new technologies, especially in high-volume areas and lower-level tasks, such as document review in the legal sector, for example, where automation is expected to bring disruption.

A key aspect highlighted by legal sector interviewees is that there is little pressure to challenge the status quo, which is reflected in the slowness of the sector to adapt, innovate and adopt new technologies. Many interviewees described the sector as being characterised by an innate conservatism and risk aversion, which makes firms reactive to market changes and shifts in client needs rather than proactive in anticipating change and leading on innovation. Firms in the legal sector tend to adopt technology when there is no other option.

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In the mass market the use

of technology is likely to be different

from high-end services, but there

is opportunity to innovate across the

sector.

Professional services firms are generally slow to adopt new

ways of working and that needs to

change.

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In this sense, innovation in the legal sector is primarily and predominantly client-led as opposed to being driven internally by the firms. Those interviewed highlighted a ‘client push’ for innovation and new technology adoption to enhance service delivery and to cut costs. This, in turn, exerts significant pressure on profitability, emphasising the need to become more efficient and agile. For example, clients in many sectors are becoming increasingly sophisticated in terms of the technologies they are using and are therefore demanding law firms use similar technologies to meet their needs. A key issue here is that clients are generally unaware of the investment required to innovate or adopt new technologies and are reluctant to pay the same amounts for services enabled by technology, which in turn adds further pressure to revenues.

Where clients also exert pressure and where change is envisaged is the billable hours model. The death of the billable hours model has been predicted for a long time, and clients are now demanding better services at lower costs, as technology can solve problems faster, and are also requesting estimates and fixed fees. As such, it will become increasingly difficult for law firms to justify the billable hours approach to costing, and there was a consensus among interviewees that fees will be under more pressure in the future. Rather than capitalising on technological change to innovate and develop new products, processes or services, innovation in the section is largely client-led.

BPS firms are also seeing pressure from regulators in different areas, which means that innovation also occurs in response to this pressure (i.e. remediation for compliance). This relates to how the government has affected certain compliance procedures, inadvertently promoting innovation in specific areas. Within the legal sector, for example, the areas that were particularly receptive to the adoption of new technologies such as AI were those impacted by new regulations targeting cost reduction and increased access to legal support. These include personal injury and clinical negligence where the government has intervened to control costs, thereby creating the need to increase work efficiency in order to remain profitable and pushing law firms to consider technology adoption. Incoming legislation and regulation is regarded as one of the biggest incentives for many BPS firms to adopt new technologies in specific areas.

However, while the majority of the firms interviewed considered themselves as innovation ‘followers’, the slowness to adapt to changes in the external environment poses important questions with regard to the agility of BPS firms and, critically, that of their business models. The legal sector is already seeing competitive pressure from a new ‘breed’ of law firms which are more agile and innovative and aim to capitalise on the disruptive potential of legal technology. The new entrants are challenging established BPS firms who need to remain agile in responding to market changes and changing customer needs. A key aspect is that their competitive advantage stems, in part, from their alternative and innovative business models. The interviewees highlighted the emergence of new business models such as subscription and crowdsourcing which challenge the established traditional models.

It is here where taking innovation a step further, beyond the offering, is critical for BPS firms. While new technologies such as AI and machine learning primarily enable product, process or service innovation, focusing innovation efforts solely on the offering provides a “highly truncated view of innovation”.5 Business model innovation is different from technological and product innovation as it requires a different approach and generates different competitive effects.6 Specifically, it entails “the search for new logics of the firm”7, which redefines how value is created, captured and delivered. Put simply, business model innovation involves making simultaneous, coordinated, and internally consistent changes to multiple aspects of the business model to reignite growth, combat disruptions, or access new markets.

There is a need for clearer regulation around the use of emerging technologies.

In the mass market the use of technology is likely to be different from high-end services, but there is opportunity to innovate across the sector.

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As such, business models can be valuable strategic tools8 and key sources of innovation and competitive advantage.9 Critically, by providing a dynamic and market-based approach to innovation that requires an in-depth understanding of the external environment, business model innovation facilitates a new way of thinking that promotes greater responsiveness and adaptation. Through such a demand side-driven approach to innovation, companies can ‘bring the outside in’ to become more agile and proactive. This is particularly important for BPS firms which need to respond quickly to technological advancements which are expected to bring disruption and to prompt significant transformation, both at the organisational and industry levels.

A continued slowness of the sector to react and adapt to technological change will open up the market to innovation that will not necessarily originate in the legal services, and there is a risk that lawyers will be cut out. In the face of such challenges, and to support the development of next generation services in the UK, it is critical that BPS firms are able to adapt and experiment with new business models that address and capitalise on the changes brought by new technologies, are better fitted to new market trends, and are better suited to meet ever-changing customer needs.

Addressing the challenges of client-led and regulation-pushed innovation and the increasing competitive pressure from new entrants, leadership and strategic vision, will be essential to driving technological change and enabling services firms to lead on innovation. However, aspects related to the structure of firms and the prevailing culture can create bottlenecks and constrain innovation and technology adoption.

DATA & INNOVATIONWith new technologies such as AI and machine learning being ‘data hungry’, adopting new technologies requires BPS firms to rethink their business models to enable better capture and use of data. The interviewees reported that law firms, for example, have access to a wealth of client data which could be leveraged for greater insight into client needs and industry trends, especially for innovation and growth. This can help to facilitate innovation beyond new products or services, in areas such as customer experience and revenue models. However, while data is expected to only become more valuable, there are a number of issues and aspects that restrict the ability of firms to capitalise on and extract value form their data. These, in turn, create additional challenges to technology adoption and the development of next generation services.

A major issue associated with this and highlighted by the interviewees is data security, which is considered to be hugely important especially as BPS firms are increasingly reliant on their IT systems for business. Ever-present threats such as ransomware attacks require firms to constantly adopt measures to mitigate the risk of data breaches. The risk is augmented by the fact that law firms, particularly, hold sensitive and confidential information about their clients. With trust being a critical aspect of the client relationship, data breaches can result in significant reputational damage.

I think one of the biggest bottlenecks is the reluctance of

law firms to truly go digital.

We need to work harder to understand

and leverage the value of data for our

clients.

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Moreover, data breaches can attract significant fines and penalties from regulators, and hence can be costly as well as hugely damaging to a firm’s reputation. General Data Protection Regulation (GDPR), for example, which comes into force on 25 May 2018, is expected to significantly restrict the ability of firms to extract value from their data. Indeed, the interviewees emphasised the extra caution that needs to be exercised around client data due to more stringent regulation and legislation. The risks surrounding data protection can thus create barriers to the adoption of specific technologies. For example, there is a reluctance among firms to use the cloud for storing information on their clients, which impedes the adoption of new technologies.

Professional bodies, such as the Solicitors Regulation Authority (SRA), and Anti-Money Laundering regulation and requirements such as Know Your Customer (KYC), can further hinder technology adoption and restrict the ability of BPS firms to capitalise on the potential of data. For firms with an international presence, there is also the issue of cross-jurisdictional compliance. As such, complying with different data protection laws in different countries is seen as an additional challenge by these firms.

With data security seen as the biggest single risk with new technology, data protection is now considered a management responsibility. As a result, new roles, such as Chief Information Security Officer (CISO) and Data Protection Officer, have emerged within the C-suite of law firms, reflecting the increasing importance of data security for the future of business in the legal sector. With data breaches expected to become the new PPI claims, it is essential for firms that their data protection measures keep up with their increased use and reliance on data.

However, while complying with existing and incoming legislation and regulation around data protection and security can be onerous, there is value in doing so. More specifically, BPS firms can derive competitive advantage by going beyond what is legally required and communicating this to existing and potential clients. For example, by adopting a more proactive approach, BPS firms can use different accreditations as a differentiator from competitors, essentially transforming compliance requirements into a source of competitive advantage.

Apart from concerns surrounding data protection, there are a number of issues around both technical and human related aspects of data. With regard to the technical side, the quality of the data that is inputted into the machines is a key aspect, as data may often be unstructured, and thus require sorting, or inaccurate, which will impact the quality of the output, and hence require cleansing. As such, getting the data ready for interrogation and analysis can be significantly more time consuming than the actual analysis. Errors and glitches are also problematic, especially in volume-driven operations as, if undetected, these can expose firms to negligence risks.

Additionally, as more technologies become available and are adopted, a key challenge in the future will be to connect and integrate different pieces of software into platforms in order to enable communication between the different practice areas and to make data more easily accessible. Achieving interoperability between systems will be a prerequisite if firms are to harness the full potential of new technologies.

We are not, and do not want to be a technology firm, but we recognise the need to embrace technology more.

Data security is a big issue and something that makes the adoption of untested technologies more of a risk.

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Regarding human related aspects, many firms will need to overcome the mentality that leveraging data is outside the scope and focus of their activities. Moreover, developing data-related skills within organisations will be critical. The ability of firms to leverage data for innovation and growth will depend on the capabilities of a diverse workforce to understand the technology and its outputs. While new roles such as data scientists are expected to become more prevalent and essential for leveraging the best value out of data and new technologies, firms will also need people with different skills who can work with the technology rather than just understand its technical side. As such, BPS firms expect an increasing demand for crossover skills between providing a service to clients and understanding the software well enough to be able to work with it. These aspects represent a wider challenge and have important implications for education, career paths and future talent pipelines. They also highlight the importance of bringing Further Education and Higher Education providers and the industry together to enable communication and the exchange of ideas around future talent needs.

FIRM STRUCTURE, ORGANISATIONAL CULTURE & INNOVATION The dominant business structure across accounting and legal firms is that of the Limited Liability Partnership (LLP), although there are a small number of Public Limited Companies (PLC) starting to emerge within the legal sector. The nature of business structure was identified as a challenge to the pursuit of innovation as there is little incentive for partners to deliver beyond internally agreed and industry wide growth and profitability targets.

In addition, there is also some resistance to change within the sector, generated in part by what many interviewees highlighted as a “it won’t apply to me” mentality. However, remaining complacent and dismissing the disruptive potential of new technologies and alternative business models will increasingly threaten the viability of firms in the next generation services sector. A key issue in this respect relates to the time horizons of the firm. As emphasised by a number of interviewees, when it comes to the horizons of the business and those of the partners, in many situations it is difficult to differentiate between the two especially as the firm’s strategy is contingent on the interests of partners.

Despite significant changes being expected in the next 10-20 years, particularly in relation to technology, strategy tends to be focused on the short-term. Those who are closer to retirement are less incentivised to address long-term issues, which can impact on firms’ strategy and readiness to tackle the challenges around technology adoption. Considering the fact that this is a sector with a large retiring population over the next 5-10 years which has also seen a lack of recruitment during the financial crisis, the shortage of middle management and future leaders is a key issue that can stymie progress in relation to innovation, technology adoption and adaptation of current business models.

When all the partners have a say it makes

it difficult to be innovative and can create bottlenecks

When firms function as a partnership rather than as a

company they don’t have the checks and balances that exist in

other companies.

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Nevertheless, developing a strategic vision, fostering an organisational culture that is open to change and incorporating a long-term focus into strategy are essential given the magnitude of the challenges facing BPS firms. In this sense, there is an internal push for transformation from innovation teams and committees. Where these exist, which tends to be in larger firms rather than in mid-market and smaller firms, which often face capacity constraints, they are seen as vehicles for change. Innovation teams can push the agenda on technology adoption, help identify areas of opportunity and risk through engagement with clients and employees and thereby promote a bottom-up approach to strategy which incorporates both internal and external perspectives. This aspect is critical to driving innovation beyond the product or service, across the different dimensions of their business models.

However, innovation teams are still reliant on buy-in at the partner level, which stresses the importance of developing entrepreneurial leaders in order to foster the development of ‘future proof’ strategic visions. An entrepreneurial mindset is essential to identify and actively seek out new opportunities, and is associated with the ability to sense, act and mobilize under uncertain conditions.10 In this respect, younger partners are increasingly expected to tackle the challenges surrounding technology adoption and to play a central role in shaping long-term strategy. Developing future leaders who have the capacity to think more entrepreneurially will be essential to driving organisational change as well as to promoting cultural change within organisations.

Apart from cultural aspects, there are significant changes expected to the actual structure and profit model of both legal and accountancy firms. Interviewees from the legal sector, for example, highlighted that the current structure, where each partner has a large cohort of junior lawyers behind, is becoming unsustainable, with little thought given to this matter. As such, rather than operating as a pyramid, with partners at the top and with junior lawyers doing the majority of work, law firms are expected to become more linear, which will challenge the current economic model. In accounting, technological advances and the availability of book keeping software has reduced the compliance burden upon firms, allowing the semi-automated preparation of accounts. This has reduced the number of firms acting as book keepers, pushing accounting firms towards higher value areas and advisory-centered business models.

These aspects have important implications for the business models of BPS firms as not only will they have to become more efficient and rethink or restructure their revenue streams but changing the roles of people within organisations will be essential. In particular, a bottom-up approach to strategy will require people spending more time on generating new ideas internally, as opposed to spending all of their time on fee generating activities. This goes back to the importance of developing entrepreneurial mindsets at senior levels, as this has a positive impact on developing entrepreneurial organisational cultures which encourage ideas and creativity, embrace risk-taking, tolerate failure and promote learning.11 The ability of BPS firms to think entrepreneurially, redeploy their resources and better align their skills and capabilities with new revenue models is an imperative.

Technology will change jobs and careers in the profession, and we need to manage that not just let it happen.

We are trying to foster a culture that is more open to innovation and technology to make the business better.

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Finally, education and training are expected to be essential in overcoming the current challenges, especially as, in many cases, cultural resistance is fueled by a fear of change coupled with a lack of trust and misunderstandings surrounding new technologies such as AI. The fear that innovations will reduce or even replace the work undertaken by legal professionals and accountants creates resistance to change and promotes conservatism within the two sectors. For example, by reducing the need for book keeping services, technological developments in accounting have impacted employment in this area negatively, with further redundancies expected in the future. Here, education and training can play a key role in conveying the benefits of new technologies, such as AI and machine learning, to professionals. Indeed, interviewees emphasised that the willingness to adopt new technologies will be greater if professionals understand its benefits and potential to significantly augment rather than replace their work. However, the challenge will be to enable communication between lawyers wanting to give legal advice and those promoting technological innovation, and to support professionals to understand and work with new technologies.

THE NATURE AND IMPACT OF INNOVATIONThe type and role of innovation may radically affect next generation services firms with regard to the nature of technological development and whether innovations may be considered to be enabling of cannibalising.

• A cannibalising technology is a technology that ultimately enables customers to carry out work for themselves and not employ the firm

• An enabling technology conversely is a technology that allows firms to improve upon their offering without cutting into their core business.

The findings highlight a number of concerns by stakeholders about developments in advanced technologies such as AI in combination with market forces in an increasing adoption of cannibalising technologies. These findings therefore have important implications for the future growth of next generation services firms.

It is broadly accepted and demonstrable that innovation of all types is ultimately beneficial for the creating or adopting firm. Innovations are not created equal in terms of their contribution to a firm’s development of a sustained competitive advantage due to the differing types of innovation which exist. Incremental and adoptive innovations (i.e. a firm incrementally improving a service, product or process or adopting an innovation developed elsewhere), while often conferring benefits to firms, are considered to be ultimately less effective and impactful than other types of innovation.12 Alternatively, firms adopting what have been termed “radical” and “frontier” innovations (i.e. innovations that are both new to the market as well as involving the utilisation of a high degree of new knowledge in their creation), provide significantly greater economic benefits than other innovation types.13 As such, the implementation of radical innovations, such as AI, can provide a significant economic opportunity for adopting firms.

Artificial intelligence and machine learning are both comparatively new areas of innovation and the potential of these are yet to be fully realised. Despite this, AI is gaining increasing traction within industry and it has gained acceptance in a number of other areas of business.14 AI and machine learning have been around in a primitive form for several decades within the manufacturing sector such as in the automation of the construction of physical goods. In this and a select number of other industries, AI and machine learning has been used and adopted with great effect.

The future of our professions depend

on highly skilled people who also

understand the value of technology.

Lots of firms are not innovation ready,

and even firms with the technology are

not using it company wide.

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Within the legal sector, AI is increasingly believed to have a significant impact upon the efficiency of this industry through the automation of routine tasks, with a study by Deloitte predicting that AI will allow for the automation of 114,000 jobs within the legal industry, particularly roles formerly undertaken by paralegals.15 While only a prediction, in practice, the law industry already uses AI in a number of areas, such as e-discovery tools and virtual assistants, with an estimated 31,000 jobs being supplanted by new technology. 16 However, this is a question as to whether such technologies are enabling or cannibalising, as while there may be increased efficiencies within the industry, it has also served to reduce employment, as well as potentially cannibalising the profitability of such firms, given the prevalence of the billable hour model. Regardless of whether such examples are enabling or cannibalising, this and other examples do demonstrate that the legal sector is not only beginning to explore the use of such technologies, but in some areas is also actively benefiting from them, given increased efficiency and reduced staffing costs.17

Technologies such as case management systems and automated account labelling software within the accounting industries have significantly increased productivity, and firms have expressed that there is a willingness amongst accountants and legal professionals to adopt technology if it aids them in their ability to do their jobs. However, the challenge is to balance these new technologies so that they increase productivity while also not taking work away from such firms. Within the accounting sector in particular, firms have cited that the development of book keeping software has cannibalised much of their business, allowing firms to do their own recording of their accounts, reducing the amount of work available to the firm, forcing some firms to exit the market and forcing others to seek value in other areas. As such, they have seen their role move away from historically time consuming and low value work towards a consultative role, allowing them to focus on higher value adding activities.

This evidence demonstrates that increasing productivity does not necessarily increase profitability, and that while firms wish to make use of enabling technologies, they are encouraged, and in some cases coerced by market forces, to adopt technology that may be considered to be cannibalising. This cannibalising/enabling binary also presents broader issues with regards to whether the government should be looking to support technologies that may ultimately cannibalise business and reduce employment within a sector. This is further complicated by the fact that it is not always apparent what the impact of new technologies may be, and whether a technology may cross the boundary from an enabling to a cannibalising one.

While the issue of market cannibalisation is one which is evidently of great concern to firms across business professional support services, this begs the question of whether a degree of cannibalisation is inevitable. Given that the advancements in the capabilities of such technologies will occur, it is likely that this will result in firms being increasingly pressured to adopt cannibalising technologies in order to maintain their long-term position and competitive advantage. Many of the interviewed firms noted that innovation within their firm is a largely client driven process, and as such they feel coerced into adopting innovations based on the client demands and are at a competitive disadvantage if they do not. This in turn results in what may be described as a perceived competitive pressure for firms, as there is a belief that should their competitors adopt such cannibalising technology before them, they will lose business.

You have to be prepared to innovate and change, and while this might seem daunting the alternatives are worse.

In the main innovation has been client-led and as a sector we need to work harder to innovate and drive change.

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These findings have several implications for the NPIF and the support of innovation within the legal and accountancy sectors. They highlight that such advanced technologies, while increasing productivity in different ways may be both enabling and cannibalizing. As such, the type of innovation supported and pursued by the NPIF and commercial partners is important. It demonstrates that while firms may prefer enabling technologies to capitalise on first mover advantage, it may be necessary to support the development of cannibalising technologies in order to maintain the UK’s leading position within these industries. These findings also highlight the conflict which exists between the short-term ambitions for profitability amongst firms and more longer-term market forces. This again supports the previous finding note that within the legal and accountancy sectors, increased productivity does not necessarily always mean increased profitability.

Significant apprehension exists around the increased adoption of AI and the potential cannibalising effects of such technologies. AI is a continuously developing and comparatively new set of technologies and the impacts of their adoption and use are difficult to predict. However, early examples of it have begun to emerge in industry, highlighting how it has served to both cannibalise and enable core business activities. Examining and anticipating these new risks are critical considerations in the targeted support and adoption of new technologies across the business model.

THE ADOPTION AND DIFFUSION OF INNOVATIONThere are several factors which may assist or hinder the adoption of advanced technologies by firms, and by extension assist or hinder the diffusion of such innovations and technologies to industries at large. This is a significant issue given that in order to leverage innovations into the broader market, identifying and overcoming what barriers to diffusion exist is of critical importance. Four main barriers and issues to the adoption and diffusion of next generation services emerged from the interviews. Alongside culture, which is discussed above, these main issues were cost, capacity and risk.

Regarding the issue of risk, it has been long established that innovations of different types do not carry the same levels of risk and reward. Incremental and adoptive innovations do not involve a high level of new knowledge for their adoption due to their effectiveness already being established in the marketplace or in the case of incremental innovations, owing to it being a step change to existing processes.18 Conversely, due to the high degree of new knowledge and overall newness to the marketplace, radical innovations have a high degree of uncertainty associated with them, sometimes referred to as an information asymmetry.19 From a commercial perspective, while providing a significant opportunity, the adoption of radical innovations such as AI also bears a higher degree of risk, ultimately deterring some firms from engaging in such innovation. However, radical innovations do confer significant economic benefits to both firms and by extension the national economy. This is due to the first mover advantage which often results in the development of a sustained competitive advantage to both firms and national economies.

As an early adopter you run the risk of

overcoming teething problems, but it can also mean that you

benefit first from any competitive

advantage.

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With this factor considered, the most often cited barrier to the adoption of such innovations was related to the current cost of technology, and the perception that further developments in AI and machine learning technologies would be a restrictive cost to the firm. This concern partly stems from the fact that most interviewed firms, even within larger legal and accountancy firms, did not develop significant levels of technology in-house, and instead sought to buy software directly from software publishers. Firms noted that this was often due to a lack of expertise, and that they were unwilling to move away from their specialisation as accountancy and legal firms towards more technology orientated ones. Furthermore, several firms noted that due to the specialisation of software companies, they believed that even if they were to bring in expertise, it was unlikely that they would be able to develop technology superior to what was already available. As such, the cost of technology was perceived to be a significant limiter across firms of all sizes and industries, with several participants citing the cost of such technology and software as the second largest expense after wages, one which may be considered the largest barrier that needs to be addressed in aiding the diffusion process amongst firms.

The second most cited barrier was that firms lacked the capacity to incorporate new innovations into their firm, in particular in terms of their ability to spare the time in terms of work hours into researching, developing and implementing new innovations, as well as the expertise required in order to achieve this. Even in cases where firms bought the technology directly, it was noted that firms were unable to spare personnel to research what technology would be appropriate and to incorporate this within their firm, particularly due to the need to retrain staff in the usage of such innovations. Although this issue was one which was most prevalent within smaller firms, this was also experienced by a number of the larger interviewed firms. They explained that the commercial focus of the firm on billable work meant that even in cases where excess capacity was built in, this tended to drift back towards the operational needs of the business.

Despite these barriers however, the findings suggest that there are a number of ways in which these barriers may be reduced, and the likelihood of the adoption of such innovations be increased. Although a range of measures were proposed, including standard grants, firms also made reference to the innovation voucher scheme, suggesting that it may be applied more broadly so that the investment in such technologies and the training of staff in their usage may be covered. This suggests that in order to ensure technology is more likely to be diffused across the network, measures need to be taken in order to ensure such innovations are affordable to the majority of firms.

The firms interviewed suggested that for them to adopt such new innovations they were unwilling to be a “first mover”. They noted several factors which inhibited their adoption and use of new technologies. These included not wishing to be exposed to new and potentially “buggy” technology, not willing to take on the risk associated with purchasing undemonstrated technology, and the overall cultural tendency within the firms to be risk averse. However, the firms suggested that they are not averse to the adoption of new technologies if they are adopted by other firms across the industry and would be motivated by the fear of being left behind in a highly competitive marketplace. As such, firms stated a willingness to be a second or third mover, adopting technology that had been tried and tested by a first mover, particularly if the proven success of such innovation is highly visible. Demonstrating the value of new technology adoption and de-risking innovations through internal organizational support and external policy, will help to encourage its broader adoption.

The legal sector looks at what their competitors are doing quite a lot, and if they see something going on with their competitors and its seen to produce an obvious advantage, that is a motivator to innovate.

A lot of the barriers are perceived, but as a business we still need to get over them.

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Accountancy and legal firms represent a significant subset of the professional services sector that have been frequently overlooked in terms of policy support. The Industrial Strategy has come to recognise the importance of professional services firms to the UK economy as well as the opportunity they represent in terms of wider multiplier effects and export-led growth. As this scoping study has set out, the adoption and diffusion of innovation has been slow to occur in legal and accounting firms, many of whom have retained established and widely-practiced business models.

The advent of innovative technologies, such as AI and machine learning, present a significant opportunity for accountancy and legal firms and the professional services sector more broadly. As well as the potential for increased efficiency and growth, the adoption of technology is likely to have a transformative impact on the nature and organisation of work over the medium to longer term. While acknowledging the generally risk averse nature of professional services firms, the failure to engage with, if not embrace, innovation is likely to undermine the future competitiveness of the sector. While emerging technologies may be viewed as disruptive to the status quo in the short term, such technologies are having profound impacts on business and societal norms.

That said, getting it wrong with respect to the adoption and diffusion of innovative technologies could result in significant financial and reputational costs for all involved. The sector needs to remain open to new technologies and able to adapt to future opportunities and challenges. This does not presume the need for every firm to pioneer innovations, but equally firms must not become laggards in internationally competitive markets or they will risk losing market share.

It is noteworthy that while many of the very largest firms are investing in innovation, a significant tier of mid-market firms are under-investing or not investing at all. Compared to some of their larger counterparts in the sector this poses a relative liability of smallness, that adds to the risk of innovating or not. The Industrial Strategy, therefore, presents a real opportunity to increase the capacity of mid-market firms by providing a catalyst to technology diffusion.

Innovation also needs to be understood as being about more than technology by the professional services sector; it is part of a broader programme of change management. There are opportunities to create value across the business models. Most conventionally this occurs through the creation of new products, processes and services, but there is also scope to think about ways of working and relationships with clients. To do this necessitates thinking beyond business as usual and requires professional services firms to work with technology providers and clients to ensure the future competitiveness of their firm and sector.

Those businesses that are able to embrace this challenge will be key in defining the future of what the Industrial Strategy refers to as ‘next generation service firms’. A central tenet of this is realising the power of data, and how through digitisation it can be protected, curated and leveraged to add value to clients. Further to the development of AI and ML, the rise of blockchain, augmented data discovery and quantum computing, as well as other emerging and enabling technologies, will see further transformation of the sector. Again, the key question for individual firms is making informed choices about what to invest in and when if they are to sustain their competitiveness and deliver future growth.

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Further to the internal activities of professional services firms to innovate, there remains a need for more effective regulation of new and emerging technologies. The professional services sector is recognised as being highly regulated, therefore new and emerging technologies represent a risk to professional services firms. This is not to say that Government needs to impose regulation, but rather work with those firms at the leading edge in the professional services sector to ensure that AI and other technologies are regulated in ways that will ensure that the UK remains a world leading centre for professional services firms.

The backdrop to this report and the Industrial Strategy more generally is the future competitiveness and productivity of the UK economy. It is essential that the professional services sector addresses the innovation challenges that it faces given its size and strategic significance to the UK. Clearly the Industrial Strategy Challenge Fund is an important mechanism to deliver this, but it represents only the tip of the iceberg. Firms across the sector, from the very largest to the very smallest, are set to experience transformational change over the next five years and so the need to be innovation ready, if not innovative, is becoming a key concern for businesses and business leaders.

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RECOMMENDATIONS & REFLECTIONSBased on the evidence drawn from our analysis of accountancy and legal firms there are a number of recommendations that are relevant to businesses in the professional services sector more broadly, they are to:

1. understand that innovation is about more than technology, and better assess where innovation will and will not add value through organisational change and by engaging clients/partners;

2. ensure clear leadership of the innovation agenda at, or reporting to, the highest levels in the firm, while investing in future leaders;

3. assess firm level barriers to adopting and implementing innovations, and prioritise those areas where innovation will add the most value to current and future operations;

4. challenge the status quo by empowering employees to explore how they can embrace innovation to improve service and productivity, as well as increasing the efficiency and profitability of the firm;

5. develop new relationships and ways of working with research and technology partners to respond to new government funding programmes intended to promote innovation.

In addition, there is a scope for the Government and intermediaries in the sector to simulate and support innovation-led growth in the professional services sector by:

1. ensuring clear and appropriate regulation around the use of innovative technologies so as to encourage firms to innovate;

2. incentivising and supporting those professional services firms who are striving to innovate through mechanisms such as the ISCF and other initiatives linked to the Industrial Strategy;

3. working to join up national and local agendas to build capacity across the professional services sector through membership organisations and by bringing businesses together around shared agendas.

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ENDNOTES1 Zott, C. and Amit, R. (2007). Business model design and the performance of entrepreneurial firms. Organization Science, 18 (2) 181-199.

2 Teece, D.J. (2010). Business models, business strategy and innovation. Long Range Planning, 43 (2/3) 172-194.

3 Günzel, F. and Holm, A. (2013). One size does not fit all – understanding the front-end and back-end of business model innovation. International Journal of Innovation Management, 17 (1) 1-34.

4 Zott, C and Amit, R. (2010). Business model design: an activity system perspective. Long Range Planning, 43 (2/3) 216-226.

5 Hamel, G. (2000). The end of progress. Business Strategy Review, 11 (3) 69-78

6 Markides, C. (2006). Disruptive innovation: in need of a better theory. Journal of Production Innovation Management, 23 (1) 19-25.

7 Casadesus-Masanell, R. and Zhu, F. (2013). Business model innovation and competitive imitation: the case of sponsor-based business models. Strategic Management Journal, 34 (4) 464-482

8 Richardson, J. (2008). The business mode: an integrative framework for strategy execution. Strategic Change, 17 (5/6) 133-144.

9 Zott, C., Amit, R. and Massa, L. (2011). The business model: recent developments and future research. Journal of Management, 37 (4) 1019-1042.

10 Haynie, J.M, Shepherd, D., Mosakowski, E. & Earley, P.C. (2010). A situated metacognitive model of the entrepreneurial mindset. Journal of Business Venturing, 25 (2) 217-229; Phipps, S.T. and Prieto, L.C. (2012). Knowledge is power? An inquiry into knowledge management, its effects on individual creativity, and the moderating role of an entrepreneurial mindset. Academy of Strategic Management Journal, 11 (1) 43-58

1 1 Shepherd, D.A., Patzelt, H. & Haynie, J.M. (2010). Entrepreneurial spirals: deviation-amplifying loops of an entrepreneurial mindset and organizational culture. Entrepreneurship Theory & Practice, 34 (1) 59-82

1 2 Sorescu, A. B., Chandy, R. K., & Prabhu, J. C. (2004). Sources and financial consequences of radical innovation: Insights from pharmaceuticals. Journal of Marketing, 67 (4) 82-102.

1 3 Keizer, J. A., & Halman, J. I. (2007). Diagnosing risk in radical innovation projects. Research-Technology Management, 50 (5) 30-36.

1 4 Chan, C. (2017). 5 Industries Being Most Affected By Artificial Intelligence https://www.fowcommunity.com/blog/future-work/5-industries-being-most-affected-artificial-intelligence

15 Croft, J. (2016). More than 100,000 legal roles to become automated https://www.ft.com/content/c8ef3f62-ea9c-11e5-888e-2eadd5fbc4a4 Accessed 20/03/18

16 Ibid

17 Croft, J. (2017). Artificial intelligence closes in on the work of junior lawyers https://www.ft.com/content/f809870c-26a1-11e7-8691-d5f7e0cd0a16 Accessed 20/03/18; Sobowale, J. (2016). How artificial intelligence is transforming the legal profession http://www.abajournal.com/magazine/article/how_artificial_intelligence_is_transforming_the_legal_profession Accessed 20/03/18

18 Koberg, C. S., Detienne, D. R., & Heppard, K. A. (2003). An empirical test of environmental, organizational, and process factors affecting incremental and radical innovation. The Journal of High Technology Management Research, 14 (1) 21-45: Markides, C. (2006). Disruptive innovation: In need of better theory. Journal of Product Innovation Management, 23 (1) 19-25.

18 Aboody, D., & Lev, B. (2000). Information asymmetry, R&D, and insider gains. The Journal of Finance, 55 (6) 2747-2766.

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