Mergers 101

If you read only one article this quarter about mergers, this should be it.  Not only is the author the former managing partner of Andersen Legal (until it imploded), before that he was managing partner of Clifford Chance.  Sure, he comes from a UK-centric perspective, but economic laws know no borders, and the once-removed context helps abstract from micro-reactions one might otherwise have along the lines of, "He thinks such-and-such a firm ought to merge, but I know them  better than that."

A theme you may have picked up on—if you haven't picked up on it, I need to work harder here—is that I believe that, for richer or poorer, merger activity is on the increase.  The jury is still out, at least in my mind, on the "richer or poorer" angle, but the trend is clear.   Let's take a quick tour of the obstacles to, and then the incentives for, mergers.

Obstacles:

• In law-firm land, there are no economies of scale.  Altman-Weil certainly seems to believe this:

• Client conflicts and client demand:  These are two sides of the same coin.  Conflicts are obviously believed to militate against large scale, although I've argued elsewhere that the common wisdom about conflicts is deeply confused, indeed incoherent.  Client demand, on the other hand, is a genuine issue:  To the extent that F1000 GC's hire individual lawyers with whom they have relationships, the size and scope of the firm behind that individual is not a compelling driver.
• Partnership agreements:  Essentially all partnership agreements have super-majority requirements for approving such hugely material changes as a merger; depending on the super-ness of the majority required, a relative handful of status quo'ers could block a merger.
• Short-term earnings dilution: The immediate post-merger period (for at least a couple of years, depending primarily on lease obligations) will be expensive as redundancies in office space need to be ironed out and technology needs to be integrated.  Since firms will almost surely expense these costs as incurred (as they should!), profits-per-partner may take a short-term hit.
• Profitability disparities:  As hard as it is to achieve equilibrium in a partnership across offices and across differential partner performance, the difficulty is squared when another firm with disparate earnings patterns needs to be folded in.
• Cultural issues:  As much alike as firms may appear to the unaided eye, I guarantee that every one believes its culture is "unique" and valuable and therefore a proper subject for historic preservation.   And post-merger, whatever else the culture may be, it will be different.

Why, then, would any firms ever merge?

• To paraphrase Dr. Johnson, the imminence of one's demise concentrates the mind wonderfully.  (The verbatim quote is: "Depend upon it, sir, when a man knows he is to be hanged in a fortnight, it concentrates his mind wonderfully.")  In other words, if market conditions are becoming such that your firm's survival in its current form is untenable in the medium to long run, drastic measures may be adopted.
• Most at risk are medium-sized firms without a clearly distinctive service offering:  These are firms that my wife, the marketing executive, would say lack a "unique selling proposition"—a benefit to their clients that is (a) distinctive; (b) credible; and (c) ownable.
• Finally, there is the importance of the market for lateral's, both individuals and practice groups.  Firms perceived as lacking a critical mass will not be attractive to laterals and, adding insult to injury, desirable partners will be all the more tempted themselves to leave.

Adam Smith would have been among the first to observe that no firm has a pre-ordained right to survive.  Indeed, according to our data from the Law Firm Research Project, no fewer than 54 firms out of the AmLaw 200 in 1999 are no longer in the AmLaw 200 as of 2004 in the same form—a 27% change in just five years.  What happened to them?  Basically, they were acquired, they merged into a different form, they dissolved, or they simply dropped off the AmLaw 200.   This can happen to you.