A few months ago, I participated in a panel on "Going Global:  What it Takes," with my friends Rees Morrison and Robert Ambrogi. 

The audio recording of the panel is now up.  You're obviously invited to have a listen.

In a new survey of 85 of the 125 largest firms in the UK, four out of five of the managing partners or executive directors responding reported that they had at least engaged in merger discussions in the past two years.  Perhaps more convincing evidence of the durability of the merger wave was that no one predicted 2006 would see less activity than 2005:  All respondents saw M&A among law firms up or at worst flat vs. this past year.

Short of outright  M&A, acquisition of laterals is also going strong.  The biggest deal of the year in the UK was DLA Piper's acquisition of a 45-lawyer media and intellectual property team from Denton Wilde Sapte.  (Not to date myself, but I remember when 45 lawyers was a halfway respectable size for an entire firm.)

"Legal services is a marketplace which is changing quite dramatically at present," said the conductor of the survey.  And maybe you should blame it on the Yanks:  A year ago 50% thought the influence of US firms was largely behind the increased M&A and lateral movement pressure.   This year?  71%.

Update 4-Jan-2006, 2:00pm:

An astute reader points out that it serves me right to believe everything you read in the MSM (my words—not his). 

In fact, I was mistaken to say "The biggest deal of the year in the UK was DLA Piper's acquisition of a 45-lawyer media and intellectual property team from Denton Wilde Sapte."  In fact, DLA picked up 11 partners, 18 lawyers, four trainees and 12 support staff.  A bigger deal was Orrick's taking 9 partners, 31 associates, trainees and legal staff, together with 32 support staff in June of last year.

I would give this very much on-the-ball reader credit, but he declines. 

Now, I for one am waiting to see how long it will be before The Financial Times prints a correction....

At the intersection of strategic decision-making and human shortcoming is behavioral economics, which teaches that a host of biases, such as overoptimism about the likelihood of success, the "principal-agent problem," and undue loss aversion, combine to form "intertwined and harmful patterns of distortion and deception throughout the organization."   At least if you believe McKinsey. 

Actually, I've long been fascinated, if not baffled and perplexed, by why such a dismaying proportion of bet-the-firm strategic decisions pan out in pain and recrimination rather than celebration and triumph.  What I'm about to describe cannot inoculate you or your firm from these problems, but a street-wise "heads-up!" cannot hurt.  Plus, these innate human biases are applicable across the board, including to your daily life. 

Let's begin with the (now) well-established economic/psychological proposition that human beings are irrationally averse to losses, as compared to fond of gains.   What exactly does that mean?  Logically, if you are offered a (free) gamble with a 50/50 chance of winning $1,000 or losing $1,000, you should be preference-neutral on taking it; rationally, you might just flip the $1,000 coin.  But studies consistently show that people won't take the gamble until the upside is $2,000 to $2,500 (the downside remaining -$1,000, of course).

In an organizational setting, this means that "loss aversion" consistently leads people to inaction and undercommitment to opportunities.   If you're a lawyer reading this, your instinct might be, "Well, that's not such a bad thing, is it?  It makes sense to take the cautious and prudent course."

Here's the rub:  The "reference point" from which to judge this gain/loss metric should not necessarily be the status quo.   What makes the status quo sacrosanct?  Put differently, unless your firm is optimal in all possible respects, some change is in order.  Do not conflate "loss aversion" with "risk aversion."   Loss aversion is not just "prudent," it's a survival mechanism.  But risk aversion is what gets one-time titan firms like Digital Equipment Corp. into Chapter 11 and GM into junk-bond status. 

The "principal-agent problem?"  Simple:  The "principal" is your firm, and the "agent" is the partner, C-suite executive, or other critical recommender/advisor.  Now suppose (a McKinsey real-life example) a capital investment has a 50/50 chance of losing its entire $2-million investment or returning $10-million.  5:1 odds sound good, right, and wouldn't you as king approve such an investment, "holding the partner harmless" if it doesn't pan out?

But consider it from the partner's perspective.  What kind of a blot would it be on your reputation to throw away $2-million of the firm's (and your partners') money?  And for how long would you be remembered as a hero if you collected the $10-million return?  Now you want me to recommend the rational choice?  I don't think so....

One more wrench in the gears before we suggest a palliative:  The "champion bias."  This simply refers to the tendency to place excessive weight on an individual's reputation for trustworthiness within the organization.  Now you're really protesting!  If senior management hasn't figured out who to trust, what on earth have they been doing?  Isn't part of the job description to select, groom, and promote trusted advisors?

To be sure, but we're evaluating "trustworthiness" in, by hypothesis, a new context:  Not the day-to-day operational routines at which they presumably excelled and for which they were selected and promoted, but in the context of a large strategic decision where their judgment is not presumptively better or worse than others who have similarly not been called up on to make such judgments.  The  lesson is: 

• Solicit a variety of viewpoints
• Invite dissent and hard questioning
• Do not permit suppression of what people really think

I know; "easier said than done," you're saying.  Well, can we at least say anything systematic about how human biases tend to affect decision-making, the better to be on guard against it?  Behavioral economics says we can.

To oversimplify life, assume there are two kinds of decisions:  The rare, infrequent, but very large decisions (M&A, expansion overseas), and the routine, serial, smaller decisions (hiring a new lateral, incrementally expanding a practice area).  Perhaps counter-intuitively (but actually not, once one thinks about it), the tendency is to be overoptimistic on the rare big bets and overly loss-averse on the little serial decisions.  Why? 

Essentially—and who would really want it otherwise?—people approach matters overestimating their skill.  Ranking themselves, virtually every one puts themself in the top 20% of drivers, honest people, faithful friends, etc.   So even if (as many studies of corporate-land have it), 70-80% of mergers fail to add value, "we'll be different!"  kicks in.  Combine that with the understandable tendency to hope for the best, to suppress dissent once such a transformational decision starts to gather momentum, and finally the lack of experience with such efforts, and overoptimism rules.

Compare that to the small, regular decisions:  Here, firms tend to be oblivious to the fact that these decisions constitute an ongoing stream of investments—a "portfolio," if you will, of projects and undertakings.  Correctly analyzed, a diverse portfolio is devoutly to be desired, and everyone knows that will entail some losers, or at least some counter-cyclicality among its elements.  But the problem is that the firm rarely stands back (that's the Managing Partner's job) and looks at these lateral hires or practice group expansions as a "portfolio."  Instead, the individuals responsible for pulling the trigger on each move evaluate the initiative in isolation, fear possible losses, and expect to be blamed if it fails.  Here we are right back at the "principal-agent problem."

Now what?  Well, lawyers are into nothing if not process, so let me suggest some procedural tools (understanding they are only tools and not cure-alls) to get around these systematic biases.  Here are a few:

• separate the small, serial decisions from individuals and entrust them to a "venture investment committee" with a conscious mandate to construct a diversified portfolio of new initiatives for the firm
• separate the proposal from the proposer, to take politics and personality out of it (or at least to help suppress it); for example, at a senior management retreat, assign people to advocate someone else's strategic recommendation:  Although somewhat artificial, it can turn an ego battle into a more rational debate
• take time to collectively reflect on and analyze past decisions; are there any detectable systemic errors?
• be crystal clear about the purpose of a discussion:  Some are meant to reach the ultimate decision, others are meant to brainstorm about alternatives, still others are meant to help the team coalesce once the decision has been made, and to drive towards the goal.  Having clarity about such things is remarkably simple, and remarkably oft overlooked.

And lastly, have courage and be of good cheer.  These decisions, made over the course of years or even of a career, will do nothing less than mold the firm, but mid-course corrections are allowed, and if you can admit error at the same time you celebrate wins, you should get to come back to bat again and again.

p.s. Yes, this is a long post: But this stuff matters.

Forgive me for an extensive quote, but it sets the stage for all that's to follow here.  From the redoubtable McKinsey:

"In today's developed economies, the significant nuances in employment concern interactions: the searching, monitoring, and coordinating required to manage the exchange of goods and services. Since 1997, extensive McKinsey research on jobs in many industries has revealed that globalization, specialization, and new technologies are making interactions far more pervasive in developed economies. Currently, jobs that involve participating in interactions rather than extracting raw materials or making finished goods account for more than 80 percent of all employment in the United States. And jobs involving the most complex type of interactions—those requiring employees to analyze information, grapple with ambiguity, and solve problems—make up the fastest-growing segment."

Before you say, "I already knew that!," consider the implications.  The Holy Grail of any firm seeking growth and supra-normal profitability is a sustainable competitive advantage. 

Transitory competitive advantages don't count. What is an example of a "transitory" advantage? Say, installing bar-code scanners at the checkout counter; this quickly becomes merely the price of entry.  But what if you could raise the productivity not of your checkout clerks but of your marketing manager?  Now do I have your attention?

As McKinsey characterizes it, lawyers and similar people who deal with ambiguity and exercise judgment are engaging in "tacit, complex interactions" (as opposed to explicit transactional interactions, which can be and are being automated, outsourced, or just plain eliminated [as when the bar-code scanner is integrated with the supply chain so that inventory and reordering can be removed from human hands]).   As the economy focuses more and more on "knowledge workers," then, "as Adam Smith predicted, specialization tends to atomize work and to increase the need to interact."

So the question for sophisticated law firms becomes, can we increase the productivity of our interactions?  Can we, in other words, do for the tacit workers what we've already done for the transactional workers?

The first thing we can say is that it's clear that "This shift toward tacit interactions upends everything we've known about organizations since the days of Alfred Sloan."  Gone is the pyramidal structure with tacit work only at the top; in are tools to help people collaborate more effectively both inside and outside their firms.  Decision support tools can take care of checklists and deadlines, and automatically point the way towards best practices.  Here's a concrete example:

"Kaiser Permanente is one of the organizations now pioneering the use of such technologies to improve the quality of complex interactions. The health care provider has developed not only unified digital records on its patients but also innovative decision-support tools, such as programs that track the schedules of caregivers for patients with diabetes and heart disease. Although it is hard to determine quantitatively whether physicians are making better judgments about medical care, data suggest that Kaiser has cut its patients' mortality rate for heart disease to levels well below the US national average."

One can only imagine the fear and loathing experienced by doctors who were asked to abandon their notebooks and manila file folders and to "trust" the digital records. 

Similarly, cutting-edge law firms will need to step back from the (false?) comfort of hierarchical staffing and move towards "environments that encourage tacit employees to explore new ideas, to operate in a [...] more team-oriented and unstructured way."

Feeling trepidation?  Here's the good news:  "Such capabilities will be difficult for competitors to duplicate.  Best practices will be hard to transplant from one company to another if they are based on talented people supported by unique organizational and leadership models and armed with a panoply of complementary technologies."

In other words:  Sustainable Competitive Advantage.

Support this effort with serious and ongoing professional development efforts, starting with recruiting for tacit skills, and then expose lawyers to diverse matters so they can become more seasoned and knowledgeable faster.  The best, if not the only, way to develop "good instincts" is through broad and sustained exposure to complexity, so one can intellectually progress from awkward and highly self-conscious analytic labors to fast and accurate perceptual insight.  Micro-management won't get you there.

Worth it?  Here is McKinsey's representation of the "disperson of average EBITDA per employee for companies by industry type, ratio of standard deviation to mean:"

What does this mean?  Simply that in "tacit" industries such as ours, the pre-tax cash earnings generated per employee are extremely "dispersed," meaning that the spread from the best-performers to the worst-performers is unusually wide.  Without knowing the numbers that went into McKinsey's calculation, not to mention the fact that McKinsey isn't focusing on law-firm-land in particular, all I can offer as a refresher course in statistics is what "standard deviation" means. 

Basically, it's a statistical measure of spread around the mean, and for present purposes all you need to know is that the higher the ratio of SD:Mean, the greater the disperson.  (68% of all members of a population fall within one standard deviation of the mean and 95% fall within two standard deviations.  Above 3 SD's and you're talking true outliers.)

For our purposes, this "wide dispersion" means excelling on tacit interactions truly distinguishes you from the competition—and doesn't hurt at year-end bonus time, either.

Still scared?

I have posited before that the traditional one-size-fits-all associate-to-partner model is coming under increasing stress. 

Evidently Allen & Overy agrees.

After suffering 25% attrition in its associate ranks last year, they have announced after a lengthy study that they will be introducing two formal new career tracks for associates:  "Managing Associate" and "Of Counsel."  The second first:  "Of Counsel," as has sometimes been the case here, will be for people who are expected to make a serious ongoing business contribution but who, for reasons of temperament or talent, don't quite make the Equity Partner cut.  A&O Managing Partner David Morley commented pointedly:  "It’s not a reward for long service.  It’s not an elephants’ graveyard."  Yes, quite.  [Subtext:  They are not damaged goods; as a client I can rest assured that I'm still in good hands at A&O when an "of counsel" is on my matter.]  Point taken.

 However, this raises the metaphysical question of what distinguishes an Of Counsel from a Non-Equity Partner.  Even A&O admits the possibility, however remote, that an "OC" could become an "EP," which is likewise true of US-style "NEP's," at least according to the party line.  

My take on the distinction?  On the surface, not much; the proof will be in the execution over time.  Indeed, the most salient point as of now is purely and primarily one of terminology:  The OC's business card and letterhead will say OC, while the NEP's card and letterhead say to the world, "partner."   To the outside world, partner is partner is partner, and the equity/non-equity distinction is (intentionally?) suppressed.

So what?  Actually, it matters:  If I were in a bakeoff for General Counsel of a Fortune 500 company, I'd far prefer my title be a (non-equity) "partner" at a name-brand US firm than "OC" at Allen & Overy, even if there is no functional distinction:  There is a chasm of semantic distinction.  So give A&O credit for candor.

What, then, of "managing associates?"

"Managing associates will have increased responsibilities and some access to partnership information and will be viewed as likely partnership material."

In other words, these are the contenders. 

Again, great credit is due A&O for being among the first to recognize—and act on (always the tricky part)—the fact that the world of associates  is not divided in Manichean fashion into washouts and stars.  While it's a fact of life in any hierarchical organization that not all can ascend to the top, it has long struck me as the height of irrationality to proceed from that truism to the conclusion that those who will not ascend to the top should be discarded after about a decade, just as they are hitting their career stride.

What to do with these "Of Counsel"'s?  Actually, I have two economically-driven suggestions:

• In today's global (or large-national) firms, while it's indisputably the case that places like New York, London, and Hong Kong generate a disproportionate share of business, we've known at least since we first heard of Bangalore that there's zero reason all the work has to be performed in those global high-rent districts.  Logically, some nontrivial percentage of the OC's (or NEP's, as I consider them functionally interchangeable within the firm) will be located in places like St. Louis, Atlanta, or Dallas, with a lower cost-of-living and lower commercial overhead.  And they are, by hypothesis, thoroughly trained and inarguably competent:  Why couldn't more "originating" partners staff their matters in the field rather than in midtown Manhattan?  The firm  could then offer either lower rates (enter acerbic comment here) or enjoy higher margins.
  
• My second suggestion looks at the situation from the OC's perspective (and I duly credit the prefers-to-remain-anonymous reader who contributed to my thinking on this; you know who you are).  As matters stand, an associate earns perhaps 30% of the amount he/she bills up to, say, 2,000 hours/year.  No one would claim this is a remotely inadequate return to the associate.  On the other hand, once the billable hours cruise above 2,000 or so, what is the associate's "return" on those extra hours?  5%?  10%?  Certainly nothing like 30%; almost the entire value is captured by the firm.  (I'm assuming that at 2,000  hours, the associate is "paid for," in the sense that benefits, rent, overhead, and a reasonable profit have all been covered by the firm from the associate's revenue, so the associate's marginal cost to the firm takes a dive.)
  
  But isn't this illogical? Don't we have our incentives mis-aligned?  After all, it's the hours > 2,000 that are the really hard ones, the ones put in on nights and weekends, the ones that are carved out of "personal" time, the ones, in other words, where a little incentive would do nicely, thank you very much.  Assume a firm chose to share the same 30% or so of revenue with an associate (or an OC) smoothly right on up the curve?  I predict some nontrivial proportion of OC's would take the firm up on the offer, as it were, to the enrichment of all.

The basic point dramatized by A&O's move remains the key:  Whatever we as a profession decide to "do" with OC's and NEP's, there are surely smarter, more economically and emotionally productive alternatives, than continuing our devil's bargain with up-or-out.

Today's Exhibit A is Peter Cornell, global managing partner of Clifford Chance, the world's largest firm by revenue, who has been in that role since 2001 and involved in CC management for two decades.  He announced the decision to the management committee last Friday and to the rest of the firm by email yesterday.  Although eligible to run for another term when his current one expires next year—and by all external accounts fairly assured of an easy re-election—he opted to stand down because "I have achieved the objectives I set when I took on the role."

And not unambitious objectives they were:  In 2001, CC had just completed its merger with New York's Rogers & Wells, although to call the merger "complete" at that point is reminiscent of calling "major combat operations" in Iraq concluded; a string of high-profile partner defections would follow throughout 2002 and even into 2003.    Second, along with half the Free World, CC  had expanded over-aggressively in Northern California during the dot-com boom.  And last, internal morale among associates was low, pummeled by what they felt were unrealistic billable hour requirements, as memorably disclosed in a leaked memo.

Credit Cornell with taking the bull by the horns.  He moved to New York to focus on righting that important office, leaving his family in Madrid, and with the help of COO David Childs, now thought to be a potential contender to succeed Peter, attacked costs and, as I have long argued, finally addressed the misbegotten partnership compensation structure that had resulted from the Rogers & Wells acquisition (an eat-what-you-kill firm) by, just last week, securing the two-thirds majority of the partnership required to institute a novel version of lockstep.   The new lockstep has three tiers, one ranging from 28 to 70 points [intended for relatively unprofitable jurisdictions], the standard tier running from 40 to 100 points, and the third running up to 120 points, targeted towards the US. 

Most importantly, CC's profits per equity partner are back on the rise, at £691-thousand (US$1.23-million) this year; the firm appears out of the sick room it inhabited for the first few years of this new millenium.

A leader contemplating his legacy could do worse than to take a page from Peter's book.

Helpfully, the FT gives us some insight.  They begin with the story of how, when "Australia's Macquarie Bank started considering a bid for the London Stock Exchange," they found every single Magic Circle firm conflicted out from representing them, and ultimately went with Baker & McKenzie, which scant years ago would barely have been visible in the M&A tables.

Some observers who are more than qualified to know think this is not just an anecdote, but a trend: 

"Keith Clark is international general counsel at investment bank Morgan Stanley, and was previously chairman of Clifford Chance. [...] He says: "In the London marketplace, you have a situation where you have got half a dozen law firms servicing a huge number of the big transactions, whereas in New York you have far more law firms. When you get into hostile M&A, those conflict issues really come into play."

"He believes the situation will only get worse."

It may be that there are "more" New York firms, but interestingly, the FT characterizes the rules on conflicts as "looser" in the UK than they are here, and still the problem arises.

I'm not sure I would characterize our rules as looser or stricter than the UK's, I just think they're different: In the UK, conflicts are analyzed from the perspective of the transaction, whereas here of course they're analyzed from the perspective of the client.  UK rules pre-empt a firm from acting for two clients whose interests are adverse in a given deal, while US rules bar firms from acting against the interest of a client even in matters wholly unrelated to the firm's representation (absent consent, of course).

An unintended consequence of the US-style rule is that firms have reason to turn away individuals or smaller clients for fear of being conflicted out of a big deal later for the sake of a small fee now. And according to McDermott Will & Emery's London managing parner, it's happening. So the US rule, superficially more "protective" of the client's interests, may deprive them of their firm of choice! Be careful what you wish for.

Pushing right back against the heightened problem with conflicts is, I believe, a more potent force:  Economics and business sense.  Again to Keith  Clark:

"[Because of increased globalization,] the ability to service a deal across a variety of jurisdictions is more significant than it was last time around. That tends to consolidate the work into larger law firms."

In other words, the larger firms' global footprints become, and the more attractive they are to dealmakers on the economic and business merits, the more likely they'll face conflicts. 

Doesn't this cry out for a "re-think" of how the profession analyzes "conflicts"?

I for one would nominate the jurisprudence of conflicts for a doctrinal re-evaluation in light of 21st-Century realities.   Being precluded from engaging the firm of your choice for what is, by hypothesis, a big deal transaction, is a far more destructive wrench in the gears than what is often the remote and hypothetical "emanations and penumbras" of a conflict—which can also be used strategically as a weapon to deprive an adversary of their counsel of choice.

But back to where we started:  Will "conflicts" law ultimately put the brakes on global consolidation of BigLaw? 

Actually, we don't have the privilege of answering that question:  Clients do.  They will vote their economic interest, and if globe-spanning firms are the model they prefer, we will evolve to match their preference. 

Conflicts, after all, are always and everywhere merely in the eye of the beholder.

According to The Recorder,

"Law firm leaders throughout California identify increasing leverage as a key strategy in their business model."

We are here to ask the time-honored question, "What can they be thinking?"

Let's back up.   Common sense would tell you that in a labor-intensive service industry, where revenue is driven primarily by sheer tonnage of hours worked, the higher the ratio of associates (and non-equity partners) to (full equity) partners, the higher the revenues and thus the profits per partner.  Right?  It turns out this is one of those cases where it's not as simple as it seems.  The beauty of what we're starting to learn about leverage is that the knee-jerk assumption (which held good, or at least held unchallenged, until just the last few years) that more leverage was a per se good is at long last submitting to quantitative analysis, which in turn enables us to ask subtler and more probing questions about what's really going on here.

For the skeptics in the audience, I submit two charts.  This from The Recorder:

...which is fairly self-explanatory.  Just doing the math, it tells the following story:

High leverage firms "enjoy" more than twice as much leverage as the low leverage firms, and for this they are rewarded with profits per partner not even one-third as rich.  [Granted, these firms were presumably not selected at random, but if the proposition under debate is whether more leverage is a per se good, proponents of that view have some explaining to do.]

And this from my friend Professor Bill Henderson:

Bill developed this data series for a slightly different purpose, but it serves ours nicely nevertheless.  He was exploring the relationship between leverage and the profitability of single-tier vs. two-tier partnerships, and at the same time adjusting for the (important) variable of what proportion of a firm's lawyers are in New York or "global" cities (read:  London, Paris, Hong Kong, Frankfurt, Brussels, Singapore, Tokyo, and Beijing). 

As you can see, across the board single-tier firms have lower leverage than two-tiers in the same market cohort, yet single-tiers are consistently more profitable (on a PPP basis).   Other factors turn out to far out-weigh the blunt instrument of leverage in determining profitability.  After all, some of the most highly leveraged work of all in law-land is commodity stuff like residential real estate closings and mortgage refinancings.  Do you still think "increasing leverage [is] a key strategy"?  Be my guest.

But wait, there's more! 

Leverage varies intrinsically with the nature of a firm's areas of practice concentration.  Litigation, especially big-bucks trench warfare litigation, is innately highly-levered as associates can be drafted into document production and review almost as massively as the Western Front consumed recruits in 1918.    High-stakes tax, private equity, and venture funding, by contrast, serve clients who by and large want a partner across the table or on the phone, so leverage opportunities are few. 

Then there's the evil twin of high leverage:  Low utilization.  It doesn't help that your leverage ratio is through the roof if nobody's busy; indeed, welcome to the worst of both worlds.

Of course, if the work is there for the taking, it's nice to be able to add capacity to handle it.  DLA Piper's co-managing partner in the US, Terence O'Malley, thinks he's noticed that "firms are focusing more on matching staffing with work flows and adjusting more quickly to surges in work by hiring laterally. DLA, for example, has hired upward of 100 lateral associates this year."  If you read this the same way I do, you wonder whether such rapid-response staffing flexibility isn't a double-edged sword.  How long would DLA (or any sophisticated firm) carry inactive associates when the work flow stops?

So where does this leave us on leverage?

We'll give my friend Rich Gary the last word (emphasis supplied):

"While leverage is a part of a law firm's overall health, using it as a measurement of success can be overrated, said consultant Richard Gary.

"In and of itself, it doesn't tell you a lot about a firm -- it's probably a symptom of something else," he said. "It's dependent on a lot of things."

Next time someone is selling your firm the elixir of leverage, sharpen your pencils.

Despite the fact that there's been a minor dust-up in the blogosphere over "BlawgWorld 2006," I thoroughly enjoyed myself at Brandy Library in Tribeca and again thank Neil Squillante, his ace assistant Sara Skiff, and TechnoLawyer in general for dreaming up and bringing to life what I consider an enlightened and creative way to expose non-blog readers to the legal blog community. 

Of all the "evergreen" topics we keep coming back to here at "Adam Smith, Esq." one of the ever-greenest (no pun...) is the eternal disequilibrium between lockstep and eat-what-you-kill partner compensation models.   Most recently, I addressed it here. 

The tension, in a nutshell, is to find a way to encourage the laudable—but very different!—behavior patterns each rewards while safeguarding against the (again, different) antisocial repercussions that both can lead to.   More specifically:

Latest to weigh in on this, decisively against lockstep, is the FT.   While recognizing that "[l]ockstep has its advantages," and that "a lockstep firm's lawyers are more likely to work seamlessly. They will be less tempted to structure deals to reward one set of specialists or the partners of one office," they neverthless opine flatly:  "global law firms can no longer afford that luxury."

What's the problem?  Retaining talent:

"A gap has opened between profits per equity partner [of UK firms] and those of top New York firms such as Wachtell Lipton Rosen & Katz and Sullivan & Cromwell.  Figures from The Lawyer magazine show US firms taking nine of the 10 top places on this measure this year, with only Slaughter & May sneaking in beside them. That allows New York firms to poach lawyers in the world's financial centres: even in London, the City firms are losing partners."

"The City ought not to stick to lockstep like the band that played on as the Titanic sunk: quaint, selfless and admirable, but doomed."

Now, as they say in debate class, would anyone care to argue the negative?  Sure!

The FT article is premised on the assumption that compensation is the primary, if not the only, consideration partners attend to when choosing allegiance to a firm.   Perhaps surprisingly, given my faith in homo economicus, I beg to differ.

First, the inevitable caveat:  Magic Circle and Bulge Bracket partners have bills to pay along with the rest of us, and the new BMW, diamond bauble, or ski weekend are always beckoning.  And certainly the opportunity to double or even triple one's take-home is something neither you nor your spouse will be willing to ignore.   As well paid as many are, demand can always outrun supply.

That said, there is genuine intangible value in a sense of collegiality in the workplace, in team-building, in delivering top-notch client service untainted by self-interest, in contributing to an institution—"The Firm"—over an extended period of one's career, and not least in avoiding the infighting, neck-biting, and generally deplorable "Lord of the Flies" behavior associated with arguing over such nasty details as origination credits. 

Moreover, my experience has long been that if a partner (or an associate, for that matter) leaves for another firm, it's never for that 15-20% pay bump; it's always really about something else.  (The pay increment is an OK reason, and it may be the "public" reason, but it's rarely the decisive reason.)  

I continue, until the facts change, to come down in the camp of "modified lockstep," with due recognition for superstars, but  not outsized recognition.  At the late and largely unlamented Finley-Kumble (which collapsed in a cash crisis Christmas Eve 1987, unable to pay holiday bonuses), the ratio of highest to lowest paid partner was 17:1.  As Fran Musselman, the eminent senior partner at Milbank who became trustee of the estate in bankruptcy of Finley-Kumble, put it:  "There is no way on earth that those two people were partners."

So I recommend strongly against unalloyed eat-what-you-kill; the partnership you save could be your own.

No sooner had we surveyed the prospects for a talent war for associates among the AmLaw 200 than along comes the Financial Times reporting on the release in the UK of PwC's annual survey of law firm finances.  (I've requested a full copy by email to Alistair Rose, the London-based leader of PwC's professional partnership advisory group and the director behind it.)

The FT's rather Fleet Street headline for the piece is "Axing of partners sees top law firms increase profitability," but a more nuanced reading produces a less dire view.  Not to be blunt about it, but "de-equitisation" has been with us for awhile now, and PwC does not seem to report any sudden spike.  Rather, these are the trends that got my attention:

• Only one-quarter of the top 25 firms (this is all UK-land, remember) reported revenue increases of more than 10%; indeed, as Rose himself summarizes it, "It's not boom time. They haven't increased the top line. The main driver of increased profits per partner has been reduced headcounts."
• When you can't jumpstart revenue, you can squeeze costs.  And this seems to be happening as well; two years ago 72% of the firms reported staff overhead costs at more than 40% of revenue, but today that number is down to 44%.
• This may not,  however, be sustainable—bringing us to the potentially impending UK talent war.  From Rose's perspective, there is now "substantial pressure" for material pay raises for associates.
• Billable hour expectations continue to escalate, up over 20% in the past two years, although the alleged "target" of 1,545 hours per year would strike many associates on the island where I'm sitting as part-time.

The intangible is how to handle what are tactfully called "work-life balance issues:"

"The restrictions on creating new partners in recent years have also limited career progression for senior associates at law firms. The survey says that has required the firms to offer bigger bonus schemes and a wider range of flexible benefits in an effort to retain their fee-earners. Even so, almost two-thirds of the leading firms reported turn-over of associates running at a rate of more than 15 per cent a year."

So here we have the unstable confluence of:

• greater billing pressures (they may be less than here, but they're way above where they were there two years ago, and the concept of relative pain is genuine)

• no recent pay raises
• reduced prospects for partnership
• increasing attrition, and
• a resort to what sound like makeshift benefits/bonus schemes.

What's wrong with this picture?  Or, as my high school physics teacher might have characterized it in his honestly-come-by New Jersey accent:  "You can't play dis game fuh-evah."

The email refers to my recent post on going two-tier, "Will The Real Rationale Please Stand Up?" and it is essentially an argument that:

"the partnership is an economic beast, and it responds primarily - even exclusively - to economic motives. Regardless of the ex post facto rationalizations that are put into place, I am deeply skeptical of any "human" motivations for something which is most easily characterized as an economic decision."

Our correspondent adduces as evidence the case of a large Texas-based firm:  "The switch from 1-tier to 2-tier partnerships is frequently secret until it is sprung upon the associates - or even the new "partners."" And while he admits that "of course the factors demonstrated in these exchanges may not be replicated elsewhere, we all know that the singular of data is anecdote."

Now it starts to get juicy, and if nothing else this reveals the passions below the surface:

"Several law students who had been summer associates this year noted the contradictory stories told them over the summer by several prominent people in the firm: 'What most people here know... is that they told us clerks a totally different story over the summer. In the partnership retreat they told us that the culture there would never allow a non-equity track. It had been proposed and soundly rejected, never going to happen, no way.  [This from the head of the Dallas office and the recruiting partner.] [...]

"As far as I'm concerned, [the firm] is dishonest and should be avoided."

Assuming these comments honestly reflect the way summer associates felt they had been dealt with, is it simply indefensible for the firm to have acted with apparent dishonesty in their approach to the change?    I think our correspondent gets it about right:   "While it is highly likely that the managing partners were in some way constrained from revealing the impending switch, we all know that there are many ways to give a satisfactory non-responsive answer."

Once the change was out in the open, however, the interesting question becomes how the firm characterized the rationale for it internally.  Again I quote:

"If the reason for the change was, as indicated in the poll, to "retain valuable associates", to "additionally evaluate" people, or to provide for an "alternate lifestyle," any one of those things could have been marketed as the reason for the change.

"While some would be unhappy with the change, others would rationally choose the "lifestyle," or be happy with the additional chance(s) for equity status which the tier-2 status provided. Notice that none of the themes listed above were given any billing at all. This would suggest that those themes are either inapplicable in this case, or that those who are in the trenches would not find them credible."

Whether or not the firm can be accused of botching its efforts to get the word out with a positive thrust, it certainly reaped criticism for the switch. 

But our correspondent makes a more intriguing point, and it relates to "the fact that the non-equity partnership was made universal."

On the premise that "rational action - economics - is about choice, [then] it is believable that some people would opt for tier 2 status for a variety of reasons, be they personal, a lack of other opportunities, a way of preserving some relationships, etc. However, you cannot make a change mandatory and then defend it on the basis that some people might have rationally made that choice."

He believes that the universal, mandatory imposition of the non-equity interregnum prior to consideration for full equity status "indicates that the PPP rationale is correct: People were angry because the "cost" of partnership suddenly went up. [The firm] pulled a bait-and-switch."

Finally, he concludes with another admitted anecdote about an associate at the same firm who landed "a major new client" while still two years away from partnership.  The firm reacted with a "surprise announcement" that they were shortening the partnership track by one year, whereupon the lucky associate made partner six months later (and is still at the firm, apparently).  Quietly, the track was moved back to eight years a bit later.  Obviously, the firm benefited economically from "capturing" the associate with the big client; but shall we draw from such behavior an inference of venality? 

For my money, the most serious charge that can be leveled at such a firm—and stick—is one of hypocrisy and willing denial of or refusal to be remotely self-aware.

But the problem is, in dealing with a partnership where trust is the sine qua non, "hypocrisy" and "denial" can be career-ending injuries.  And certainly our Texas firm has poisoned its own well, at least in the eyes of those quoted here.  While I don't want to invest 100% credibility in anonymous complaints about changes deleterious to the complainer (and some people will of course complain even about salubrious changes—they just can't stand change), this firm is certainly playing with fire not to have a candid, engaged, thoughtful, respectful dialogue internally about such a pivotal decision as introducing a non-equity tier.

Switch or don't switch; just don't prevaricate or contradict yourself.

The American Lawyer is out with their annual survey of the AmLaw 200 managing partners (147 responded this year—summary Q&A results here), and while the news is almost overwhelmingly good (at least if you're a partner in the AmLaw 200, and not a client of them), there's what may be a storm front on the distant horizon.

First, the good news:

• 89% are "optimistic" about next year, and 0% pessimistic; the other 11% are merely "uncertain."
• And why shouldn't they be optimistic?  A stunning 95% expect profits per partner to grow next year, and 68% expect PPP to be up more than 5%.
• 78% expect deal flow to increase "moderately," 8% "significantly," and only 13% expect it to "stay flat;" precisely 0% foresee a decrease.
• 99% (99%!) expect to raise billing rates in 2006, by about 5% on average.
• Only 5% expect their incoming associates' class to be smaller than this year; slightly over one-third anticipate it will be the same  size, one-quarter say it will grow less than 5%, but fully one-third say it will grow by more than 5%.
• But those associates won't cost much, if any, more per capita:  37% anticipate no increase in starting salaries, 27% an increase of less than 5%, and 36% an increase of more than 5%.  Given that starting salaries have essentially been frozen since 2000, this indicates a relatively militant cost-containment mentality.  (Although essentially everyone admits that if one major firm jumps ahead, the thundering herd will follow.)  As for what associates have to say about this?

  "Associates are definitely getting fed up with how flat salaries have been," says an associate at O'Melveny & Myers. "It's not because we don't think we're paid enough, it's watching the partners' share increase while ours stays the same. We're more like regular employees as the years go by and not partners in training."

This comment exposes the potential storm clouds.  As the pithy and insightful Aric Press puts it, "the war for talent has returned."  And it's a war both for partners and associates.  As for partners, there are just not enough "game-changing" candidates for most firms to differentiate themselves through lateral acquisitions—though that scarce has discouraged them from trying.  (One-quarter of the firms fess up to being on the prowl for a "merger," and my strong suspicion is that that number would double if not triple if the question were recast, and truth serum administered, to include "acquisitions of small [non-equal] firms" and "material lateral groups.") 

The market for partners, in other words, has reached a type of mature equilibrium.  You may like it or—judging by the number of firms citing the inability to grow as fast as they'd like in key markets including China, London, and New York—you may not, but this seems to be reality for now.   In other words, deal with it.

The associate market is where it gets more interesting, and dicier.   Since I can't phrase it better than Aric, I'll let him say it:

"Firms complain bitterly that these young lawyers are leaving before the firms can fully recoup their investments in them. They have no one to blame but themselves. The profitability model is built on churn."

And don't kid yourself: The associates know that as well as you do.  They're "infantry fodder," and the partners' munificent compensation intrinsically depends on washing out as many associates as possible, stopping just short of completely and utterly blowing up the potential-partnership-carrot.

Sure, you're saying, but this model has worked for decades and decades; what, me worry now?

Permit me, or rather, The Wall Street Journal, to suggest what's different this time:  Gen X (roughly, those aged 25 to 40).   They are not your Baby Boomers in attitude.   Gen X'ers do not identify themselves by what they do, insist on work/life flexibility and balance, and will willingly forgo promotions to maintain that balance.  When asked to rank the ten  most important characteristics of a job, Gen X substitutes "flexibility" in the slot where Boomers put "meaningful work."

What, then, is to be done? 

McKinsey suggests a new breed of software tools, which include deep skills assessments and artificial intelligence algorithms, to better match knowledge workers with projects.  What does this mean?:

"By sifting through a database of employee skill sets, the tools generate staffing solutions to meet current demand and to anticipate priorities for emerging projects. The deployment of these solutions at a technology-consulting firm has cut project completion times by 10 to 40 percent and overall resource requirements by 25 to 40 percent."

And, this article was written three years ago—the tools have only improved.

It gets better.  The tools don't just assign warm bodies based on availability; they intelligently select people best-suited to each project, weighing a combination of prior experience (so they know where to begin) and opportunities for professional development (so people are challenged and can grow and expand their competency set).   And that's the key.  Challenged, growing associates are less tempted to leave—and more likely to look like bona fide partnership material 8 or 10 years from  now.  After all, they literally will have done more different things and know more as a lawyer.

McKinsey uses the hypothetical (or is it?—sometimes I wonder with McKinsey) of "a corporate-law firm that has a lackluster development or retention strategy and high levels of attrition among its [associates]."   Stopping well short of the more ambitious goal of giving the tempted-to-bail associates more challenging work, McKinsey posits what could happen if the software were simply able to identify a pattern of associates who work with a particular combination of senior partners suffering an abnormally high (even for this firm!) defection rate.   Knowing such a pattern exists, the firm might be able to reduce attrition simply by changing assignment patterns.  And as we, and McKinsey, know, less attrition means increased utilization means increased realization and collection.

What customer relationship management tools are to business development, and what risk management tools are to finance, human-capital tools may be to staffing and assignments.  All your firm has to sell is talent.  Consider arming yourself with this new weapon in that war.

A few days ago I received this email from a reader, with respect to my "Optimal Partner Compensation" post:

"I like your point of view, but with one question: how do you calculate/compare the 30 percent kicker [up or down] at the end of the comp cycle without a formula, particularly in a middle- to large-size firm?"—Dave [from an AmLaw 100 firm]

Here's my response:

The short answer to your question is, I think, two-fold:  First of all, a formula always makes life simpler—no question about it.  Particularly when everyone understands the formula going in ("transparency"), it's hard for anyone to argue they were surprised/disappointed at the end of the year. 

The biggest source of discontent with compensation is always the catch-all complaint that it was "unfair."  By definition, if there's a formula and one behaves all year long based on the metrics in the formula, it's  hard to complain that it was "unfair"--one can of course take issue with the metrics themselves, but that's a different topic.  You cannot argue that the rules were changed in the middle of the game or "interpreted" wrongly--because it's a formula, there's no "interpretation" involved. 

But the problem with formulas, IMHO, is like the old joke:  "For every problem, there's a solution which is obvious, simple--and wrong." 

Bringing me to the second point:  I just don't believe as a matter of conscience and my (limited!) understanding of human nature that a year's worth of complex professional behavior and activity can be reduced to a formula.   As they say, "stuff happens." 

Just hypothetically, imagine that an important part of The Formula is hours personally billed and collected by a partner (not unreasonable as a component, although I would argue overweighting personal-billables can lead to "hoarding," consciously neglecting associate development, and other anti-social behavior).   Now suppose a key practice group leader decamps early in the year to a competitor, and you or I suck it up and step into the breach left by the departure, for the good of the firm.    I will bet our billed-and-collected hours would not be what they would have been had we stayed "home" in our familiar practice area with our familiar clients. 

But should we really be penalized for doing what's best for the firm? 

You get my drift.

Moreover, there's still life to the notion that partnerships are, if not for life, at least for the long run.  The  implication of this, I believe, is that people can forgive and understand what they might perceive as "minor" deviations from perfection from year to year if there is an ongoing solid consensus that over the long run the firm rewards people fairly. 

As I said in the original post, the acid test is if over time and across all partners, people will agree that "yeah, it seems about right."  Never under-estimate the power of humans (and lawyers in particular!) to sniff out fundamental unfairness—and its virtuous opposite.