Question(s) For Your Firm in 2006

Legal Times is asking, "What Five Questions Will Law Firms Face in 2006?"  I'd like to suggest there's really only one question, and these "five" are each just facets of the same phenomenon.

Their five:

1. More merger mania?
2. Soaring compensation?
3. Billing rates topping out?
4. Further cost cutting?
5. Client relationships more critical still?

Mergers:  Although framed as an across-the-board issue, the fact is that merger activity is highly focused on firms establishing, or beefing up, their beach-heads in just two cities:  Washington, DC, and New York.  I've long been of the view that a Washington presence (which need not be jumbo-sized) is de rigueur for a national firm to be taken seriously.  We simply live in regulatory times, and it's almost irresponsible not to have the ability to join the legislative/administrative conversation at its primary source.   (No, I don't own any property on K Street, but I wish I did!)

New York is likewise critical simply because it's the financial capital of North America, as well as hub to industries ranging from publishing and advertising to fashion and—surprise—law itself.  But unlike DC, mere "presence" doesn't cut it here:  Firms need a critical mass in NYC to make it into the serious consideration set.  What's "critical mass?"  Roughly, north of 125 lawyers.

The biggest challenge is that in both cities, the pickings of merger targets are getting slim.   That's why I predict we'll see more and more smaller-bore mergers where national firms opportunistically pick up relatively little firms that have an attractive specialty.  Just as an example, Seyfarth Shaw picked up a Manhattan-centric real estate firm, Mandel-Resnik (specializing in representing co-op's and condos) as of January 1.   Total haul?  A grand total of seven partners—but arguably (and IMHO) an excellent fit, as real estate is a labor-intensive industry and Seyfarth Shaw is definitely a "go-to" labor law firm. 

Look for more of these rifle-not-shotgun targets.  But do not envision "merger mania" as an undifferentiated nationwide phenomenon.

Compensation:  Obviously, here are two "compensation" markets:  Partners and associates. 

As for associates, I predict we will finally see the pent-up dam burst, so to speak, and starting salaries will get the first bump-up (+$10,000 seems to be the number people are using) since the (in)famous dot-com-driven Gunderson-Dettmer pop to $125,000 in 2000.

The partner compensation market is also bifurcated, if you will, into the equity/non-equity market and the lateral market.  In a coincidence, today we also saw the release of the annual summary of financial results for the Top Ten Bay Area firms, and it tells a tale of high (and unsustainable) rates of growth in the ranks of non-equity partners, and extremely parsimonious additions to, or even subtractions from, the equity ranks.  Just a sampling:

• Morrison & Foerster shifted 50 partners—15% of the entire partnership's ranks—from equity to non-equity.
• At Pillsbury-Winthrop, the firm ended 2005 with 10% fewer equity partners than it began the year, despite absorbing Shaw-Pittman.
• Gibson-Dunn, while LA and not Bay Area-based, switched to a tiered partnership last year.
• Wilson-Sonsini is the only firm on the list that remains "single tier," without non-equity partners.

In other words, non-equity ranks are here to stay, or to grow.

As is activity in the lateral marketplace.  Don't think there's a war for talent?  Well, there is, and it's being fought primarily with the weapon of money.  Attractive laterals are not commodities, and the fight to gain and then retain them only escalated last year. 

Billing Rates:    Pressure from corporate clients to cut legal expenses increased last year and will only continue to rise.   So:

"The string of rapidly escalating billing rates has pretty much run its course," says Bruce McLean, managing partner at Akin Gump Strauss Hauer & Feld. "We're going to have to find different ways to improve profitability."

The problem is that just what those "different ways" are is opaque, at least if firms limit their toolset to fiddling with billing rates. "Alternative fee arrangements?" Mostly imaginary. Or, as John Beisner, DC managing partner at O'Melveny, puts it somewhat drily: "There is a challenge to find ones that are broadly applicable."   In other words, plain old dumb discounting remains the order of the day.

Was I harsh with that "dumb discounting" jibe?  Yes and no.  Yes, I was harsh in that long-term, solid, favored clients deserve recognition of their status, and the clearest recognition is a break on fees.  Plus, the firm enjoys economies with established clients in that there's no new-business-development overhead.  But no, I will stand by it to the extent that just saying, "let me take 10% off—'special for you today!,'" as they say in New York, does not engender loyalty and in fact invites the question:  "If you can make nice money at 10% off, what sucker would ever pay full freight?  [And the next question is:  "How about 20% off?"]

The demise of the billable hour has been foretold so often that we've stopped covering it here; at least until there's some tectonic change in the landscape.  Suffice to say that imagination and innovation will ultimately prevail in billing structures.  We'll know it when we see it.

Costs:  Many strategies avail themselves here, and outsourcing seems to be the favorite son.  Far be it from me to disdain outsourcing—indeed, I've often noted that BigLaw can outsource to the Midwest or the South (internal offices or otherwise) without needing to skip 12 time zones away—but the issue of quality, perceived or actual, remains a live one.  If I'm a Fortune 500 GC hiring Cravath or Wachtel, do you think "outsourcing" is an option?

I would argue that same (correct and legitimate) mindset applies to almost any firm in the AmLaw 50, if not the AmLaw 200.  The back office is one thing, but substantive work?  First thing you know, that GC will say to him/herself:  "I'm not paying firm X 90¢ on the dollar to ship their work to Cleveland; I'll hire another inhouse person for 30¢ on the dollar."  Beware false economies.

The article makes pregnant reference to another potential source of "cost savings," to wit practice specialization.  The somewhat ham-handed attempt to make this point gropes at it obliquely by offering that "par[ing] down practice groups" may be "another option."

What "paring down," a/k/a specialization, means, is simply this:  Become a boutique. 

Client Relationships:  Aaah, at last the heart of the matter, and where all of these questions intersect. 

Think about it:  Mergers are driven by the need to offer a more complete offering to clients; compensation is driven by the war for talent, in order to serve clients; new billing initiatives are 110% driven by clients, not firms; cost-cutting matters only in a world where clients demand value for money.

As it should, it all comes down to clients. 

Which leaves us where? 

I suggest, back in the land of virtuous and vicious cycles.  Strong firms will deepen and extend their client relationships by providing a more compelling array of services from highly talented people priced to yield a compelling value.  Weaker firms will lose cost-conscious clients as their talent pool dwindles, billing models stagnate, and practice group offerings ossify.

It's not five questions, it's one:  How can your firm in 2006 get closer to your clients?